December 8, 2022

A number of risks have emerged in global markets this year as the decades of low interest rates and central bank dominance are now behind us. As we enter 2023, central bankers, policymakers, and investors are trying to identify the next market fracture that threatens to create widespread financial instability. Financial and economic challenges for Europe are certain as European industry suffers from the global energy crisis, forcing a reassessment of the bloc’s industrial strategy. Meanwhile, as a tech “Cold War” between the US and China develops, analysts warn another nuclear cold war could be on the horizon – this time with China in the mix. 

Financial instability: the hunt for the next market fracture

Eric Platt, Kate Duguid, Tommy Stubbington, Jonathan Wheatley, and Leo Lewis, Financial Times

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Global markets are facing a reckoning after decades of falling interest rates and central bank largesse. Soaring inflation is being met by rising interest rates, a slowing of central bank asset purchases, fiscal shocks, and illiquidity. Various shocks to the market, such as bailouts to European Union energy providers and the closure of the nickel market in London, have occurred over the past year, which, while disparate, may augur a broader financial crisis and lead to a “shock [that] leads to the amplification of vulnerabilities,” as the Federal Reserve’s vice-chair stated last month. The issues vary by market. For instance, the scarcity of short-term debt in the European Union may be hurting the European Union’s repo market, while the Bank of Japan continues to struggle with an increasingly dysfunctional bond market due to its “yield curve control” policy. Meanwhile, liquidity issues in the US treasury market may prove disastrous if a crisis brews, given the far-reaching impact there. Risk lurks in credit as well, particularly if investors become anxious and begin to exit their positions. Finally, emerging markets are also at risk due to the combination of high interest rates and a strong US dollar. Risk is therefore widespread, and should a crisis hit any one of these markets, the impact has the potential to spill over and pave the way for crisis worldwide, as one trend builds on another.

Europe’s Industrial Straetgy

Europe urgently needs a new industrial master plan

Faith Birol, Financial Times

America’s green subsidies are causing headaches in Europe

Charlemagne, The Economist

The global energy crisis is threatening to deal a heavy blow to European industry and undermine its competitiveness globally. Russian gas plays a key role as many European industries depend on the availability of cheap Russian natural gas, which is no longer available. The European Union therefore ought to reassess its industrial strategy and focus both on “low-emissions” production, while becoming stronger in the production of batteries, electric vehicles, electrolyzers for hydrogen, heat pumps, etc. In effect, the EU should build upon the “Fit for 55” and REPowerEU strategies geared towards clean energy. The Europeans could jump-start this initiative via the disbursement of government funding; however, not all EU countries have the same fiscal means individually, and achieving disbursal at the EU level risks reawakening the Northern/Southern dispute pertaining to fiscal prudence.

Beyond that, any such policy would take time to implement and would not come without immediate headwinds. Competition is increasing in various countries. China is already ahead of the curve in domestic manufacturing of clean energy, while Japan, South Korea, and India are headed in that direction. Additionally, the United States Congress recently passed the Inflation Reduction Act (IRA), which likewise threatens European manufacturing in the short term by offering subsidies for “Made in America” clean energy manufacturing. Given the business environment, some European manufacturers may take the US up on that offer. The result is a brewing Transatlantic spat between the EU and the US, especially as the IRA may violate World Trade Organization rules. European industry is therefore headed for significant downside. Time will tell whether the EU will be able to pivot. Failure to do so could leave Europe’s competitive edge weakened as deindustrialization manifests itself moving forwards. 

The China-US Tech Battle

Taming China’s Tech Power

Gina Raimondo Foreign Affairs

How the U.S.-Chinese Technology War Is Changing the World

Agathe Demarais Foreign Policy

The recent US export controls on semiconductors to China are already having effects on the global semiconductor industry. In October, the Biden administration passed one of the most aggressive controls aimed at kneecapping China’s technology sector. Claiming that Beijing is rolling back reforms and decreasing China’s openness, the Commerce Department has enacted measures designed to limit China’s ability to purchase or manufacture advanced semiconductors and computer chips that would be used for military and AI development. There are two main reasons for this: The first is that COVID exposed how vulnerable US supply chains were to unexpected disruption. The second, and more important reason for the export controls, is that Washington has had concerns about espionage from technology made by Chinese companies for many years – specifically noticing a pattern in the 2000s where Beijing would invite foreign firms to invest in China, Chinese companies would steal the firm’s technology, and Beijing would force the firm out of the Chinese market. If China were able to gain the lead in semiconductor manufacturing, it would mean they would have access to develop more advanced missiles, lasers, and air defense systems than the US.

In the Chinese tech sector, semiconductors present a useful chokepoint for the US. Beijing buys over $300 billion worth of foreign semiconductors every year, making computer chips China’s largest import. The majority of these semiconductors are made using US technology at some point in the process which is not surprising due to the American dominance in the market. The effects of the export controls are already being felt. The Chinese will have to delay the full implementation of 5G infrastructure throughout their country, as 5G technology is dependent on advanced microchips. Two of the top semiconductor manufacturers, Taiwan’s TSMC and South Korea’s Samsung, are rethinking their supply chains, and planning on building plants within the US and China.

How will America deal with three-way nuclear deterrence?

The Economist

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America faces an ominously-familiar challenge, this time with more than just two players. A nuclear arms race, a staple of the Cold War era between the US and the Soviet Union, is heating up again – this time with China. China, which has an estimated 200-300 warheads, is planning on expanding its arsenal to potentially as many as 1,500 by 2035. Additionally, analysts warn that China is shifting its nuclear policy from a “never first strike” stance to a “launch on warning” one, where nuclear missiles would be deployed after an incoming nuclear strike warning. Complicating the matter is the dearth of nuclear arms control talks between the US and Russia, which are unlikely to resume given Russia’s invasion of Ukraine. Ever since February when Russia launched its war against Ukraine, the US has been on edge about the threat Moscow poses – a threat that has only seemed to increase with Russian nuclear posturing. This is different from the Cold War as new technology has engendered new weapons, like hypersonic missiles which are difficult to detect and shoot down. Space and cyberweapons threaten command-and-control systems, potentially reducing the US’s nuclear defenses in the case of an attack. The Cold War was difficult enough to manage with just two powers; a third may complicate the equation beyond control. Luckily, some analysts argue that China is a long way from nuclear parity with the US and that arms control talks may still come.