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MFG Asset Management 2022-inreview

Globalisation

is morphing into something less

Michael Collins, Investment Specialist

Michael Collins,
Investment Specialist

Michael Collins, <br>Investment Specialist

Michael Collins,
Investment Specialist

‘Geoeconomics’ is fanning an inward turn that produces some winners but mostly losers.

Tennis staged its first ‘open’ tournament in 1968, when the British Hard Courts were staged at Bournemouth. The open tag meant professionals were welcome to play in national tournaments including Grand Slams, which until then were restricted to amateurs. For more than five decades, prestigious tennis tournaments welcomed players from any country. 1

No more. This year’s Wimbledon has banned players from Belarus and Russia. Their offence? Russia attacked Ukraine, and Belarus was a base for some of the Russian invaders. While no one will call it the Wimbledon Almost-Open, the fracturing in the global nature of sport competitions reminds how the era of hyperglobalisation is over. Hindering the movement across borders of commodities, components, culture, goods, ideas, money, people and services appears an irreversible trend for the foreseeable future.

The most recent impetus is that war between Russia and Ukraine has elevated a strategy known as geoeconomics, 2 when economic and financial tools are used to promote national political goals. About 30 Western countries are choking Russia with the most draconian financial sanctions and export controls ever imposed on a leading power. The freezing of half of Russia’s foreign-exchange reserves is such a breach of trust and property rights it portends an unfixable tear in the US-dollar-dominated global financial system. 3 As too are moves to cut Russian commercial banks from the US (SWIFT) payments system and to confiscate the assets of Russian individuals connected to power. Europe’s move away from Russian hydrocarbons shows how free trade only happens when the world feels secure.

The pandemic was the previous setback to globalisation because it showed that producing essential goods far away from where they are needed is too risky, no matter the cost savings from cheap labour. Washington has no intention, for instance, of allowing China to remain the source of 50% of US penicillin imports. 4

“The era of hyperglobalisation is over.”


An initial impediment in advanced countries for the globalisation that occurred from the 1980s was the cultural pushback against the loss of local political accountability, and the political reaction from those who lost jobs as manufacturing shifted abroad. The winners were the billion-plus people in emerging countries who soared out of poverty. 5 These countries, foremost China, expanded in political muscle. Beijing’s flexing, often in norm-breaking ways (Hong Kong, for example) counts as another blow to globalisation because it provoked fear, mistrust and retaliation.

The post-hyperglobalisation era too will come with winners and losers and economic and political consequences. Winners will include emerging countries close to, and friendly with, Western powers. Countries such as Mexico stand to gain from any ‘near-shoring’, or ‘regionalisation’, of production. 6 US allies stand to gain from “friend-shoring”, as US Treasury Secretary Janet Yellen described strengthening links among countries that (mostly) share liberal values.7 An example is the new US-led Asia Pacific Economic Framework that groups 13 (anti-China) allies. 8Other victors will include Western businesses producing essential items deserving of tariffs and subsidies. Unworthy winners will be companies of lesser offerings that are talented at ‘rent seeking’. This term describes when businesses manipulate policymakers to boost their profits. Losers will include emerging countries that missed out on investment that would have created local jobs and wealth. A notable loser might be China as it becomes more estranged from the West, even if Western adversaries enjoy cheaper commodities and energy from Russia. 9

The economic consequences of ‘slowbalisation’ are faster inflation

“The economic consequences of ‘slowbalisation’ are faster inflation (at least initially) and slower growth.”


Other also-rans will be multinationals that seek customers across the globe and companies that were prepared to have production arrangements that spanned the world. The ‘splinternet’ will be starker as governments block access, protect local data and toughen cybersecurity. For consumers, production ‘misallocated’ to higher-cost locations, steeper tariffs and rent seeking (price gouging) spell lower living standards.

The economic consequences of ‘slowbalisation’ 10 are faster inflation (at least initially) and slower growth. 11 Emerging countries will miss out on know-how and an opportunity to build wealth through exporting. Barriers preventing investment in emerging countries, however, could give workers in advanced countries greater bargaining power. As the global pool of labour deglobalises, Western workers might achieve a greater share of national incomes, which after four decades of hyperglobalisation fell to record lows. 12

While inequality might decline, there might be less wealth to fight over because profits might be lower in a more-fenced world. Returns on capital might be reduced because protectionism will inhibit economies of scale. Companies will carry larger inventories as just-in-time production has proved vulnerable to transport delays and much else. Reduced profits spell lower corporate tax takes.

Hindered capital flows suggest investors might have to stomach lower returns. Governments, especially in the emerging world, might need to pay higher interest rates to woo bond investors. Slowing economies would make it harder for governments to trim debt-to-GDP ratios. If less competition leads to less innovation, reduced productivity would mean lower living standards and reduced long-term investment returns.

Politically the world is likely to split into “distinct economic blocs with different ideologies, political systems, technology standards, cross-border payment and trade systems and reserve currencies”, as IMF Chief Economist Pierre-Oliver Gourinchas, sees it. 13 One US-led group will favour a rules-based order among themselves. The other China-led bunch will group authoritarian countries extolling a power-based world and possibly democracies such as India, Indonesia and South Africa that hang back from a rules-based global system. The Chinese-US “lose-lose tech war” 14 will create a schism across tech platforms and ‘data sovereignty’, 15 and will mean less innovation. The IMF estimates that ‘technology fragmentation’ will cost smaller countries that straddle multiple tech hubs 5% of their GDP. 16

A split world means less international cooperation on global challenges such as climate change, pandemic responses and resolving food shortages. In any emergency, which grouping could save a crisis-hit G-zero world, as the G-20 did in 2008 by standardising the response? 17 Not the WTO. 18 Nor a hyperpolarised US. In a fragmenting world, more military spending might be required, which ties up resources (though often spurs innovation). In emerging countries, hunger and lower living standards might lead to uprisings and defaults.

Within countries, globalists will battle patriots for political power. One destabilising by-product of stronger national identity politics is that it tends to fan secessionist movements, especially when nationalities absorbed into countries such as the Catalonians in Spain have such distinctive identities.

What might remain the same? The US currency is bound to stay the world’s reserve currency because it lacks a credible rival, even as US opponents seek alternatives.

To be determined? The cleverness of policymakers. The West would best avoid a permanent stand-off against a rival bloc, in what would be ‘the clash of civilisations’ that Samuel Huntington warned of in 1996. 19 Advanced countries, through an empowered IMF, might need to rejig the international financial system for a multipolar world to better support emerging countries. 20 But even if policymakers prove sound, the era of inefficient globalisation heralds a poorer future than otherwise. Perhaps people might feel more secure.

Now for the qualifications. Globalisation always proceeded at different speeds and security considerations were never ignored. 21 Globalisation is so layered it’s hard to generalise about its direction or pace. It’s debatable too whether the end of hyperglobalisation is a form of deglobalisation or another type of globalisation. More the latter because trade flows are exceeding IMF pre-pandemic forecasts, 22 China-US trade reached a record in 2021, 23 and authoritarian governments still apply export-led economic models. Note too that any retreat from the recent pace of globalisation has natural limits, as does the China-US split. Too much is intertwined and too many vested interests favour the status quo. Short of China invading Taiwan, the West would be reluctant to incur the costs of suddenly isolating China, while Beijing has an interest in preserving, rather than snapping, ties with the US. The internet might make people feel they are as tied to a globalised world as before.

People and businesses will be connected but not like they were. Their state of mind has turned away from the hyperglobalisation that, for all its drawbacks, enriched the world. A more-stunted form of globalisation points to less prosperous times. Even winning Wimbledon will be tainted.

 

Cemented status

The Asian financial crisis of 1997-1998 contained lessons for the region. One was the need to assemble foreign-exchange reserves to protect currencies against adverse capital flows if need be. By 2014, China’s symbol of success was that it had amassed a record US$4.0 trillion of foreign reserves, the bulk in US-dollar-denominated securities. 24

By all reports, China was stunned earlier this year when Washington weaponised the US dollar against Russia after it invaded Ukraine, even though the US had so acted against Afghanistan, Cuba, Iran, North Korea and Venezuela. Russia’s central bank could defend the rouble only by raising interest rates to 20% and thereby crush Russia’s economy.

The greater the damage to Russia, the greater the incentive for US opponents to explore ways to shift foreign-exchange reserves away from US-dollar-denominated assets. Included in such efforts are Beijing’s drive to internationalise the yuan and build a cross-border yuan payments system. 25

But it would be hard for rivals to dethrone the US dollar as the world’s reserve currency. 26 At the end of 2021, 59% of global currency reserves of US$12.9 trillion were denominated in US dollars (even if that’s down from 72% in 1999 when the euro appeared). At year end of last year, the next favoured currency was the euro at 21%, the yen at 5.6%, UK sterling at 4.8% and the renminbi at 2.8%. 27

“It would be hard for rivals to dethrone the US dollar as the world’s reserve currency.”

It would be hard for rivals to dethrone the US dollar

The US dollar has peerless status because the currency of the world’s largest economy is the world’s medium of exchange and unit of account and US securities are the global financial haven. US capital markets are deep and liquid. Investors trust the rule of law and other infrastructure such as an independent central bank that gives them confidence US-dollar-denominated securities will hold their value.

Away from currencies, options for diversifying away from the US dollar include crypto currencies, commodities, namely gold, and a global fiat money such as the IMF’s special drawing rights. But crypto currencies including so-called stable coins are unstable – Bitcoin (not a stable coin) fell more than 70% since it peaked last year to June. They have no intrinsic value, are awkward to trade and the amount on issue is small. The market worth of cryptos on June 20 was US$1.2 trillion, just 9% of global forex reserves. 28 Gold is awkward to trade physically, needs to be stored and its price gyrates. The IMF’s rights would be stillborn as a reserve option.

As for currency rivals to the greenback, the euro is stymied because the lack of a eurozone government limits the sale of the needed securities. A bigger problem is the eurozone monetary union lacks the political, fiscal and banking union a currency union needs to endure. This means the euro’s future is not assured.

China’s currency lacks the backing of a trusted democratic government and rule of law.

“China’s currency lacks the backing of a trusted democratic government and rule of law.”


Other Western currencies such as the Swiss franc and the yen lack the security issuance to be substitutes for the US dollar. These countries are part of the West’s sanctions on Russia. They aren’t out to undermine the West’s ability to torment Russia.

The yuan, and its digital equivalent, is not a threat to the US dollar because China’s currency lacks the backing of a trusted democratic government and rule of law. Beijing restricts China’s capital account, the country’s financial markets are underdeveloped and Beijing does not want to lose the control over the economy it would forgo if the yuan were market set. China, which sells sovereign bonds denominated in US dollars, is too dependent on the US-dollar-based global financial system to flee from it. 29

Currency composition of foreign exchange reserves since 1999

Currency composition of foreign exchange reserves since 1999 Source: IMF. June 2022

Over time, however, China could widen use of the yuan among the emerging countries that are its closest and biggest trading partners. The US could undermine the reserve power of its dollar by allowing inflation to get out of control, running massive fiscal deficits that boosted Washington’s debt to uncomfortable levels, or if social cohesion broke down.

But the yuan’s chance of deposing the US dollar in the foreseeable future, even in a split world? About the same as Russians or Belarusians competing under their nationalities had of winning this year’s Wimbledon.

 

Michael Collins
Investment Specialist

July 2022

0.25 CPD hours

 
  1. Britannica. ‘Professional and open tennis.’ britannica.com/sports/tennis/Professional-and-open-tennis.
  2. US political analyst Edward Luttwak invented the term geoeconomics in 1990. See ‘From geopolitics to geo-economics.’ Logic of conflict, grammar of commerce.’ The National Interest. No. 20 (Summer 1990). Pages 17 to 23. jstor.org/stable/42894676. See also ‘The geoeconomic world order.’ Anthea Roberts, Henrique Choer Moraes, Victor Ferguson. Lawfare blog. 19 November 2018. lawfareblog.com/geoeconomic-world-order. A cautious note is that geoeconomics has led to war – in 1941, sanctions, especially an oil embargo, against Japan for invading neighbours prompted the country to attack the US.
  3. Yu Yongding, a former president of the China Society of World Economics. ‘America has stopped playing by the monetary rules.’ Project Syndicate. 27 April 2022. project-syndicate.org/commentary/us-freeze-russian-reserves-what-it-means-for-china-by-yu-yongding-2022-04
  4. US House of Representative member Mark Green. ‘My nearshoring bill would curb China and reduce illegal immigration.’ 2 May 2022. washingtonexaminer.com/restoring-america/courage-strength-optimism/my-nearshoring-bill-would-curb-china-and-reduce-illegal‑immigration
  5. Our World in Data. ‘Global extreme poverty.’ Updated 2019. ourworldindata.org/extreme-poverty
  6. John Authers. ‘How to be a winner from globalisation.’ Bloomberg News. 5 April 2022. bloomberg.com/opinion/articles/2022-04-05/de-globalization-could-help-countries-like-mexico-make-up-ground-lost-to‑china
  7. US Department of the Treasury. ‘Remarks by Secretary of the Treasury Janet L Yellen on the way forward for the global economy.’ 13 April 2022. home.treasury.gov/news/press-releases/jy0714
  8. The countries proposed as members are Australia, Brunei, India, Indonesia, Japan, Malaysia, New Zealand, Philippines, Singapore, South Korea, Thailand, the US and Vietnam.
  9. ‘How China under Xi Jinping is turning away from the world.’ The New York Times. 23 February 2022. nytimes.com/2022/02/23/world/asia/china-xi-jinping-world.html
  10. The Economist magazine claims to have invented the term in 2019. ‘Globalisation has faltered.’ 24 January 2019. economist.com/briefing/2019/01/24/globalisation-has-faltered
  11. Bloomberg Economics estimates deglobalisation will lop US$1.6 trillion from global GDP in 2022, Bloomberg. ‘Age of scarcity begins with $1.6 trillion hit to world economy.’ 19 May 2022. bnnbloomberg.ca/age-of-scarcity-begins-with-1-6-trillion-hit-to-world-economy-1.1767910
  12. Federal Reserve of St Louis. FRED economic data. ‘Share of labour compensation in GDP at current national prices for US.’ Labour’s lowest share was around 2010. fred.stlouisfed.org/series/LABSHPUSA156NRUG
  13. IMF Chief Economist Pierre-Oliver Gourinchas. ‘Shifting geopolitical tectonic plates.’ June 2022. Finance & Development. imf.org/en/Publications/fandd/issues/2022/06/Shifting-geopolitical-tectonic-plates-straight-talk
  14. Kishore Mahbubani and Tony Chan. ‘The lose-lose tech war.’ Project Syndicate. 20 May 2022. project-syndicate.org/onpoint/us-china-tech-war-by-kishore-mahbubani-and-tony-chan-2022-05
  15. ‘The era of borderless data is ending.’ The New York Times. 23 May 2022. nytimes.com/2022/05/23/technology/data-privacy-laws.html
  16. Diego A Cerdeiro et al. IMF Working Papers. ‘Sizing up the effects of technological decoupling.’ 12 March 2022. imf.org/en/Publications/WP/Issues/2021/03/12/Sizing-Up-the-Effects-of-Technological-Decoupling-50125
  17. Ian Bremmer, president and founder of the Eurasia Group, first used the term G-zero world. See Ian Bremmer and Nouriel Roubini ‘A G-zero world.’ Foreign Affairs. March/April 2011. foreignaffairs.com/articles/2011-01-31/g-zero-world
  18. ‘The WTO’s lonely struggle to defend global trade.’ Financial Times. 13 June 2022. ft.com/content/f81e4abe-cf53-485c-afbf-1b3870872384
  19. Samuel Huntington. ‘The clash of civilisations and the remaking of world order’. 1996. Free PDF found at: academia.edu/4610592/Samuel_P_Huntington_The_Clash_of_Civilizations_and_the_Remaking_of_World_Order_1996
  20. ‘The international monetary system is more unfit than ever.’ Project Syndicate. 29 April 2022. project-syndicate.org/commentary/us-dollar-dominance-unsustainable-international-financial-reform-by-andrew-sheng-and-xiao-geng-2022-04
  21. Even globalisation champions Ronald Reagan and Margaret Thatcher used tariffs and industrial policy to push the national interest.
  22. Prachi Mishra and Antonio Spilimbergo. IMF Analytical Series. ‘Globalisation and resilience.’ 24 May 2022. imf.org/en/Publications/fandd/issues/2022/analytical-series/Globalization-Resilience-Mishra-Spilimbergo
  23. US Census Bureau. ‘Trade in goods with China.’ The US imported US$505 billion of goods from China in 2021 compared with US$433 billion in 2020. The US exported US$151 billion worth of goods to China in 2021 compared with US$125 billion in 2020. census.gov/foreign-trade/balance/c5700.html
  24. China’s hoard, the world’s biggest that stands at about US$3.2 trillion now, empowered Beijing to manage China’s balance of payments. The stash seemed to give Beijing power over the US because China could dump its US-dollar holdings and thereby destabilise US financial markets, boost bond yields and damage the US economy. But gathering these reserves came with disadvantages and risks for China too. China has invested in securities that offer little income; thus a country with a low GDP per capita (US$11,819 for China versus US$63,310 for the US) has forgone consumption and investment by idling resources. A focus on building reserves has kept China’s economy unbalanced; these structural problems are high savings and investment and low consumption. Any slump in the US dollar or the underlying securities – as threatened in 2008 – would hammer the value of these reserves. China’s long willingness to hold these US stockpiles meant Beijing found these risks manageable. China’s forex reserve peak is found at: People’s Bank of China. ‘Reserves management and foreign exchange interventions.’ BIS Papers No 104. 2019. bis.org/publ/bppdf/bispap104g.pdf
  25. Jiahao Zhang, Sichuan University. ‘Analysis on the impact of the foreign exchange reserve of China on its macro economy.’ E3S Web of Conferences. 2021. e3s-conferences.org/articles/e3sconf/pdf/2021/09/e3sconf_iaecst20_01159.pdf
  26. The US dollar has dominated as the world’s reserve currency since the US and allies agreed at the 1944 Bretton Woods conference to peg the currency at US$35 per ounce of gold. The US’s dollar reserve status was further cemented in 2008 when the Federal Reserve acted as the international lender of last resort when it created swap-line facilities with other central banks and foreign banks.
  27. IMF. ‘Currency composition of official foreign exchange reserves (COFER).’ 31 March 2022. data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4
  28. CoinMarketWrap. ‘Total cryptocurrency market cap.’ Updated daily. coinmarketcap.com/charts/
  29. ‘China still loves the US dollar.’ Bloomberg News. 13 October 2021. bloomberg.com/news/newsletters/2021-10-13/what-s-happening-in-the-world-economy-china-still-loves-the-u-s-dollar