by Joseph Y. Calhoun
I don’t often write about global geopolitics because I think, in general, investors spend too much time worrying about things they can’t control or aren’t going to happen or wouldn’t matter much if they did. The best example is the Middle East which has been a mess my entire life and long before it for that matter. Changing your investments based on the latest threat in or from the Levant is a recipe for constant chaos. The only accurate prediction about the Middle East will always be that the various factions that have been fighting for centuries will continue to fight. And that no matter who is in charge they will have to sell oil to make ends meet. And make no mistake oil is the only economic reason we care about the region.
The recent Paris attacks, though, have me thinking more about how global geopolitics is affecting the global economy. The terrorist attacks Europe has experienced in Madrid, London, Paris and other locales are raising old barriers across the continent. Borders where goods, people and capital have crossed freely for the last few decades are now manned and monitored again. Capital largely continues to flow freely but people and goods are starting to be restricted; you can’t restrict the flow of people without also obstructing the flow of goods. For now, the people and goods continue to flow, just more slowly. One can’t help but think though that if the borders become literal barriers again it won’t be long before the metaphoric ones – protectionist policies – return as well.
If one also considers the antipathy toward Germany that permeates most of Europe and the perception – and reality to some degree – that the EU and especially the EMU are much more favorable for the Teutonic members than the Latin ones, then one begins to see how the fragile union might devolve into its former squabbling, fractured self. The feared break up of Europe and the Euro has until now been based on economic considerations but physical security would seem a larger concern at this point. If the EU can’t guarantee physical security and has already failed at providing economic security, it’s raison d’etre is….what exactly? To provide employment for feckless bureaucrats?
The desire for physical security isn’t confined to Europe obviously; the Paris attacks have amped up the political debate in the US over immigration, with Syrian refugees and physical security now replacing Latin Americans and economic security as the targets. The emergence of Donald Trump as a right wing populist to challenge the near universally populist Democrats means that both parties are now pandering to the population’s baser instincts of fear and greed. That isn’t to say that their fears aren’t real or legitimate just that the solutions offered by populist politicians are simplistic and unlikely to achieve the intended results. Indeed, history says that walling ourselves off from the world is more likely to create less security, physical and economic, rather than more.
The demonization of foreigners, this emerging isolationist consensus – a natural response in many ways to the jingoism of the last decade’s Western governments – is not confined to the debate over national defense or immigration. It is also a part of the economic debate. Politicians exploit our economic insecurities, laying blame on foreigners – the Chinese are the most often cited bogeymen – for problems created by our own policies. Donald Trump says he will be a tougher negotiator and get better trade deals but doing so will require threatening consequences – trade restrictions – that would please Smoot and Hawley and potentially repeat the mistakes that led to the Great Depression. Jack Lew decries corporate inversions and announces new rules designed to prevent US companies from doing what our corporate tax code incentivizes them to do. Meanwhile, Pfizer and Allergan look to structure a deal that has Allergan – an Irish corporation with a low tax rate and the smaller of the two companies – playing the role of acquirer to avoid the new rules. Will the current administration or future ones regularly reject takeovers of US corporations unless they are carried out by other US corporations? Will other countries follow suit?
The inequality debate is rooted too in the discussion over trade policy, globalization and outsourcing. The decline of the American middle class, the rise of the so called creative class and the consequences of the financialization of the US economy are all part of the same populist, isolationist rhetoric. Foreigners are demonized as stealing American manufacturing jobs, polarizing the US between the haves, largely in the coastal cities, who benefit from free trade and the have nots, largely in the interior of the country, who don’t. It mostly isn’t true – productivity has reduced manufacturing employment much more than free trade – but it has enough of a whiff of truth that it works as a political strategy even if it would fail miserably as an economic one. Monetary policy has attempted to assuage the middle class angst with expanded credit but that has exacerbated the divide as financial engineers have been rewarded at the expense of real ones.
We see this nationalistic impulse in the so called currency wars, the devaluations intended to steal some of what is left of global growth for one’s own country. Rather than pursue domestic policies that would improve growth, politicians are happy to leave it to central banks to try and gain a trade advantage by weakening the national currency, seeking to enrich through impoverishment, a policy doomed to failure. The unintended consequences are reflected in money markets where conditions once thought impossible or at least illogical have become commonplace. In the process of trying to recover from the last crisis we are creating the conditions for the next.
Meanwhile, global trade is contracting, down for three years in a row and a major reason for the weak recovery from the last recession. The growth and falling inflation of the 90s was, in a lot of ways, driven by the expansion of trade, the liberalization of the global economy as former communist nations adopted more liberal, free market economic policies and joined the world trade order. That expansion appears to now be reversing in a cacophony of nativist rhetoric, a global phenomenon that encompasses, unites and animates the far left and the far right. As I said in my Weekly Snapshot:
The political left is happy to see people cross borders but would gladly restrict the flow of capital and goods. The political right is happy to see capital and goods cross borders but would gladly build a fence to restrict the flow of people. I’m afraid that the compromise might be to restrict people, capital and goods.
This political pandering has consequences for our society and economy that are hard to predict. The recent college campus protests would appear to be another manifestation of this growing desire for security over all else. Students want to create “safe spaces” where they are free to extend their childhood, protected from harm both real and imagined. With the random violence and economic upheaval that has marked their lives, from 9/11 to Madrid to London to Paris to the dot com bust to the Great Recession, is it any wonder that our young adults seek to be protected from the real world? The intolerance practiced by our leaders is reflected in the intolerance of the students who shout down anyone who doesn’t toe the politically correct line, a feat that becomes harder by the day. We have lost the ability to take a joke, to distinguish between satire and seriousness. In the process, we divide rather than unite, for fear of offending and being subjected to the modern day pillory of social media.
As I said at the beginning, I don’t generally spend a lot of time thinking about geopolitics as it relates to investing because it isn’t generally profitable. This closing of the global economy, this emerging trend toward protectionism in the form of currency devaluation and populist politics is already impacting the global economy but in the short term probably shouldn’t impact our investment approach. We don’t know yet how far this will be taken, if the rhetoric will turn into actual economy damaging policies. For now, the most obvious impact has been the rising dollar and falling inflation expectations with, so far, little impact on real growth expectations here in the US. But the direction is disturbing especially with the US coming into an election year when the rhetoric may have more impact on market outcomes.
As investors we have more immediate concerns. Growth remains stuck at the secular stagnation, new normal pace of 2 to 2.5% growth. The economic data continues to point to weakness even as the Fed prepares to enter a tightening cycle. Inventories are building as sales and investment stagnate. The energy industry, responsible for an historically large proportion of investment since the crisis, is in deep trouble as the dollar rises and oil prices sink. Earnings are falling and margins appear to have peaked. Stock market valuations are extreme and market technicals are unhealthy with a small number of stocks leading the averages higher even as most stocks head south. Investors have plenty to worry about that is real and now without delving into what is speculative and possibly far in the future.
The closing of the global economy, the reversal to some unknown degree of the globalization process, has negative consequences for the lives to which we’ve become accustomed. Much of the disinflation since the early 90s is a direct result of increased trade and reversing the process will in time mean less choice and higher prices for Americans. And no, it won’t, despite what the protectionist populists would have you believe, bring back high wage manufacturing jobs. The giant sucking sound Ross Perot warned about isn’t coming from Mexico but rather from Silicon Valley and we should be thankful for it not ruing it. We should be preparing our young adults for the real world and the jobs of this century rather than coddling them and trying to bring back the jobs of the last one. The closing of the global economy is not a fait accompli. But we will have to resist with all our might the siren song of the politicians who tell us what we want rather than need to hear and push back against the monetary policies that are a poor substitute for better fiscal and regulatory policies.