Market Overview
As America welcomes a new president committed to fundamental market change, investors around the world might do well to ponder a world radically different in the wake of COVID-19. Two issues of note for those wondering how events might play out are the twin issues of China’s explosive entry into the 21st century, on the one hand, and the ‘financialisation’ of the World’s economy, on the other.
On joining the WTO on 11th December 2001, China brought 1.4 billion people with an average wage below $1,000 p.a. into the G3 (US, Europe, Japan) trading system that had a population of 0.9 billion and a $30,000 p.a. average wage. It was thought trade might liberalise China’s politics while Western consumers would benefit from cheaper goods as the invisible hand made any necessary adjustments. Things did not go exactly as planned. After 19 years, China gained 15 million manufacturing jobs whilst the US lost 5 million. Though the West’s companies prospered mightily thanks to the torrent of low-cost labour, it was the Western system that came under pressure, as societies faced polarising inequality. Plunged into a deflationary productivity crisis, their central banks printed money and cut rates, but all they boosted was asset values.
With regulations and borders dissolving, asset and liability piles dwarf the World’s US$80 trillion GDP, the system now evolved well beyond the standard macro textbook’s fractional reserve banking model. Just two examples: listed assets total $250 trillion and the global liquidity (a sea of credit and collateral) sloshing round trade and finance lines is around $130 trillion. In 1986, the latter stood at a mere $10 trillion. Global liquidity (140% of GDP) is vastly bigger than net world savings (30% of GDP) with China’s $36 trillion liquidity larger than either the Eurozone or USA’s, each $29 trillion in 2019. Gross trade flows dwarf net trade surplus or deficit figures, so the work of the financial system is no longer providing new funding but rolling over existing finance. This means liquidity is vastly more important for keeping the show on the road than interest rates.
Going into 2021 there is plenty of scope for uncertainty, but we can expect plenty more intervention including the addition of fiscal stimulus to the liquidity and interest rate barrages. While the numbers are large in relation to state budgets, they are drops in the overall liquidity and asset oceans. Labour supply has experienced a deep shock, which could be hard to reverse given lockdown incentives to stay home. Business is not missing the chance to replace labour with automation where possible, while high skill jobs will stay in demand. This means labour costs in a recovery could rise even while unemployment fails to shift (though against this argument is that one in eight Americans reported going hungry in December). Even if inflation exceeds 2.0%, we can expect the Fed and others to keep their foot on the gas if at last we do reflate. From 1933 to 1937, the US managed 3.5% p.a. inflation. How much more could it achieve today with its enhanced arsenal?
Which brings us to Mr. Biden’s economic programme. ‘America needs a new Economic Philosophy’ by Jennifer Harris and Jake Sullivan (Biden’s NSA adviser-to-be) in February’s edition of Foreign Policy spelled out the priorities. Authoritarian capitalism is challenging market democracy as the prevailing model, and America needs to deal with a new era of great-power rivalry, inequality, technology and climate change. Experts failed to predict China’s impact, and everything is up for a re-think: worker power, taxation of capital, monopolies, public investment. The days of neoliberal confidence in competitive markets as the best way to maximise individual liberty and economic growth, the argument goes, are history. Underinvestment is now a bigger threat to national security than national debt and a national industrial policy is a traditionally American way of doing things – from Henry Clay’s American System to Johnson’s Great Society. What better reason, goes the thinking, than the threat of climate change to justify ‘a surge of directed public investment that underwrites a shift to a post-carbon US economy through R&D, deployment of new technologies and development of climate infrastructure’?
Conjuring the ghost of the Moon race, it is also a better response to Xi Jinping’s ‘Made in China 2025’ strategy than outright war. This time trade and economic policy will not prioritise tax havens and Goldman Sachs’s access to overseas financial systems but have ‘a laser focus of what improves wages and creates high-paying jobs in the United States’. Similar thinking is mirrored in EU and UK post-COVID exit plans. Rising wages, taxes and massive infrastructure spending, a lull in globalisation via onshoring all suggest inflationary pressure. On the other hand, the economic contest triggered by China’s rise could well be a high payoff race for investors with a process capable of reconciling risk and opportunity in the face of complex global change.