Interest rates and inflation look set to be higher for longer, ditto for public debt levels. China’s flailing economy and the global economic and geopolitical fallout. Expansion of BRICS bloc membership changes nothing and everything. Beware ‘risk blindness’, faltering climate policies and bubbling AI.

  • INFLATION AND INTEREST RATES: HIGHER FOR LONGER. Central bankers assembled at their annual symposium in Jackson Hole made it crystal clear that they have not yet vanquished inflation. It is down from its peak, but inflationary pressures remain higher than normal and are becoming long-lasting because of structural, rather than cyclical, reasons. (1) The changing structure of the labour market, (2) environmental risks that require state-led investment in the energy transition, (3) new patterns developing in global trade and reduced global competition: all these suggest that there are more shocks to come and that prices will play a greater role in adjusting to all the “shifts and breaks” (Christine Lagarde). In turn, this will force central bankers to go on raising interest rates, which will then be kept higher for longer.
  • PERMANENTLY HIGH PUBLIC DEBT, AND THEN WHAT? Concerns about high levels of public indebtedness were pervasive at Jackson Hole, with the implicit acknowledgement that reducing them via a combination of higher taxes or spending cuts seems impossible. This would require elected policymakers to run large primary surpluses which, in times of slower GDP growth, social divisiveness, and political polarization would equate to political suicide. No country is immune from an economic, financial, or political crisis triggered by public over-indebtedness, but emerging markets are more vulnerable than developed economies. The latter tend to benefit from higher demand for the public securities they issue, perceived as ‘safe’ or ‘safer’.
  • CHINA’S FLAILING ECONOMY. For years, China defied the naysayers, but the chickens are now coming home to roost. Signs of deep economic problems that conflate with each other can be found everywhere: (1) weak consumption, (2) a real estate bust, (3) elevated youth unemployment (whose data is now suppressed), (4) a ‘capital strike’ in the private sector (which contributes 60% of economic output and 80% of urban employment), and (5) pervasive bad macro data in a deflationary environment. The commentariat often frames the outlook in binary terms (‘implosion’ versus ‘rapid turnaround’), but it won’t be either. The economic decline will be gradual – China will remain a large economy for decades to come but can’t avoid waning demographics – the greatest threat to its economy.
  • … AND WHAT THIS MEANS FOR THE WORLD. The Chinese economy is in this situation because its “authoritarian demons are catching up with it” (Adam Tooze). As the notion of “comprehensive national security” promoted by Xi Jinping supersedes everything else, it has the effect of (1) paralysing the country’s animal spirits and (2) rendering it almost un-investible for foreign investors. China’s misfortune will benefit no one. From an economic standpoint, it will constrain global growth. From a geopolitical standpoint, dealing with a declining China could prove more challenging than dealing with a rising one. A Chinese leadership in a position of weakness and increasingly frustrated by the tech ‘war’ unleashed by the US (the US President just imposed new curbs on investment in sensitive technologies in China) may be tempted to look for a scapegoat.
  • BRICS versus G7. At the recent BRICS’ summit, Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the UAE were invited to join the five-member bloc (Indonesia declined to express its interest). This expansion is driven by China to counter the G7 and confront (in Xi’s words) “US hegemony”. Such an odd alliance is unlikely to achieve much – it will not ‘spur’ global economic growth, will not exert any influence, and will not replace the USD. However, it crystallizes the emergence of a new geopolitical landscape characterized by (1) rising anti-western sentiments, (2) a fractured old ‘international order’, being turned upside down, (3) the upcoming end of Western-dominated global institutions (like the IMF or the WB).
  • RISK BLINDNESS. ‘Surprises’ as different as those caused by the Maui wildfires in Hawaii, or the Russian expropriation of Western assets, tell a similar story: that of risk blindness, or at the very least risk complacency. Even though decision-makers ‘knew’ about the risks, they failed to adapt in time to a fast-changing natural or geopolitical environment, and thus, failed to mitigate the risks. More generally, investors tend to underprice environmental and geopolitical risks, a fact repeatedly shown by organisations as different as the IMF or Singapore’s sovereign wealth fund (for climate risks). Food is a case in point. The combination of Russia’s bombing of Ukraine’s grain terminals and extreme weather events globally will most likely boost food inflation, but this is not yet reflected in risk premia.
  • FALTERING CLIMATE POLICIES. Last month we warned about ‘climate fatigue’ and the mounting backlash against climate policies. This is a global phenomenon caused by the distributional effects of net 0 policies: phasing out carbon-emitting cars or domestic heating systems causes immediate and concentrated losses among the poorest members of society for benefits that seem diffuse and too distant to matter. Hence grassroot opposition, to which politicians tend to respond by either favouring the status quo or inaction (like most Republicans in the US). Environmental policymaking is more complex than just choosing the most efficient measure. It’s about making it acceptable to those impacted the most by providing a form of social insurance. This relates to the second bullet point above about permanently high levels of public indebtedness.
  • BUBBLING GENERATIVE AI? Since last year, the excitement about generative AI has led to the massive deployment of capital in AI start-ups (11 now count as unicorns) and enthusiastic forecasts about its economic impact (McKinsey says it will create between USD2.6 and 4.4 tr of economic value annually). Now, some AI specialists are sounding the alarm, denouncing the hype surrounding AI. Like Gary Marcus who warns that “the revenue isn’t there yet and might never come” because AI doesn’t work as well as expected and lacks ‘killer business applications.’
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