Confusion over interest rates. Tariffs and tit for tat trade war. Global economic fallout from China’s repressed domestic demand. Rising concern over geopolitics. Europe at risk. Green backlash notwithstanding, ‘greening’ almost everything is inevitable and must be paid for. Be neither over optimistic about AI’s impact on growth nor over pessimistic about its impact on the labour force – at least not yet.
- INTEREST RATE CONFUSION. For months, the markets have been consistently wrong about interest rates. Even ‘pundits’ like Krugman admit to being “fanatically confused” about the direction of travel. Over the medium-term they see in equal measure reasons to argue that rates might return to very low levels; or remain at “higher-for-longer” levels. When factoring in non-economic considerations (climate and geopolitical risks, international fragmentation, de-risking and decoupling), our call is that “higher-for-longer” is the most plausible outcome. Investors have stopped believing that central banks will cut interest rates as much as anticipated. For the rest of this year, they now expect the Fed to cut interest rates once, and the ECB to cut earlier and more, but only to an extent that avoids divergence in rates becoming an unmanageable issue (by over weakening the €).
- NEW US TARIFFS ON CHINA. Ever since Trump let the protectionist genie out of the bottle in 2019, trade policies have led to ever-more fragmentation. The new round of tariffs imposed by the US on Chinese imports will, as protectionist policies always do, lead to an increase in prices and stifle competition. But this is beside the point. Tariffs are used to defend national interests, with subsidies becoming a key instrument of economic policies. Geo-economics has unleashed a tit for tat trade war, with no end in sight.
- “CHINA OVERCAPACITY”: A RED HERRING. China’s problem is not overcapacity, but rather deficient domestic demand, or excess savings (as Michael Pettis has observed). Much like Germany or Japan, China ‘creates’ a problem for the global economy by repressing domestic demand which it then externalises via exports and trade surpluses. As these can only be absorbed by trade partners via (1) higher household debt, (2) higher fiscal deficits, or (3) higher unemployment (or a combination), this ends up triggering a backlash. The bottom line: unless China changes radically its economic policy by prioritising domestic consumption (which Xi has no intention of doing), the global economy will be worse-off and geopolitical tensions will increase (the two conflate).
- EUROPE AT RISK. Still open and playing by the ‘old’ multilateral trade rules, Europe is the outlier among the three key players (China, EU and US) who account for 42% of global exports and imports. But not for much longer. Macron keeps emphasizing the need for a “Buy European strategy in key sectors”. As do other EU leaders – like Mario Draghi when he recommends “shielding” the EU industry to prevent it falling further behind in the race for AI and tech. This is part of the “wall of investment” required to protect Europe from the trifecta of risks it faces: economic, electoral (the rise of the far right) and military.
- CLIMATE FINANCE – ALL AT ONCE. $9-10 trillion a year is the ballpark figure required for a meaningful green transition. This investment is an absolute necessity that will pay-off in the long-term, but how to finance it? Investors must prepare for a broad array of measures, impacting the bottom line of almost all companies in almost all industries. Policies under consideration include: (1) levies on aviation, shipping and oil & gas extraction; (2) new, increased or windfall taxes on wealth, corporations, tourism, oil & gas giants, (3) replacing fuel subsidies with green subsidies, (4) new financial instruments like carbon credits and ‘intelligent regulation’ to green everything. Despite the current green backlash in the West, such environmental policies are inevitable. Unless drastic action is taken, the surge in extreme climatic events (50C today in Delhi) is (according to a team at Harvard) likely to reduce world GDP by 12% in the medium-term.
- GEOPOLITICAL RISING CONCERNS. In 2012, we quoted the late Jean-Pierre Lehmann (then a professor at IMD Lausanne) saying: “The Western liberal order is coming to an end. There won’t be a ‘new’ international order, but a chaotic transition to greater uncertainty.” Twelve years on, the West must accept that its absolute supremacy is over. Nothing illustrates this point better than the proxy world war being waged in Europe, with two broad alliances squaring off in Ukraine. Any illusions that it will remain confined to the Ukrainian battleground are dispelled by the intentional shadow war being conducted by the Kremlin against NATO. Evidence of GRU ramping up sabotage across Europe and of attempts to test NATO’s borders (like in the Baltics) are proof of this. Investors are still underpricing the risk of escalation and the ‘poisoning’ effect that this proxy war has on global trade and capital flows: volatility across equity and currency remains remarkably low (VIX hovering around 14, compared to an average of 25 over the past 5 years).
- AI AND GROWTH. Much hope is placed on generative AI to deliver greater productivity, and therefore higher economic growth. Financial firms, tech companies and consultancies keep offering ‘rosy’ scenarios in which AI will “revolutionize everything” and propel the global economy to new heights. Experts are more circumspect, making three key points. (1) AI adoption is not as widespread as originally anticipated; (2) AI will soon enable major scientific and technological breakthroughs with applications in fields as diverse as medicine and the fight against carbon emissions, but (3) the boost to GDP will not come immediately. Don’t expect any meaningful impact from AI on growth before 2030.
- AI, THE LABOUR MARKETS AND THE “MANICURE ECONOMY”. The angst about the effect of AI on employment is overdone. Today, AI has only taken over around 5% of labour tasks, with a speed of progression that does not point to an upheaval any time soon (with a few exceptions). In fact, in this tech era, jobs that require interpersonal skills and face-to-face interactions are growing faster than all the others, manicurists growing the fastest, followed by skincare specialists, HR specialists and make-up artists (in the US), and new ‘occupations’ that barely existed in 2000, like fundraiser, trainer, coach, personal chef and personal tutor. These service jobs require ‘social fluency’, pointing to human advantage over machines. Would you want to be coached by a bot?
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