Global economy has never been the same since 2008. A decline in interest rates followed and maintained the channel that started in 1981. It seems a bottom has been reached in terms of rates and interest rates have been rising ever since. There are many factors for such a change in economic landscape. As economic pie shrank countries are forced to look at what they can keep for themselves rather than buy cheap stuff from others. The importance of been able to grow the economy is been felt more since the pandemic and with the debt burden still hurting rising rates have only added fuel to fire. In that respect ever increasing debt and keeping rates low hasn’t helped even more so rising inflation has put a dent in those plans. The monetary policies have been replaced by fiscal profligacy. It brings growth but with inflation causing those institutions to fail that are not designed to face such outcomes. A 13 year bull market in stocks and bonds has made everyone programmed for only one outcome. In such an environment a small change in variables causes large distortions in outcomes.
Source: tradingeconomics.com, Federal Reserve
The world has changed considerably since the pandemic. The economic fault lines have become more prominent since the Fed had to do repo operations in 2019 with the pandemic only accelerating the speed of the economic decline. In this article we will try to understand what the future holds in terms of world hegemony and why geopolitics is shaping economics.
Then there are geopolitical issues. The USA is feeling the heat of its own policies. In starting a pseudo war with Russia and clamping down China’s growth it is stuck between a rock and a hard place. Countries today are more focused on controlling their outcomes. The dollar which is the biggest exported good out of USA (It accounts for 12% of global trade but 58% transactions happen in dollars) is causing imported inflation in many poor and developing countries. Countries can control inflation due to lose monetary policy by tightening interest rates. But they have little control on inflation brought about by strong dollar weakening their currency and therefore leading to higher import bill in dollars and increased interest cost on dollar loans. There is a need felt by those countries to a. Rid themself of the dollar strength impacting their own currencyb. strengthen their own currency to prevent social unrest and economic constraints.
In this context, countries are trying to make those importing their goods to deal in their local currencies. This would mean other countries would need to store their local currencies there by providing support to the local currency. Also, as resources are constrained it would also mean good relations among those wanting to trade. Hence, we can see Saudi Arabia dealing with Russia and China and use of local currency even by Kenya been agreed with Saudis. At the same time India has signed agreements with multiple countries to deal with local currencies. Same with Brazil which deals heavily with China in commodities. While one may argue that it may lead to the demise of the dollar, it is well understood that no one would want to do so. For one, neither is anyone having the institutional support and a local bond market nor does one want to do undergo the effects of Triffin’s paradox i.e. survive with higher fiscal deficits. It is for this reason that no one would even want to replace the dollar. Yes, it’s use may come down in percentage terms but it will still be used for pegging the currency value. Also, a dollar as a reserve currency keeps USA weak as it forces them to provide ever increasing monetary support which had now become inflationary and will eventually affect the local purchasing power. Hence, we are seeing the rise of the BRICS and the countries who want to join them. But the call on the dollars demise is premature. If anything, it is possible we see a potential surge in dollar in coming days and force corporates to default.
Countries globally are now getting divided on matters of trade and with the western powers more focused on defence, wars and climate change, many countries are getting increasingly wary of their actions. The G7 may eventually lose its economic might but it is also bringing down capitalism and eventually free markets. Prices of commodities will more likely be dependent on whom one wants to trade or not as the supply dries up. This is making countries more aware of their resource security. Therefore, a plethora of deals were signed by China for securing LNG supplies and oil connection from Russia to counter the trade hostilities the USA is showing. Similarly, energy dependent countries are now focusing on securing cheap energy supplies through long term deals. Hence even Japan is now looking at Russian oil because a higher cpi wreaks havoc on its monetary policy. Similarly, those countries capable of exporting foodgrains and other important daily necessities will have significant clout. We are already seeing some tug of war in control on oil prices between OPEC and USA. These are signs of times to come. At one end a war on climate change by western countries is reducing capital flows towards traditional forms of energy and at the other end there is no cheaper alternative that is cost effective and similar in efficiency. We are now seeing globalization benefits getting restricted and alternative forms of capitalism that is significantly tainted.
In our previous blogs, we had identified how the global central banks’ monetary policies will be replaced by fiscal support and eventually lead to a higher inflation with resource constraints forcing every country to save its currency. This is now in motion. We have seen a shift from global integration to diversion and shifting from globalization to increased focus on localization. This trend is only going to increase further. To Each his own. The calm in financial markets is making people complacent. However, policy makers have a tough job to make their economies grow. In the absence of any real drivers they will be forced to find disruptions that divert attention. Markets are on thin ice and are driving higher more in hope of stimulus and pause in rate hikes. There is no real impact seen in credit markets even as banks are failing. It will only reinforce the belief that the fed has their back. When the rate cuts start it will be interesting to see if the same optimism exists. The geopolitics then will shape the economy swiftly.
-By Nishant Maheshwari and Vishal Vora
Disclosure: The views expressed are those of the authors and should not be construed as a financial advice. Investors should consult their financial advisor for financial advice.