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Quarterly Outlook
Q2 Outlook: Debt-financed spending versus rising populism
Summary: The relentless rise of populism, in all its guises, at once exposes Europe’s deep structural flaws and presents it with an imperative to reform. Modern Monetary Theory is increasingly proposed as a solution to growing inequality, but beware: it is no panacea.
Europe, born of liberal democracy and multilateralism, is now a continent whose political foundation is under threat as the ascent of populism, political intolerance and simmering geopolitical tensions threaten to undo the liberal world order. This rising populist tide is ever-swelling in the run-up to May’s EU parliamentary elections. These elections promise to fragment the existing state of affairs as a vast swathe of dissatisfaction and backlash against globalised society in the context of anaemic Eurozone growth rises to prominence, albeit without any clear idea of what might replace the status quo.
From Trump and the China-US trade war to Brexit and the gilets jaunes, the threats of this regime shift are evident. The tectonic plates are shifting, even if we are yet to feel the consequences of the extremist versions of these movements, like a hard Brexit. After a 30-year spate of deregulation and laissez-faire economics, this new paradigm will create a different business and investment environment and the implications will be far-reaching, creating fresh headwinds and therefore risks. For those wishing to dismiss this unfolding (and global) transition as insignificant, think again!
These forces are complex, deep-seated and contain multiple moving parts, rendering both the cause and effect uncertain. This narrative is far from complete, but we have attempted here to articulate some of the concerns and threats to basic assumptions that have underpinned asset prices and equity returns.
Populism is not a new phenomenon . In fact it is as old, if not older, than democracy itself. The philosophy itself is hard to define, but simply put, the root of the movement stems from the conflict between “ordinary” people and the minority “elite”, where the alienated masses present a deep dissatisfaction and mistrust of the prevailing establishment.
There are many narratives that can explain the surge in populism, but from where I stand, the most compelling is derived from the result of “hyper-globalisation”, a term coined by economist Arvind Subramanian. Since the 1980s, the shift towards a new economic order of globalisation, free markets and technological advances has enabled huge growth in global GDP, generated wealth and driven up corporate profits, and lifted millions out of poverty. For developing countries like India and China, this has presented huge opportunities, but the West also has also capitalised on cheap labour and product markets. This, then, set global disinflation in motion, suppressing bond yields and increasing leverage, which in turn have boosted asset prices since the 1980s.
But this shift, which for years has been viewed as only beneficial, has not been without its losers. For the West, three decades of hyper-globalisation have spurred an unprecedented wealth transfer away from labour. Corporate profits as a percentage of GDP have risen steadily, while real wages have stagnated, leaving wealth concentrated among the few and income inequality up sharply. Pre-tax incomes of the top 1% are now at levels last seen in 1929, on the eve of the Great Depression.
Global corporations have plundered the gains as workers have grappled with this breakdown in equality alongside new competition from cheap migrant labour and automation alike, with labour all the while taking a smaller slice of the pie as taxation and rent-seeking dwarf real gains. Throw in high house prices, a crippled welfare state, deflation and lower growth pushing down yields and penalising savers, and labour’s pie looks increasingly worse. Moreover, when the 2008 crisis hit, instead of undercutting this system, the policy response and the failure to clear markets exacerbated the situation.
QE worked to reflate asset prices, but not wages or productivity, spurring further inequality and eroding confidence in the establishment’s ability to navigate Western economies. Given all this, the backlash is not all that surprising. Indeed, it might be surprising that it didn’t happen sooner.
What does this mean for markets, economic policy and the threat to globalisation? As the backlash intensifies, so will the battleground, making it increasingly difficult to price risk and determine the policy response against a complicated and polarising backdrop.
Aside from reactive or palliative redistribution policies, any response that will bring real improvement and tackle the misfortunes of those caught on the wrong side of globalisation seems a long way off. The current new political era is the result of decades of societal shifts and the solution could itself take decades to work though. We hope not, but there is little evidence to the contrary.
As development and inequality specialist Branco Milanovic wrote: “Neoliberals and the centre-right have now for a decade agreed that something has to be done to reduce inequality of wealth and income. But whenever there is any proposal, they are against it. I conclude they are in favour of inequality reduction by magic.”
Europe’s exports account for 50% of GDP (double that of China), which leaves the bloc vulnerable to the global slowdown. Combine the growing populist stance with an already wilting economy, unable to stimulate growth and employment even with the European Central Bank’s €2.6 trillion money-printing scheme, and the forecast becomes one of change. As resistance to previous economic policy consensus grows and austerity is shunned by the ever-growing tribe of populists, the conversation is shifting.
A push towards radical fiscal expansion to stimulate demand under the guise of Modern Monetary Theory is likely not the utopian answer we are searching for. The experiment could end with far more pronounced structural imbalances, runaway inflation, currency corruption and the corruption of the monetary system as we know it.
From Trump and the China-US trade war to Brexit and the gilets jaunes, the threats of this regime shift are evident. The tectonic plates are shifting, even if we are yet to feel the consequences of the extremist versions of these movements, like a hard Brexit. After a 30-year spate of deregulation and laissez-faire economics, this new paradigm will create a different business and investment environment and the implications will be far-reaching, creating fresh headwinds and therefore risks. For those wishing to dismiss this unfolding (and global) transition as insignificant, think again!
These forces are complex, deep-seated and contain multiple moving parts, rendering both the cause and effect uncertain. This narrative is far from complete, but we have attempted here to articulate some of the concerns and threats to basic assumptions that have underpinned asset prices and equity returns.
Populism is not a new phenomenon . In fact it is as old, if not older, than democracy itself. The philosophy itself is hard to define, but simply put, the root of the movement stems from the conflict between “ordinary” people and the minority “elite”, where the alienated masses present a deep dissatisfaction and mistrust of the prevailing establishment.
There are many narratives that can explain the surge in populism, but from where I stand, the most compelling is derived from the result of “hyper-globalisation”, a term coined by economist Arvind Subramanian. Since the 1980s, the shift towards a new economic order of globalisation, free markets and technological advances has enabled huge growth in global GDP, generated wealth and driven up corporate profits, and lifted millions out of poverty. For developing countries like India and China, this has presented huge opportunities, but the West also has also capitalised on cheap labour and product markets. This, then, set global disinflation in motion, suppressing bond yields and increasing leverage, which in turn have boosted asset prices since the 1980s.
But this shift, which for years has been viewed as only beneficial, has not been without its losers. For the West, three decades of hyper-globalisation have spurred an unprecedented wealth transfer away from labour. Corporate profits as a percentage of GDP have risen steadily, while real wages have stagnated, leaving wealth concentrated among the few and income inequality up sharply. Pre-tax incomes of the top 1% are now at levels last seen in 1929, on the eve of the Great Depression.
Global corporations have plundered the gains as workers have grappled with this breakdown in equality alongside new competition from cheap migrant labour and automation alike, with labour all the while taking a smaller slice of the pie as taxation and rent-seeking dwarf real gains. Throw in high house prices, a crippled welfare state, deflation and lower growth pushing down yields and penalising savers, and labour’s pie looks increasingly worse. Moreover, when the 2008 crisis hit, instead of undercutting this system, the policy response and the failure to clear markets exacerbated the situation.
QE worked to reflate asset prices, but not wages or productivity, spurring further inequality and eroding confidence in the establishment’s ability to navigate Western economies. Given all this, the backlash is not all that surprising. Indeed, it might be surprising that it didn’t happen sooner.
What does this mean for markets, economic policy and the threat to globalisation? As the backlash intensifies, so will the battleground, making it increasingly difficult to price risk and determine the policy response against a complicated and polarising backdrop.
Aside from reactive or palliative redistribution policies, any response that will bring real improvement and tackle the misfortunes of those caught on the wrong side of globalisation seems a long way off. The current new political era is the result of decades of societal shifts and the solution could itself take decades to work though. We hope not, but there is little evidence to the contrary.
As development and inequality specialist Branco Milanovic wrote: “Neoliberals and the centre-right have now for a decade agreed that something has to be done to reduce inequality of wealth and income. But whenever there is any proposal, they are against it. I conclude they are in favour of inequality reduction by magic.”
Europe’s exports account for 50% of GDP (double that of China), which leaves the bloc vulnerable to the global slowdown. Combine the growing populist stance with an already wilting economy, unable to stimulate growth and employment even with the European Central Bank’s €2.6 trillion money-printing scheme, and the forecast becomes one of change. As resistance to previous economic policy consensus grows and austerity is shunned by the ever-growing tribe of populists, the conversation is shifting.
A push towards radical fiscal expansion to stimulate demand under the guise of Modern Monetary Theory is likely not the utopian answer we are searching for. The experiment could end with far more pronounced structural imbalances, runaway inflation, currency corruption and the corruption of the monetary system as we know it.