By Benjamin Picton, senior macro strategist at Rabobank
Be Careful What You Wish For
In April of this year, Christine Lagarde gave a speech before the Council on Foreign Relations in New York in which she warned that “we are witnessing the fragmentation of the global economy into competing blocs”. Regular readers of this Daily will be familiar with the speech; we made quite a big deal of it at the time, because it is a big deal! We have been warning of this fragmentation for a number of years. Great Power competition is back, and we’re not going back to the halcyon days of US hegemony, ever-liberalising trade, secularly lower inflation and assumptions of the death of history anytime soon.
The Lagarde speech will be rightly viewed as a watershed in years ahead. Much like “whatever it takes”, or comments from Paul Volcker in the late 1970’s when he told students at Warwick University that “it is tempting to look at the market as an impartial arbiter... But balancing the requirements of a stable international system against the desirability of retaining freedom of action for national policy, a number of countries, including the United States, opted for the latter... Controlled disintegration in the world economy is a legitimate objective for the 1980s.”
We’re watching the global economy being re-organized before our eyes and, like Volcker in the 1970’s, policy-makers are prioritizing freedom of action for national policy. Increasingly, we are seeing financial markets and global trade being more clearly subordinated to national policy objectives. There are no atheists in a foxhole, and no free-market liberals in a multipolar world (at least not in the halls of power).
The latest illustration of this emerging truth comes in the form of further trade restrictions between the United States and China. Phillip Marey wrote of this yesterday, when he noted that the Chinese government had taken steps to restrict the export of gallium and germanium, which are critical for the production of semiconductors. Retaliation from the United States appears likely to come in the guise of new restrictions on US companies providing cloud computing services to Chinese entities. New rules would require government signoff before those services could be provided, with politically-sensitive AI products being of particular interest.
Politicians (especially in Europe) are quick to point out that what is happening here is not ‘de-coupling’ but a ‘de-risking’ of trade relationships. Some lessons appear to have been (belatedly) learned from the inability to source personal protective equipment, drugs and ventilators in the early days of the Covid19 pandemic, and the reliance of European industry on cheap Russian energy. The liberal worldview naively discounted the possibility of war in Ukraine. To borrow from Smith, this was not because of a wrongful view of the humanity of the Russian President, but from a mistaken regard to Russian [economic] self-interest. But Vladimir Putin does not subscribe to Western liberal ideas, and the material prosperity of Russia did not win out over nationalistic policy priorities. If we follow Volcker’s warning from the 1970s it won’t win in the West either, when push comes to shove.
Elsewhere, markets were quiet yesterday as Americans were on holiday to celebrate independence from Britain. German trade data showed further softness in the exports, which fell by 0.1% in May and saw growth in April revised down by two ticks to just 1%. Imports, meanwhile, rose by 1.7% in May, making for a slimmer than expected trade surplus of €14.4bn in the month. The struggles of German manufacturing in recent times are well-documented, but perhaps the most interesting thing about the weakness in German trade has been how closely it mirrors the weakness in Japanese trade. Japan has been running a trade deficit since the middle of 2021, and Germany data is trending in the same direction, despite recovering some ground in the back half of 2022.
What does this mean for the world economy? Germany and Japan have both been bulwarks of the US-dominated system that has existed since the end of the Second World War. The Yen and the Deutschmark (now the Euro) have provided important ballast for the Dollar reserve system, and the trade surpluses of these countries have allowed for large US deficits to be recycled before providing the capital back to Wall Street in the form of US Treasury purchases. Emmanuel Macron has been clear that he is seeking “strategic autonomy” for Europe, but European living standards were seeded by US Dollar transfers under the Marshall Plan, and European security continues to be underwritten by the Truman Doctrine under the Aegis of the United States military. Is it reasonable to expect that Europe can achieve anything like strategic autonomy from its current position, with a hostile neighbour knocking on its door in the East?
Lagarde has correctly diagnosed that the global landscape is changing, but how it will look in the future remains uncertain, and there are still signs of denial. Europe has been a beneficiary of US foreign policy priorities over the last 80 years, but will it remain a beneficiary in the future? Britain made the mistake of overestimating its ongoing relevance to the global system in the middle of the last century. It took a cold US reaction to the Suez Crisis to eventually disabuse it of this notion. In seeking strategic autonomy for Europe, Emmanuel Macron should be careful what he wishes for. Especially with a US Presidential election due next year.
