Order or Disorder under Heaven

Writer: 
Andrew Sheng

At a time when the world is wondering how to make sense of sharp swings in foreign policy, the two Koreas’ historic rapprochement must mean a great sense of relief for anyone who cares about peace. 

The sense of insecurity is most acutely felt In America.   The fact that former FBI Chief James Comey has come out openly to say that his serving President is “morally unfit” for office says a lot about how the line has been drawn between those who want to stay in power and those who think that the direction America is heading is wrong. 

The reasons why the rest of the world is disoriented is precisely because the old order is changing - all is not well under heaven.   All we know is that what is replacing it is going to be very different. 

Last year, financial markets returned best results from the romance of tax cuts and the promise of tech, even as the global economies were beginning to recover finally under their own steam.   This year, the IMF Annual Meetings suggest that the recovery will continue, but there are dark clouds, such as the unsustainable US fiscal and trade deficits, looming into 2019. 

Of the two most important “signals” that I have discerned when thinking about the future, the first is understood and yet not fully absorbed.   The obvious assumption in the post-world order was that the United States was the centre or pivot of the world, with global institutions, such as the Bretton Woods IMF and World Bank, United Nations and World Trade Organization, underpinning that world order. 

We now have a situation whereby all under Heaven is in disarray, because the US itself is undergoing a massive political change.  Since 1776, the United States has essentially been a two-party state, with general swings of opinion from inward-looking protectionism to outward looking imperial ambitions.  But since the Second War War, when the US finally emerged as the dominant power without equal,  it has stood at the centre of the rule-based liberal world order that not only served global interests, but her own interests. 

Mr. Trump’s election showed that this view has changed.  Fundamentally, Mr. Trump understands that further increases in military expenditure without returns are not sustainable, nor are US trade and fiscal deficits.  Hence, the demands are now elevated for all, allies and foes alike.   This explains why Mr. Abe did not have a comfortable weekend in Mar-A-Lago.   The US has demands on Japan that Mr. Abe may not be able to deliver, especially because of domestic problems. 

The easiest historical parallel is the period of the Reformation (1517-1648), when the dominant Catholic Church was debating on key issues with different contenders,  including the church’s dogma that the earth was at the centre of the universe.  The Reformation occurred not because of religious differences (although there were many), but because fundamentally the English, Dutch and new European powers wanted secular freedom from Rome.  When the earth is no longer the centre of the universe, as discovered by Galileo, then everything becomes relative.   There is no longer absolute power or rights or wrong - all are relative in the new order.   That is exactly what is happening when we switch from a unipolar to a multipolar order. 

A new period of bargaining and jockeying for positioning is occurring world wide. 

The second signal also obscured by too much noise is the fact that the elites are now increasingly out of touch with what the masses are thinking.  By the elites, I would include academia and media, who basically repeat their idealistic picture of the world, but completely ignoring the dark side of free markets - crime, predatory behavior, corruption and vices that the majority have to deal with.   The majority are voting in leaders who they think are brave enough to deal with these major social issues.

The elites call this the rise of populism - essentially a revolt against the establishment.   Mr. Trump’s supporters are those who sent him to the White House to disrupt, and the more he disrupts, the more they support him.   He simply cannot and will not back down from his electoral promises.   The more the media and the Democrats attacks Trump personally, the more they feed the media frenzy, which makes money for the media, but confusion reigns for all.

All this remains good so long as the financial markets and the economies are holding up without a Trump slump.   We are now observing a “holding period” in which the financial markets are guessing whether interest rates will rise and whether the advanced economies are going to slow down.  

On the former, there are increasing signs that we have already passed the trough in interest rates and that they will continue to go up.   US ten year treasures have just touched 3.00 percent.   Fund managers are all looking for better yields.  One tends to forget that one reason why US interest rates have remained low over the last two decades is the “glut” in savings from the emerging markets, including the oil producers.   That “glut’ has now disappeared as even China’s current account surplus has declined to less than 1.4 percent of GDP, and Middle East oil producers are now struggling to balance their budgets.  The surplus has shifted to Europe, which recorded a current account surplus of 3.5% of GDP.  Germany’s surplus alone is 7.8% of GDP in 2017.

This is why the current politics in Europe will shape growth in the coming months.  If Germany and France cannot agree on reflation, and the European economy slides backwards, then the populist politics will get even more ugly.  Much will depend on how French President Macron persuades Germany Chancellor Merkel in the reflation game.     

Taken these two key signals together, I would expect much more wider range of shocks to the financial markets than has been the norm so far.  The choices within Asia are essentially between defending the stability of the exchange rate as the dollar strengthens, or higher interest rate pain.  

It goes to show that there is never a free lunch, even for central banks.  

Andrew Sheng writes on global issues from an Asian perspective