Perspectives

2019 – breaking point?

Rope hanging on by a thread

ECR Research

There are challenges aplenty to navigate over 2019 ranging from the US-China trade war; increasing geopolitical risks; hair-raising scenarios for Italy and Brexit to name but a few. It all amounts to a new and uncomfortable global reality in the making, one in which markets’ perception of political risks in advanced economies more and more resembles that attached to emerging economies.

The global economy did quite well over 2018 until stock markets decided the party was over. Their retreat owed much to tentative monetary tightening, a looming trade war, Brexit angst, protests in France, the Italian budget drama and concerns over the Chinese growth slowdown.

Some analysts claim that geopolitics has made a comeback in recent years after almost two decades in which the US ruled the roost, a period over which liberal democracy appeared invincible. However, geopolitics has never gone away. The likelihood of the western capitalist, democratic welfare state surviving is increasingly called into question. Freedom has been under pressure worldwide for over a decade in any case. Also, it is now no longer a given that all countries will tend to evolve into liberal democracies in the end, be it sooner or later. There is, alas, an element of chickens coming home to roost.

The least evil version

Yet we should not forget that the mode of governance implied by liberal democracy is more resilient than appearances suggest. It came under very heavy fire in the 1930s but then the New Deal, modern social democracy and (counterintuitively) a world war helped to save liberal democracy. The nuclear holocaust that threatened in the 1950s and the economic stagnation and oil crises of the 1970s cast doubts on it but, yet again, solutions were found to prop up the system.

Now, owing to the credit crisis and China’s accelerated rise to power, it appears that another era has started in which liberal democracy needs to develop and adapt in order to “stay in business”. China is trying out a different form: the authoritarian one-party state with a hybrid economy, involving both the free market and a government that is pulling the economic strings. Other countries are emulating its example in one way or another.

It is understood that undermining democratic foundations can undercut growth in the long-term: democracy and structural, sustainable growth mostly go hand in hand. Corruption, machinations, misuse of power, and frustration run rampant if democracy crumbles. At the same time, however, we should not forget that countries such as China have managed to suppress political liberties for a long time and still have delivered innovation, reforms and very rapid growth.

West past its peak?

It is difficult to avoid the conclusion that the time is well and truly over when the West enjoyed a combination of robust economic growth, higher productivity, rising real wages, technological advances, plus a generous social safety net that supports people who threaten to fall through the cracks. Whether the West manages to address the dissatisfaction and uncertainty that has gripped sections of society (without buying off the discontent with mushrooming budget deficits) will be absolutely pivotal in 2019 and years ahead. Politicians in Italy and France seem to have fallen into this trap. Simultaneously, countries in Central and Eastern Europe continue with policies that go against the grain of the EU’s democratic foundations.

Brexit worries

London also frantically tried to unravel a united EU front but did not succeed. As things stand now, the UK is set to leave the EU by the end of March. We still think the UK will not hurtle out of the EU without a deal and that the worst scenario will be avoided after much ado and a creative implementation of the rules. This does not mean to say that (especially) the British will get off scot-free in 2019, as the Tories seem incapable of getting their own house in order. Plus, the alternative for a rudderless Conservative government could be a cabinet led by Jeremy Corbyn, something that many investors fear.

Clash of the century

Another prospect that will probably not make the markets very happy is a third year of Donald Trump in the White House as President. They applauded Trump’s election and were content with the first half of his term, but the reasons were strong deregulation, tax cuts and an accommodating Fed. These three pillars are no longer in place and President Trump should really start focusing on constructive rather than destructive policies. Owing to the Republican losses during the midterms, he will get less done concerning domestic issues. Foreign policy appears to offer more opportunities. It very much remains to be seen if his focusing on ‘international relations’ (or the lack thereof) will really be a good thing, particularly as he proves unable to impose any form of discipline on the White House. The turnover hasn’t helped: more than two dozen senior figures in the administration have now been fired or quit since he took office in January 2017, the latest being John Kelly, his third chief of staff.

The trade war with China is one of the most important issues for the financial markets. Beijing has been given until 1st March to take measures that please Washington sufficiently to stop it from imposing hugely increased import tariffs on Chinese products. China appears to be making an effort to buy more US products and to make it easier for foreign businesses to operate in the Chinese market. Yet, the underlying reasons for the American-Chinese tensions are still there, and further escalations are likely.

How China will continue to make headway and how the West – particularly America – is going to deal with this will be one of the most prominent political stories for the markets throughout 2019 and in subsequent years. The difference with the Cold War is that there is no single communal enemy facing the West at present, which could force it to unite and put aside differences of opinion. To quote Dominique Mosi, the French political scientist and writer, “respect and balance are the keys to success for any alliance … and, let’s not forget, the perception of a common threat.”

Underestimated risk

So, from a political viewpoint there are plenty of indications that 2019 will be turbulent. Overall, we think the biggest danger is, as FT political columnist Jana Ganesh recently pointed out (and he is not the only one), that the Trumpists, the Brexiteers, and the yellow vests are not just united in their will to shake up the established order but are virtually unanimously under the illusion that the only consequence will be economic disruption. That is to say, they underestimate the risk that their actions will have a domino effect, with social collapse as an unintended but possible outcome. As Ganesh says: “Social order is to some extent self-cancelling. The longer people have it, the more they take it for granted.”

As it stands, western political-economic foundations will continue to weaken amid deteriorating economic conditions; insufficient productivity growth; roofs that were not repaired in the good times when the sun was out; mounting tension between China and the US; disputes between the democratic Western countries and the authoritarian states in general; a frailer German-French axis in Europe; and more paralysis in Washington under a president who goes for increasingly grotesque antics as he is pushed into an ever-tighter corner.

With growth slowing, central banks running out of ammunition and structural reforms absent, it may not be so easy for the financial markets to ignore the political problems that have been simmering for a long time. Previously, the political risks played a relatively small part as far as the markets in the industrialised countries were concerned. However, under the new normal, the political risk perceptions in these ‘advanced’ countries and in the emerging markets may well start to resemble each other more and more.

Another implication of the growing tension between and across countries is that it will be harder to take large-scale concerted action to tackle a new emergency; as the G20 did when the credit crisis erupted. As central banks have used up most of their resources, more countries will turn to fiscal stimulus and there will be political pressure on central banks to step on the monetary accelerator – once again – as we saw earlier this year in the US, India and Turkey.

All in all, 2019 is shaped to be a fascinating, challenging year for markets and businesses, with geopolitics and national economic policies globally major risk factors.

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