Flat world no more

Judging by the headlines, the US continues at the centre of the global system.  Emerging market currencies and equity markets around the world are in sharp decline, in significant measure because of stresses associated with a strengthening US dollar.  Revised US GDP growth came in at an annualised 4.2% in Q2, even as Europe treads water, with an expectation of ongoing US monetary policy normalisation. Combined with the actions and rhetoric from the White House, from tariffs and sanctions to military alliances (and daily psychodrama), it can seem that the world is revolving around events in the US.

But below these headlines, tectonic plates are moving.  A few years before the global financial crisis, Tom Friedman captured the global zeitgeist with his argument that the world was flat.  But if it was once possible to argue that (Western-led) politics and technology were combining to create a flat world, increasingly politics and technology are combining to create a more lumpy, multi-polar global system.  And from Washington DC and Germany to Canberra and Beijing, the past few weeks have provided further evidence of a fragmenting, more regional global economic and political system.

The ongoing NAFTA negotiations provide a clear example.  Ignoring the reality TV show style of US negotiations with Mexico and Canada, one interpretation of where this is heading is towards a more regionally-ordered trading system.  The proposed rules of origin standards, with minimum requirements on wages, are likely to create some pressure for more production within NAFTA.  More generally, the proposed terms may accelerate the re-shoring of supply chains from Asia to the American region for American consumption, particularly for activities that can use new technologies such as automation or 3D printing.  Despite Mr Trump’s efforts to build the border wall, the end-point is likely to be a more self-contained North American economic unit (albeit with Canada and Mexico being TPP members and negotiating FTAs with the EU).

This regional (less global) focus is reinforced by the US withdrawal from the TPP, which would have embedded the US in a broader Asia Pacific set of economic arrangements, as well as the ongoing threats from President Trump to impose tariffs on imports from Europe.

The second development that speaks to growing fragmentation is pushback from Europe to the unilateral use of sanctions by the US (‘war by other means’).  The most recent example of this was subjecting European firms to secondary sanctions if they continued to do business with Iran after US withdrawal from the Iran nuclear deal.  The US could do this because of its economic weight and centrality to the global financial system.

But in a recent op-ed in Handelsblatt, German Foreign Minister Heiko Maas floated an idea for a separate payments system that would be independent of US.   Although Chancellor Merkel has distanced herself from these comments, there is some support in Europe.  The French Finance Minister stated that he wanted ‘Europe to be a sovereign continent not a vassal, and that means having totally independent financing instruments that do not today exist’.

At best this is a long-term journey: the USD dominates international transactions (~90%) and comprises about two thirds of global reserves.  The euro is a long way from being a serious reserve currency contender. As with security arrangements, Europe cannot realistically create a financial system that is independent of the US in the short-term.  But the fact that this conversation is starting is instructive, responding to growing structural differences between the US and Europe.  Of course, this is also consistent with China’s preference for a more diversified global financial system that is less reliant on the USD.  There is no quick solution here, but there is a growing constituency for a more diversified set of global economic and financial arrangements.

The third development highlights the growing intersection between economic and political relationships.  The ambition of China’s global positioning was apparent this week, as President Xi announced an additional $60b of loans and financing for African countries at a summit with Africa’s leaders this week in Beijing.  China is working to extend its economic and political presence through Eurasia into Africa. 

But limitations are also apparent.  The Australian government found time in between knifing another Prime Minister (now onto their 6th since 2010) to ban Huawei and ZTE from participating in the roll-out of Australia’s 5G network – on the basis of national security concerns.  The new Malaysian government has just cancelled Chinese infrastructure projects; and there were complaints at the Pacific Islands Forum in Nauru this week about China’s debt diplomacy in the Pacific.

However the growing intersection of international economics and politics that is clearly evident in China’s rise will reinforce a regional bias to activity, with an increasing share of international commerce being shaped by strategic relationships.

Tectonic plates are moving around the world, with competing blocs emerging.  Although there are some advantages in having a more diversified global system, there will be costs and frictions as global footprints of firms and countries are restructured.  Small economies in particular will need to be nimble to respond to these changes.

This reshaping of the global system, which extends well beyond trade wars, will have a profound effect on markets and economies.  Previous episodes of great power transition have led to gradual changes in global institutions from reserve currencies to international trading arrangements.  And this process is being accelerated by current US belligerence and poor quality policy-making.  Although the US remains central to the global system, competition is emerging. 


David Skilling