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Blain’s Morning Porridge, 15^th January 2024: Forget inflation and rates – The faultlines of the Global Economy are shifting

“Heat the beans and cool the pie.”

Markets remain fixated on the near-view questions of when and by how much central banks will ease. They may be missing a much more fundamental and happening shift in econ-geopolitics as the global economy coalesces into 3 new blocks. That should have profound implications for investment strategies.

This week I find myself in properly Welsh Wales after my Father-in-law’s emergency hip-replacement. 2-years waiting then he has a fall and breaks it – so finally they act! Everyone up here can speak English, but doesn’t – which is rather wonderful. She-who-is-Mrs-Blain is explaining everything to me. Every time I come to Wales I get lost because God decided Welsh didn’t need any vowels – thus Road directions are utterly indecipherable. (Outside North Wales who knew a Ysbyty was a hospital?) And you have to randomly drive at 20 mph depending on the whim of local politicians. Driving slow is an “experience” and one my Land Rover’s old gears struggle with.

Other learning experiences the last few days include never, under any circumstances, stop on the M54, the benighted motorway between Brum and Telford in the UK Midlands. Listening to the radio they said petrol prices were the lowest for 2 years. I noticed the price of diesel on the A303 – £1.43. A few hours later we were on the M54. We decided to stop, grab a bite, give the dog a run and fill the tank. £1.76 for diesel – 23% higher than on the road! I complained and got told it was my own fault for stopping at the worst service station in Britain.

Back to markets.

A client told me Friday he felt 2024 were already a bit “Meh”. He’s already bored by the constant analysis of when and by how much rates will fall, countered by watching the inflation barometer stuck around 3%. Get used to it…. Inflation will remain sticky. There are too many secondary inflationary effects at play in terms of wages, rate multiplier effects, supply chains, and adjustments to miraculously fall back to 2%. It’s the old rule: 20% more effort will achieve 80% of the desired result. To garner the remaining 20% improvement requires 80% more effort! It’s a variation on the law of diminishing returns.

If you are just looking at rates and inflation, take the blinkers off. There is a much larger global shift underway. It’s not just the 60 odd elections underway this year – at least the victory by the DPP in Taiwan didn’t trigger anything outward bound by China. Everyone is so focused on the big one, Tuesday 5^thNovember, in the USA, we might be missing the wood for the trees. The global economy is changing more swiftly and decisively in the coming year than we’ve seen in decades – be positioned for it.

Last week in London I met a very senior City figure who alerted me to a fascinating development. For decades, probably centuries, the global shipping market that facilitates global trade has been ensconced in London. The bulk of marine P&I insurance and reinsurance has been transacted in London’s insurance market – over 90%. In recent years – post Ukraine – suddenly that has fallen with new markets/services being offered in the Middle East and Asia, providing insurance for Russian cargos: sanctioned in the West, but fair game in the new China co-prosperity sphere.

It’s not just nations rejecting US led sanctions in the United Nations. They are now changing the way the global economy works. It’s the clearest sign yet of how the US and dollar hegemony is being challenged – nope, that’s the wrong word – by-passed is better. The global economy days of the WTO is so-over. Something new and more brutal will emerge. Competition is good – there will be winners and losers. This time, the West looks the weaker party.

Many investors base their decisions on a fairly limited and simplistic perception of the global business environment and economy. They see it as something to analyse in terms of how economies are likely to expand and grow, thus how much they can optimise incomes, returns and investment….. or will economies contract to see consumption collapse and corporates fail? They work out how booms and recessions will impact bonds and equities based on a fairly static model of the global economy effects on rates and how these impact costs, taxes and other factors. They can add on a level of tech themes, like AI, as to how the economy will change.

The last decade of predicting how the model works has been particularly difficult because of distortions in markets. Ultra-low interest rates distorted the risk/reward equation: because money was so cheap, investors were more inclined to take risks and speculate, and because everyone was doing it.. markets went up! Don’t forget, anyone under 40 in these markets has never really worked through a real financial crisis or long-term higher (normalised) interest rates.

That’s a big divide in the market – we boomers who consider bond rates of 4% to be low, while the millennials think 2% is insanely high! Capitalism needs the right price of money to guide efficient consumption vs investment decisions, and keep speculation and inflation is check. Simple as.

However, the boom/bust recession/recovery model is far too simplistic when larger, more dynamic, forces of change are underway. The market environment is changing at a pace we have not seen in decades. Smart investors not only have to react to the entropy of new tech, (like AI), will trigger, but also factor things like how Society, Demographics, Trade, Geopolitics and National Politics, plus externals like climate change, are undergoing seismic shifts.

For instance. Think about trade – the most important driver of global economic growth. Forget the rhetoric between China and the US – that’s literally just noise. The reality is how the global economy is now coalescing into three new blocks:

• China/BRICS – the new East
• USA
• The Rest, including Yoorp

I don’t for one moment think there will be an easy economic relationship between China (already in slowdown, perhaps decline) and India (on the emergent), or that the emerging growth economies of Asia will accept Chinese hegemony – but they will likely become the epicentre of the global economy. The Belt and Road, and now BRICS, are clumsy Chinese attempts to lead. But overall, the shift in economic power from West to East bodes well for the multiple nations of the Asian/Middle East region in an economic race with many of the competitive features that fuelled the West over the last 3 centuries.

Meanwhile, the outlook for the USA is more troubling, There is a growing expectation Trump will win the coming election, and precipitate a whole series of isolationist moves, not the least being cutting the links to Europe with the US largely exiting NATO. Economically, the US will probably thrive as an internalised and diverse economy – for a while. Trump’s plan for economic autarky may appear attractive to US voters, but long-term internalising the economy will have a cost.

I recently read an insightful comment from Gavekal (economic forecasters) on the Ottoman Empire. In the 1600’s it threatened its version of hegemony over the whole of Europe. After a series of military reverses – including the siege of Vienna – it consolidated within its own borders, becoming increasing weakened and sniped at by the rising European powers. The rest, as they say, is history. Will the USA under Trump ultimately head the same way?

And what of Yoorp? Where will Europe decide to play in a world where China/Brics is the more dynamic option? The UK, defined by our “speshul relationship” with the US and Brexit, could well be left on the wrong side of the new global economy – unless there is a deal more pragmatic politics in coming years.

We live in a dynamic global economy. The relationships that defined geopolitics are changing. There will be a host of other factors such as global warming, power/energy, food security and conflict that define this period of change. Who would want to be caught on the wrong side of it.

More to the point – who would risk being focused on the wrong investment approach as the world changes! Today it’s the US economy that seems golden, that can post returns to dwarf lesser markers. For how long does that remain true?

Out of time, and back to the day job

Bill Blain

The Morning Porridge, Shard Capital and Bowline Capital Advisors