Currently, the data is inconclusive. Some show recession, and some very strong growth. The narrative is not straightforward. Heightened macroeconomic volatility means that there’s a growing probability that policymakers will miss the mark. They will either over-tighten (more likely) or under-tighten, each one with a different set of repercussions. The same goes for every major policymaker, not just central banks.
This is no accident. It starts with the growing rift and imbalances between two huge economies which remain interdependent: The US and China. And if indeed its geopolitical imbalances that hinder sanguine policymaking, expect this to last for some time.
Yet there is a glimmer of hope that the situation is reversible, as last week’s news suggest. Pragmatic Britain is back and it is already seeing some rewards. As a first result, it achieved a breakthrough, the “Windsor Framework”, a workable deal for Northern Ireland. The deal itself is of limited impact, an incremental first step towards averting a trade war. More market access for the financial sector will be a difficult task to achieve, but when people negotiate in good faith anything can happen. At an age when the West has forgotten war, electorates will eventually see that confrontation results in worse economic outcomes and it was international cooperation that increased their wealth.
Volatility. The end of the macroeconomic “Great Moderation”. This was our theme entering 2023. We are already seeing data that is volatile, and contradictive. US Housing and manufacturing are at 2008 Global Financial Crisis levels. Yet consumption for January was one of the strongest numbers ever recorded. China is reopening fast. Yet, there are no traces of inflation. Japan is experiencing inflation for the first time in decades. However, for the time being the Bank of Japan is insisting on yield curve control (i.e. money printing). This volatile and unpredictable macroeconomic backdrop is also non-directional.
Now consider a key policymaking organization like the US Federal Reserve. Every month, it waits for 2-3 key pieces for inflation data, but also other numbers, indicating the general strength of the economy, such as retail sales, employment etc. What happens when the figures are so unpredictable? Or when they are not telling a coherent story? Interest rates are a longer term consideration and can’t go up and down at every meeting. The Fed needs a direction, even if the data can’t provide it. Thus, data-dependency may provide a good “objective” narrative as to why interest rates go towards a particular direction, but when the story isn’t clear, it is ultimately it is people who decide, and people have biases. Economists, in particular, are a profession notorious for biases, usually created in academia.
This creates confusion for markets, who may see the same data and reach different conclusions. The Fed has indicated that it will proceed with single rate hike instalments. After the latest data, double rate hikes are back on the table.
So, inescapable conclusion number one, is that there’s a growing probability that policymakers will miss the mark. They will either over-tighten (more likely) or under-tighten, each one with a different set of repercussions. The same goes for every major policymaker, not just central banks.
The lack of a clear economic narrative does not mean, however, the lack of an overall narrative.
To understand why the world is so imbalanced, we need to turn to history, and ask its scientific father, Thucydides. American political scientist Graham T. Allison, called our situation the “Thucydides Trap”. As one power emerges, conflict with the incumbent becomes inevitable.
Our world that is gravely imbalanced, and inefficient not necessarily because the economy can’t find an equilibrium. It’s shifting supply chains that is the problem. A better explanation is that the great nations of the world persist that antagonising each other and undoing the decade-long benefits of globalisation is somehow good for their internal electorates. China’s move to re-establish its authority on big businesses. The US’s ‘inflation reduction act’, a clear turn towards protectionism espoused by the second successive government of the world’s leading western power. Sanctions and counter-sanctions. We are quickly moving towards a bi-polar world, not too dissimilar from the one we grew up in. I suppose not too dissimilar from what most people in most of history experienced. Athens and Sparta. Rome and the Goths. Byzantium versus the Ottoman Empire. England versus France and Spain. America and Japan. America and the Soviet Union.
As Washington blames Beijing for the pandemic and espionage and Beijing blames the West for exploitation… and espionage, the scenery is all too familiar for any first-year history student. The two countries build up their armouries, pressure their scientists and seek to create fortress economies.
From this week’s Economist
The rest of the world is quickly falling in line. Russia has picked a side, easily but at a heavy (future) cost. Chinese leaders may soon have a say in Mr. Putin’s decisions, and those of his successors. A lot of Africa is beholden to Beijing by means of debt and so are some Asian countries. The EU is wavering, but its allegiance to NATO and America is strong. The same with Japan, even though China is now its biggest trading partner. India will try to balance and might just achieve that. So will commodity-rich South America and the Arab world.
Economics, in terms of models and forecasts, work when there is predictability and cooperation. Where there is escalation they tend to become unpredictable, the natural consequence of long-term prosperity becoming a secondary priority.
Now escalation does not necessarily mean war, especially between nuclear powers. That much history teaches us. War, for all its devastation, was often useful to resolve differences quickly and redistribute income, Walter Scheidel argues. ‘Cold’ wars, on the other hand, tend to last. If things continue in their present confrontational direction, then a new Cold war Status quo could be created. This means a partitioned world, one where we will not have an overabundance of everything and one that will probably not be as cheap as it was in the first years of the 21st century.
Inescapable conclusion number two: if indeed its geopolitical imbalances that hinder sanguine policymaking, expect this to last for some time.
One can’t see escalation from one direction. The whole point of escalation is that all sides opt to challenge one another. Moves and counter moves.
Yet, those looking for a glimmer of hope should look no further than Europe, and, more recently, Great Britain*. In the past seven years, the prevailing narrative was that antagonising Europe, its biggest trade partner, would result in a better economy overall. Yet, it became apparent that after the pandemic the UK economy has been lagging its developed counterparts by a lot of key metrics. It is experiencing higher inflation and lower growth than its peers, as well as labour shortages and supply chain disruptions. ARM, a British chipmaker based in Cambridge, recently shunned a London listing worth $70bn, opting for a US one, a major blow for London’s status as a global financial centre.
So the Government, despite its commanding majority in the Commons, has changed its strategy. It no longer tries to thumb its nose at its neighbour, even if it is egged on to do so by some MPs and part of its core electorate. As a first result, last week it achieved a breakthrough, the “Windsor Framework”, a workable deal for Northern Ireland. The deal itself is of limited impact, an incremental first step towards averting a trade war. More market access for the financial sector will be a difficult task to achieve, but when people negotiate in good faith anything can happen. Where there’s a will there’s a way.
Escalation meant a trade war. De-escalation means that the relationship could further evolve in other issues like migration, collaborating on scientific programs and reducing frictions in trade of goods and -more importantly – services, all good for the economy. The first bilateral summit after five years between France and Britain is to be held this Friday. It’s the beginning of a very long road. The UK government has demonstrably opted for pragmatism after a period when government was driven by ideology, and Europe responded in kind, no longer wanting to ‘punish’ the UK for leaving. In the decade following the Eurozone crisis many other European nations have gone through a similar process, with most of them eventually growing tired of populism and repudiating it in favour of realistic policies.
Inescapable conclusion number 3: At an age when the West has forgotten war, electorates will eventually see that confrontation results in worse economic outcomes and it was international cooperation that increased their wealth. As long as no accidents happen.
*A historian of the not-so-distant past may have laughed at my assertion. Europe as a beacon of economic sanity and political stability... However, the Old World has had its fill of wars and crimes. London diffused a bomb from the Blitz just three weeks ago. It might just be that Europeans know the price of instability and conflict in a way that younger powers do not. History can only teach those who seem willing to listen, or else it is bound to repeat itself.