The month of May was eventful to say the least. The S&P 500 Index had one of its worst start to the year with 7 straight weekly declines for the first time since 2001. The index closed the month flat +0.01%, taking year to date 2022 returns to -13.3%. Its technology counterpart, the NASDAQ, touched bear market territory. The index is down -22.8% year to date as of end of May.
It is a surprise markets are still alive and trading. Rampant inflation globally, lockdowns in the second largest economy, a war with no signs of easing, Europe seemingly punishing themselves by trying to rein in Russia with sanctions, rising oil prices, rising rates, slowing economic growth across various countries, climate change affecting agriculture, food supply issues, a crash in Terra USD – a supposedly stablecoin pegged to the dollar, are just some events that took place and continue to cloud market expectations. These risks are stressing the resilience of global supply chain, putting risk on one of the greatest themes that had propelled the modern world, Globalization.
Trading of goods has been ongoing for as long as people have been around. It can be traced back to silk roads from the early 1st century and spice routes up till the 15th century. The era of the First Industrial Revolution was largely confined to Britain and its colonies, resulting in trade growth that was rather siloed. In the aftermath of the two World Wars, and after the disintegration of the Soviet Union in 1991, trade and globalization gathered pace under the leadership of the United States of America. Trade worldwide once again rose to pre-war levels in 1989. The World Trade Organization (WTO) was established and nations actively entered into free-trade agreements. Simultaneously, a new Industrial Revolution started, with the Internet going mainstream. Alongside these events, we also saw the opening up of China to the world trade system. The result has been globalization on steroids.
Unfortunately, this growth largely leveled off and started faltering in recent years. Then President of the United States, Donald Trump, followed through on months of threats to impose sweeping tariffs on China for its alleged unfair trade practices. That saw the value of world merchandise exports peak in 2018. Signs of the emergence of a new trend towards localization in the world economy was faintly emerging, with businesses looking for ways to bring manufacturing closer to their consumers. By 2019, trade between the U.S. and China fell by nearly 17%. Soon after, COVID plagued the world leading to a temporary shutdown in transportation and mobility across the globe.
The World Economic Forum, which took place in Davos this May after a two year hiatus due to the pandemic, echoed the urgent need reboot and redefine “globalization”. The framework of open markets that has shaped the last three decades of commerce and geopolitics looks increasingly shaky. Economists and investors fear that globalization may have peaked and at a turning point now. The Covid pandemic and the economic fallout of Russia’s invasion of Ukraine; two cataclysmic events that no one foresaw, has expedited this fear.
China has played the role of key supplier to the world since it started opening up to World trade. However, the zero tolerance policy held by Beijing towards the COVID- 19 virus remains a source of downside risk to the domestic and global economic outlook. Supply chain constrains in China as a result remains a source of risk to global inflation. Although ports remain open during the lockdowns, control measures are disrupting activity as port workers, truckers, and factory workers stay home. The resulting rising shipping costs have a sizable and statistically significant impact on inflation globally.
At the same time, the war in Ukraine has created a new negative supply shock for the world economy, just when some of the supply-chain challenges seen since the beginning of the pandemic were expected to fade. Since the start of the Ukraine war, two of the world’s largest grain exporters have been destabilized by sanctions and fighting. Russia is a key player in the global energy and metals markets and Ukraine is a sizable agricultural producer. Commodity prices have risen sharply, reflecting concern about possible supply disruptions globally. The supply of basic commodities from medicine to wheat have been disrupted, exacerbating existing inequalities. The World Food Programme estimates the war and the impact on food and fuel prices will push close to 47 million people to the brink of famine.
The World Trade Organization, which once spearheaded Globalization and free trade, today is struggling to provide all three of its main functions – administering multilateral trade rules, serving as a forum for trade negotiations, and providing a mechanism for settling trade disputes. Instead, the organization is faced with the possibility of removing Russia’s “most favored nation status” at the WTO – a move that will allow United States and its European allies to impose tariffs well above global rates they have pledged to all WTO members.
Old winners of globalization – multinational companies – are finding themselves at odds with the globalization narrative. The option that a multinational can go to any country with cost advantages without any questions is over. Companies will face more cases like Russia and China where doing business carries a heavy price. To do business in China for example, the second largest economy in the world, companies are increasingly expected to play along with Xi Jinping’s plans to decouple China from the West, become self-sufficient and build a China-centric economic order.
In order for any politically controlled economy to work, it has to serve domestic needs. Confronted by recent difficulties in the global stage, many countries have turned inwards, to defend their own supplies and people by erecting export bans and buffering domestic industries. Even on a corporate level, global supply chains are being redrawn as companies shift further away from the just-in-time model. Prioritization of economic control over growth in China, coupled with its virus-induced policy of enforced isolation, have highlighted the shift towards self-reliance. The ongoing Russian invasion of Ukraine has also accelerated this shift towards a multi-polar world.
Slowly, the image of a global village that was built by Globalization is disappearing, replaced by localization. Reverse globalization is a movement towards a less connected world, characterized by local solutions, and border controls rather than global institutions, treaties, and free movement. Each economy is attempting to insulate itself from the other and then diminish the influence the other has on it. And just as globalization was deflationary, its unwinding will likely be inflationary, adding further to the already high inflation levels.
One thing for sure though is globalization will not reverse itself into localization immediately. Rather, what we see happening in recent years is more regional collaborations and pacts with allies.
- The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which concluded in 2018 is dominated by East Asian members.
- ASEAN and five regional partners in 2020, signed the Regional Comprehensive Economic Partnership (RCEP), arguably the largest free trade agreement in history which includes China, but excludes the USA. RCEP covers a market of 2.2 billion people and $26.2 trillion of global output. The partnership will create a trade grouping that covers about 30% of the world’s population.
- India, Japan, Australia and the United States together formed the Quadrilateral Security Dialogue (QSD, more commonly known as ‘The Quad’) representing the growing defense ties between the members. It held its first ever virtual summit level meeting last year.
The World Economic Forum of 2022 rightly titled their theme for the year, “History at a Turning Point: Government Policies and Business Strategies”. As the World wobbles and finds its footing in this new era, we believe, at least within Asian equities, the time is ripe for economies with strong domestic consumption and domestic production capabilities such as India and China.
Countries that serve as an alternative or complement to China in terms of production will also do well in Asia as multinational companies seek to produce locally/close to end customer. Vietnam for instance has for many years positioned itself as a “china plus one” site for global multinational companies.
ASEAN, with his regional tie ups on trade, will also likely come out stronger.
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