The long and short of it: Deglobalisation, slow-balisation or re-globalisation?

The post-war world order is based on sovereignty and territorial integrity. According to former German ambassador to Russia, Rudiger von Fritsch, keynote speaker at our most recent Invesco Fixed Income (IFI) Global Investors’ Summit, Russia’s Ukraine war upends this by assaulting globalisation. The international system and economy must be protected and adapt. 
 

Historical context

The Cold War global economy was carved up

Given an adversarial relationship, “First World” Western economies traded among themselves, staying clear of the “Second World” Soviet bloc. “Third World” developing countries were in a half-way house, trading with the West and Soviet bloc. Some were isolated, like China or North Korea, by choice, or by US-led sanctions, like South Africa and Iran.

After the Soviet collapse, the Western economic and political model became more influential. The West encouraged emerging markets to pursue political and economic liberalisation. These included: lightly regulated goods, service, labour and financial markets; low barriers to foreign trade and investment; independent central banks, judiciary and media; democracy, freedom of expression, choice and association.

As trade barriers fell, productivity accelerated

Tight supply chains were structured to be “lean-and-mean” – maximising efficiency, minimising production costs and inventory. These achievements boosted potential growth, return on capital and per capita incomes (Figure 1).

Some countries began to catch up with the West – especially China. South Korea’s catch-up even accelerated. Russia emerged from post-Soviet crises and began to catch up as Putin restored stability.

Limits to globalisation

Underpinning these gains was a view that integration would reduce the risk of conflict by spreading prosperity and make the cost of war unacceptably high. But Russia’s invasion of Ukraine demolishes such hopes and is dramatically changing the West and the world.

Remilitarisation in Europe is beginning. Germany has abandoned “Ostpolitik”. This is its framework of economic engagement with the Eastern bloc that guided its foreign and security policy for generations. It has committed to boosting defence spending sharply.

The global peace dividend is disappearing

Military spending may rise beyond Cold War levels to restore the security environment for economic activity. This could raise public spending, implying higher taxes or bond-financed deficits, diverting resources from private consumption and investment.

Perhaps most important of all, financial and economic integration can no longer be expected to prevent conflict – and imposes significant economic costs on all sides if war does break out. Where outright conflict is ruled out by the risk of nuclear war, economic decoupling may be the best option. 

Commodity markets are already segmenting regionally due to sanctions aimed at decoupling

Figure 2 shows that the Russian Urals/Brent price spread has collapsed sharply, even though oil prices shot up with the invasion and boycotts, for the first time. Western firms self-sanctioned, reducing Russian oil purchases. The West have boycotted Russian oil; but India and China, are buying more.

Geopolitics and war do not threaten globalisation alone. National politics and income/wealth inequality also matter

Brexit reintroduced UK-EU trade barriers into the most integrated free-trade zone in the world.  President Trump also imposed tariffs in US-China and US-EU trade, the largest economic relationships in the world.

Given political and geopolitical pressures, guardrails and ringfences are rising in the global economy

Barriers in specific, sensitive sectors, “dual-use” technologies that can be used for both civilian and military purposes are very likely. These include high-tech, artificial intelligence and big data semiconductors.

“Friend-shoring” – US Treasury Secretary Yellen’s idea of relocating supply chains to reduce risks to national security or values may complement goals like resiliency and redundancy. These are a major shift from “just-in-time” approaches that minimise inventory and optimise efficiency regardless of location.

Secondary sanctions and self-sanctioning, driven by a severe Western public backlash against Russia’s invasion, also matter. Firms and investors need to consider stakeholder, reputational and national security concerns, and an increasing emphasis on non-economic and financial factors in their decisions.
 

Limits to de-globalisation

There are many reasons to expect deglobalisation. Geopolitical tensions and domestic political dynamics point away from even “slow-balisation”.

Yet we expect deglobalisation to be limited. And we don’t expect any significant further global integration. Rather, we expect “re-globalisation – the restructuring of trade and investment relationships – not comprehensive decoupling.

That said, we expect as much disengagement with Putin’s Russia as quickly as possible. And we don’t rule out further radical decoupling, in the event of other major conflicts.

Any new trade deals are likely to be regional or bilateral, not global or multilateral, amounting to re-globalisation. Further integration would be based on geographic, sectoral or security goals, rather than pure economic and financial merits.

We believe full-blown de-globalisation would be too difficult, costly and dangerous. Integration did foster great interdependence among many major economies, whatever their political system or ideological orientation.

Figure 3 shows large, persistent current-account surplus/deficit economies. The US is the world’s largest, most persistent major deficit country. The UK and EM countries like Brazil, India and South Africa, are relatively small. On the other side of the ledger: a range of major surplus economies – China, the eurozone, Japan and commodity exporters, Saudi Arabia and Russia.

Thus, the US and its trading partners need each other. Full deglobalisation would likely be demand-deflationary for trade surplus economies, and stagflationary for the US and other trade deficit countries.
 

Freezing/seizing foreign exchange reserves: Prelude to de-dollarisation?

Shortly after the invasion, the West unexpectedly froze half of the USD650 billion in total Central Bank of Russia foreign exchange reserves under its jurisdiction. This sanction triggered doubts about the dollar’s role as the dominant reserve currency. While we share the concern, we believe rapid change is unlikely.

The freeze was done jointly across leading reserve-currencies, rather than another unilateral US sanction. It wasn’t done lightly either, but for what the West sees as a major assault on the international system and a sovereign, fledgling democracy.

There’s no clear alternative to the US dollar. The EU was as involved as the US, which probably rules out the euro as an alternative to the dollar. Concerned about reserve freezes, the Central Bank of Russia shifted half to gold or Chinese renminbi after the annexation of Crimea. Yet it left the other half within Western reach, probably because it could not find deep or liquid alternatives.

Norway, Switzerland, Japan, Korea, China, Saudi Arabia, Russia, India and Brazil hold the bulk of some USD15 trillion in global official foreign exchange reserves. Most are unlikely to shift into renminbi, given geopolitics as well as the sheer scale of liquidity and investment needs.

Instead of a costly, complex portfolio rebalancing away from the dollar, international transactions may switch to other currencies to avoid Western reach. Some of Russia’s energy trade already seems to be shifting to renminbi, Indian rupee and Turkish lira.

However, less reliance on the dollar in global trade may reduce inflows into US asset markets. The US needs foreign capital to fund its trade and fiscal deficits, so such reduced flows may imply somewhat higher interest rates, a more volatile dollar and slower growth.

Investment implications: Diversification, instead of convergence or divergence strategies

Re-globalisation is likely to increase the benefit of country selection and diversification. Geo-economic friction (e.g., Brexit; Trump’s fair-trade focus), supply-chain restructuring, geopolitical tension or open conflict all point to diverging national economic and financial policies, and performance.

This stands in stark contrast to the asset-class dominated performance of recent decades. In the heyday of globalisation, risk premiums converged and moved together as the global economy became increasingly integrated. Financial crises and structural changes, like demographic transitions, caused divergences – as with Japan from the early 1990s or during the eurozone financial crisis (Figure 4).

Evidence of diversity in the global economic continues to emerge. China’s central bank is easing, the and the Bank of Japan remains dovish. Meanwhile, the US Federal Reserve and Bank of England have become hawkish, and the European Central Bank is moving toward tighter policies. This is reflective of major economies are in diverse cyclical positions. Accordingly, bond market performance is diverging around the world.
 

Conclusion

Globalisation has underpinned major economic gains – higher productivity, faster growth, lower inflation – since the Soviet collapse in 1991 and China’s entry in the World Trade Organisation in 2001 through the last decade. Recently, international tensions (e.g., Brexit, US-China rivalry) boosted trade barriers, threatening these gains.

Russia’s Ukraine war and Western retaliation are weaponising trade and finance. Many fear deglobalisation, while others hope for “slow-balisation” – i.e., slowing integration. We expect “re-globalisation” – i.e., decoupling in some sectors and economies and openness elsewhere – and a silver lining: value in selective diversification as national performance diverges with policies.