Brexit, rising populism across Europe, the ascent of Donald Trump in America, and the backlash against income inequality everywhere.
A slew of political and economic forces have nurtured a growing narrative that globalization is now on life support—a potential game-changer for global financial markets, which have staged a rapid expansion since the end of the Cold War thanks to unfettered cross-border flows.
No more: Trade volumes have stalled while the “politics of rage” has taken root in advanced economies, driven by a collapse in the perceived legitimacy of political and economic institutions, a new report from Barclays Plc warns. The result, the bank says, is an oncoming protectionist lurch—restrictions on the free movement of goods, services, labor, and capital—combined with an erosion of support for supranational bodies, from the European Union to the World Trade Organization.
“Even mild de-globalization likely will slow the pace of trend global growth,” Marvin Barth, head of European FX strategy at Barclays, writes in the report. “A sense of economic and political disenfranchisement due to imperfect representation in national governments and delegation of sovereignty to supranational and intergovernmental organisations” has generated the backlash, he said. He cites as a major factor the collapse in support for centrist parties in advanced economies and adds that the role of income inequality may be overstated.
The report echoes Harvard University economist Dani Rodrik’s earlier contention that democracy, sovereignty, and globalization represent a “trilemma.” Expansion of cross-border trade links—and the attendant increase in the power of supranational authorities to adjudicate economic matters—is a direct threat to representative democracy, and vice-versa.
The veto Monday of the EU’s free trade deal with Canada by the Belgian region of Wallonia—whose leader said the deadline to secure backing for the deal was “not compatible with the exercise of democratic rights”—is a sharp illustration of this trilemma.
Barth paints a sweeping picture of the global investment landscape in this new era.
Barclays isn’t the first bank to paint this picture—Bank of America Merrill Lynch warned earlier this month that recent “events show nations are becoming less willing to cooperate, more willing to contest.” Looser fiscal policy, trade protectionism, and wealth redistribution could unleash a wave of inflation, BofA argued, recommending that investors snap up real-economy assets to hedge against a “war on inequality.”
David McWilliams, a former economist for Ireland’s central bank, wrote in an Oct. 14 article that the backlash against globalization represents an especially major shift for the U.S. Federal Reserve and its policies.
“Because we are so used to disinflation being the objective, it is difficult to get our heads around the following: if American politics shifts to address middle class insecurity and inequality by introducing tighter immigration, protectionism, and moves to higher wages, then inflation will become not just the unintended consequence of policy, it will become policy itself,” McWilliams wrote.
Rising inflation means the discount rate investors use to value assets will naturally rise—threatening asset valuations—while short-term market rates will become less stable, leading to an increase in market volatility, he argued. The Barclays analyst also reckons a fall in trade volumes and protectionism will create higher inflation—and, thereby, tighter monetary policies—in advanced economies, while fiscal policy will be increasingly used as a tool to pacify the discontented.
While the view that import restrictions will fuel inflation is largely straightforward, the outlook for currencies is mixed. Import substitution reduces demand for imports and thereby reduces demand for foreign currencies, while tighter trade balances (all else being equal) also tend to place upward pressure on currencies, the economists argued. What’s more, the currency dynamics of a sharp rise in protectionism in the U.S. are unique. “The fiscal cliff and debt downgrade revealed that bad policy choices in the U.S. still result in safe haven inflows,” the analysts wrote Oct. 14. “Higher tariffs might have a similar impact: U.S. assets are likely to benefit from a flight to safety or flight to quality bid in the face of a global stagflationary shock.”
And there’s the rub: If major advanced economies erect trade restrictions at the same time, the net impact on relative exchange rates and the outlook for carry trades—if interest-rate differentials stay constant—might be limited even as global output stages a downturn.