What I read this week: The scared new world and new wealth creation dynamics

By Ritesh Jain

Is global free trade at risk? Americans have provided this for seven decades and now their President-elect Donald Trump threatens to change that order. But think again, had it been Hillary Clinton at White House, would she too have ended the global system one way or the other? Geopolitical strategist Peter Zeihan analysed the changing world order in an interesting piece.

I also found this Credit Suisse analysis of wealth creation trends around the world.

Enjoy reading and have a great weekend ahead!

Zeihan on geopolitics: The scared new world

Geopolitical Strategist Peter Zeihan, a global energy, demographic and security expert…reveals the “Scared New World” to us, expressing his thoughts on a breakdown of the global system and its impact on the global economy.

“Free trade isn’t really free,” believes Peter Zeihan. Free trade requires someone providing the physical security and global ballast and market access to indirectly subsidize the rest of the system.

The Americans have provided this for seven decades, and for the last three decades they have done so without asking for anything in return. In 1944, Americans re-forged the global system, shifting it from a series of warring imperial networks into a global system, which they personally managed. However, with the Trump rise, this whole thing is now in its final years. Perhaps in its final months.

Trump is a purely domestic entity, disconnected from US governance at all levels. Yet this isn’t all Trump. The United States has been moving this way for a good 25 years, and Zeihan thinks that, even a President Hillary Clinton would have ended the global system one way or another.

The only primary difference he believes to the international order of Trump versus Clinton is “timeframe”. Clinton would move the United States away from the international order in a relatively slow manner. Probably 4 to 8 years. Trump would do it in 4 to 8 months.

Irrespective of the timings, Zeihan was certain that one way or another the global system was going to breakdown and we would find ourselves in the Disorder. He views the world from afar and focuses on the structure. With a shorter runway, a few things which are clarified:

§ One of those first moves — will be to declare China a currency manipulator as well as revoke its status as a free market economy, aiming to put Chinese economy into its first recession in 30 years. The time will prove whether, President Xi’s political consolidation efforts have progressed enough that China can weather the resultant internal political and economic explosion.

§ Almost everything from the Obama presidency will be undone by the end of January 2017, including large law passed during his tenure “Obamacare” and any international treaties negotiated by Obama — whether they be the Paris Climate Accords or the TransPacific Partnership – will be dead.

§ The World Trade Organization will have less than a year to respond to U.S. cases, which may lead to some unilateral moves like obviation of global trade order, if not dealt with in adjudication at a pace and in the way the new White House desires.

§ North Atlantic Treaty Organization (NATO) is expected to be dead for all intents and purposes. Russia’s moves into Ukraine will increase, and broad scale Russian plans for its entire western periphery will accelerate. The only way forward for Europe will be for Sweden and Germany to massively rearm.

§ Formal talks between the United States and the United Kingdom on some sort of post-Brexit trade deal will open. The only question is, “Whether these talks heralds British entrance into North American Free Trade Agreement (NAFTA)?”

§ The alliance with Korea and Japan will no longer require U.S. troops in those countries, and even that assumes the alliance isn’t ended outright.

§ Mexico will have no choice but to work with Donald Trump. The most constructive path forward will indeed be a border wall that Mexico will indeed pay for…but on Mexico’s southern border rather than its northern one. How Mexico City handles this issue will determine the future success of both Mexico and NAFTA.


Rights, wrongs & returns: Global 2017 – State reflation & stagflation?

Macquarie published a report – Rights, Wrongs & Returns: Global 2017 – State Reflation & Stagflation?… with a view of, “The state is emerging as an economic driver rather than just a policy facilitator”.
What was different about the last decade vs. 1950s-80s or even 1990s? The Macquarie report pointed out that the key difference was that the private sector gradually atrophied and no longer multiplied demand at the same pace as previously. This was the reason why the public sector had no choice but to become far more aggressive.

Macquarie said it was popular desire for growth and wealth creation (despite falling productivity) that led central banks over the last two decades towards increasingly more aggressive policies, and the same logic is now forcing the public sector to contemplate even more aggressive fiscal responses, or perhaps an outright merger of fiscal and monetary arms.

“Central bank independence comes from an understanding of the macroeconomic policy problem that is not relevant to our current time”, Larry Summers, November 2016.

After almost a decade of experimental monetary policies, there is a palpable feeling of change in the air. Whilst no commercial bank would dare to unwind monetary accommodation (~1/3 of GDP), monetary stimulus is now finally recognized as counterproductive.

The end of status quo: ‘We can create the biggest economic boom in this country since the New Deal when our vast infrastructure was first put into place. It is a no-brainer’, Donald Trump, Nov 2015. ‘If you are a citizen of the world, you are a citizen of nowhere’, Theresa May, October 2016.

Investors are always comfortable with a status-quo, as they feel confident that there are investment and economic rules that they can follow with some degree of certainty. Hence, death of ‘status quo’ tends to be highly destabilizing, until new policies acquire the same dogmatic value.

Investors are today jumping on a bandwagon of fiscally-led reflation, just as they did in 2009-11 on the bandwagon of monetary-led reflation. Hope of salvation never dies, no matter how much evidence is against it.

Macquarie sees four challenges with the reflationary excitement that arose following Brexit and the latest US elections:

§ The global economy carries 3x as much leverage and unlike ‘80s it is wrecked by tectonic technological shifts. It is also an economy that is struggling to grow productivity and where private sector refuses to multiply demand. Unless this dynamic changes, more aggressive fiscal policies are far more likely to result in stagflation than healthy reflation. Implying, cost of capital and US$ would remain two hard and binding constraints on the ability to do much on a fiscal side.

§ Year 2017 is likely to be a transitional year. The emerging new world would be dominated by the public sector, which instead of trying to facilitate the private sector by offering incentives aiming to change private sector behaviour, will simply give up, and become an active agenda setter and the driver of the economy. In Peter Drucker’s words, the state would go from ensuring the right climate to ensuring weather.

§ In order to be truly successful, the Governments need to break the nexus between borrowing and spending. In this world, the idea of Central Bank independence needs to be junked, and the two arms of Government policy (i.e. fiscal and monetary) need to be merged. We call it nationalization of credit but other investors prefer to describe it in less precise terms as ‘helicopter money’. However, in most EMs, fixed asset and infrastructure spending are likely to be grossly distorting and unproductive.

§ Lastly, there is no doubt that eventually fiscal policies are likely to become ever more aggressive and independent of country’s debt carrying capacity, with distinction between fiscal and monetary policies disappearing and two arms merging into one potent weapon and there will be a need for globally co-ordinated policies. However, it is hard to imagine such co-ordination, unless there is no other alternative.

Summarising, Macquarie states, “We are currently residing in what we have called a ‘Twilight’ zone on the way to a brand new world.” It is likely to be a difficult ‘birth’, but ultimately, the new world would have less trade, greater localization and an almost complete dominance by public sector.

The question is whether one needs a ‘jolt’ to the system first.

Policymakers are unlikely to embrace more radical solutions, until they have no choice and it is unclear that ’17 would bring the required ‘jolt’. Macquarie expects, that healthy reflation (rising real GDP and higher but moderate inflation) remains the least likely outcome, whilst state-driven stagflation (overheating without much real growth) is more likely.

Periods of stagflation could morph into disinflation before flipping back. Neither bonds nor equities are likely to be unidirectional; nor is it certain that bond yields will be higher.

Macquarie expects ‘17 to be four seasons rolled into one. There are far too many cross-currents to second-guess risk trades. Hence, the tactical macro calls to be as risky as relying on pollsters. In this ‘fog of war’, it continues to ignore rather than embrace the state, and highlight non-mean reversionary & secular growth strategies.

Credit Suisse (CS) – Global Wealth Report 2016
In its seventh edition, the Credit Suisse – Global Wealth Report 2016 confirms a course of weak global wealth growth and despite the significance for economic activity, the global distribution of wealth remain scarce.

As per Credit Suisse’s Global Wealth Report 2016, Global Wealth has risen by USD 3.5 trillion to USD 256 trillion, which represents an increase of 1.4%. Among the major economies, the USA and Japan were able to generate substantial additional wealth, while the United Kingdom recorded a significant decline as a result of currency depreciation.

Also, the gap between the world’s haves and have-nots does not appear to be getting any narrower and a mere 0.7% of the global population owns nearly half the world’s wealth. The report identified Russia as the world’s most unequal country with a huge 74.5% of the nation’s wealth controlled by the richest 1% of people. India is the second most unequal country in the world with the top 1% of the population owning 58.4% of the total wealth, followed by Thailand owning 58% of total wealth.
Emerging economies to outperform

Developing economies currently account for around 18% of global household wealth, against just 12% in 2000. At present, China accounts for 9% of the global wealth holders, less than the number of residents in USA and Japan, but well above the number in France, Germany, Italy, and the United Kingdom.

Developing economies are likely to outpace the developed world in terms of wealth growth, although CS estimates, that the developing economies will still only account for just under a third of growth over the next five years.

In contrast, residents of India remain heavily concentrated in the bottom half of the distribution, accounting for more than a quarter of the members. However, the country’s high wealth inequality and immense population mean that India also has a significant number of members in the top wealth echelons. By 2020, China is expected to account for more than half of this growth, with more than 7% coming from India.

India – Holding Pattern
In terms of its own currency, India’s wealth has grown quite quickly since the turn of the century, except during the global financial crisis. Annual growth of wealth per adult in rupees has averaged 6% over 2000 – 2016. Prior to 2008, wealth also rose strongly in dollar terms, from $2,040 in 2000 to $5,100 in 2007.

After falling 26% in 2008, it rebounded, reaching $5,100 in 2010, but since then has fallen 25% due to currency depreciation. Wealth per adult has not regained its previous peak, and was just $3,840 in mid-2016.

Personal wealth in India is dominated by property and other real assets, which make up 86% of estimated household assets. This is typical for developing countries. Personal debts are estimated to be only $376, or just 9% of gross assets, even when adjustments are made for underreporting. Thus, although indebtedness is a severe problem for many poor people in India, overall household debt as a proportion of assets in India is lower than in most developed countries.

While wealth has been rising in India, not everyone has shared in this growth. The share of the top 1% in the country’s total wealth improved from 40.3% in 2010 to 49% in 2014 to 53% in 2015 to 58.4% in 2016. But the numbers do suggest that the very rich are expanding their share at a faster clip now.

The richest 10% of Indians haven’t done too shabbily either, increasing their share of the pie from 68.8% in 2010 to 80.7% by 2016. In sharp contrast, the bottom half of the Indian people own a mere 2.1% of the country’s wealth. There is still considerable wealth poverty, reflected in the fact that 96% of the adult population has wealth below $10,000.

Data from Credit Suisse shows that India’s richest do well for themselves whichever government is in power. In 2000, for instance, the share of the richest 1% was a comparatively low 36.8% of the country’s wealth. In the last 16 years, they have increased their share from a bit more than a third to almost three-fifths of total wealth. Very clearly, most of the gains from the country’s high rate of economic growth have gone to them.

At the other extreme, a small fraction of the population (just 0.3% of adults) has a net worth over USD 100,000. However, due to India’s large population, this translates into 2.4 million people. The country has 248,000 adults in the top 1% of global wealth holders, which is a 0.5% share. As per the estimates, 2,260 adults have wealth over $50 million, and 1,040 have more than $100 million.

Concluding, United States is likely to remain the engine of global wealth growth in the coming years, with total wealth reaching USD 112 trillion by 2021. This is USD 28 trillion more than in 2016, equivalent to more than a third of the gain worldwide. Emerging economies are likely to show significantly more dynamism. In the ranking by total wealth, India will probably jump from 14th place to 12th position, overtaking Switzerland and Taiwan.

India Ratings & Research – One Nation One Tax
India Ratings and Research published a report “One Nation One Tax”, explaining the implications of Goods and Services Tax (GST) and believes GST would have a bearing on the profitability of most industries. Further, additional cess on some of the products, if absorbed by the respective businesses, would impact their margins.

India is set to become a single market. GST would benefit industry as it would eliminate the cascading impact of taxes and allow unrestricted flow of input tax credit, and lower the compliance cost through simple tax regime as against the current multiple tax slabs and laws.
Removal of cascading impact of taxes would result in reduction of prices of most of the goods domestically and would make Indian exporters price competitive in the international markets.

Working Capital Requirement to undergo Change – Implementation of GST would make movement and sourcing of goods across the state borders easier. Availability of tax credit on both input goods and services would impact the working capital profile and profitability of most of the companies positively.
Ind-Ra believes that this increase in working capital due to cash outflow (from payment of tax on movement of goods from one warehouse to another) would be more than off-set by reduced inventories and the consequent reduction in working capital requirement.
Cost of Production to be lower and Cost of Services to go Up – Under GST both the state and central taxes are levied concurrently on the cost and with the uninterrupted input tax credit mechanism, the over-all cost of production would come down.

Since GST would be replacing the service tax, services would become costlier given that the current service tax rate is 15%. Ind-Ra believes that most services would be taxed at a standard rate of 18%.
Sector Implications: Industries that would benefit from lower GST tax rates would include cement and auto manufacturers, while those that could be impacted negatively would include the cotton and apparel segment of the textile industry and print media, which are currently either tax exempted or subject to concessional rates of taxes.

Abatement of tax, if not continued under the GST regime, would have a bearing on the profitability of logistics and real estate industries. Within the infrastructure industry, contracts in project phase can face viability issues if they are unable to pass on the increase in cost due to higher taxes or if the government incentives are discontinued under GST.
Implementation of GST, would increase the cost of services such as telecom, transportation and rented commercial properties space.

Tax Leakage to Come Down – The compelling rationale to switch from the current regime to the GST regime is to eliminate the cascading impact of taxes or simply put “tax on tax” which leads to increase in the price of the end product. Other equally important areas which the GST would address are the multiplicity of taxes at central and state levels, leading to cumbersome and cost bearing compliance exercise for businesses, by bringing about uniformity in tax rates and structure.

Since, the input credit would be available only on taxes paid to the central or state government and after an automated reconciliation through an IT infrastructure, users of input supply would insist on tax invoices to claim the input credit, there by plugging the leakage due to non-payment of taxes or “Kaccha Bills” as it is popularly known in India.

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