Taking Stock Spring 2021

Globalism may be dead! But long live globalisation!

The world of capital markets is still dominated by US equity and bond markets. Will today’s capital markets eventually follow trade and reorient themselves towards Asia?

Nov 15, 2021

8 minutes

Michael Power
The world of capital markets is still dominated by US equity and bond markets. Will today’s capital markets eventually follow trade and reorient themselves towards Asia?

The popular – even populist – narrative has it that globalisation is dead.

It isn’t; it is just being – quite literally – re‘Oriented’. The globalisation era we are soon entering will no longer be centred on the West with the US as its anchor: it will be Asia-centric with China at its hub. After a two century safari to the North Atlantic, the centre of economic gravity is returning to from whence it came and to where it has been for 21 of the past 23 centuries: Asia.

Yes, the woolly-worded globalism that littered the rhetoric of the West’s political elite after the 1989 fall of the Berlin Wall may have now died and been hurriedly buried. But then this interment is hardly surprising. In the 20 years since China joined the World Trade Organisation (WTO) in 2001, the commercial arm wrestle between East and West has seen the latter cede considerable ground and the former visibly gain the upper hand.

COVID has had the effect of accelerating the global transfer of power.

With hindsight, we will likely and ironically learn it was Donald Trump who called time on the US-centred Old Order even as he tried to eulogise it with his ‘America First’ policy. Global influence has visibly slipped from America’s grasp with President Biden not being able to stem the continued outflow, let alone reverse it. Afghanistan may not be the full stop to this sentence, but it comes close.

As Yuval Noah Hariri noted in March 2020, pandemics fast-forward history. Thus COVID has had the effect of accelerating the global transfer of power. That the US was last year to wake up to the statistics that over 90% of its personal protective equipment needs and over 80% of the ingredients required for its antibiotic regimes would be ‘Made in China’, spoke volumes then. And it still speaks volumes now.

And it is not just the geography of the global economy that is shifting its centre of gravity: it is the very way that economies are run by their governments. Not just in China but almost everywhere, the state is becoming more involved in the economic affairs of its citizens. Since the early 1980s, China has championed its model of state-directed production. In the West, even before COVID, partly because of aging populations, the Old Order was moving steadily towards state-subsidised consumption. COVID served only to quicken that migration. In its wake, Western nations particularly have disgorged large amounts of the detritus of debt that was used to fund that consumption.

Granted, China’s debt has risen substantially since 2000 too, but at least it has something to show for it: the infrastructure required to accommodate a further 400 million citizens in cities (60 million more than the US’s entire population), two thirds of the world’s high speed rail track, 8 out of 11 of the world’s busiest airports, a third of global solar and wind capacity, and a lot more besides.

Whilst the shifting of global economics is very evident, of course this has yet to be reflected in military terms, even if China technically now has the world’s largest army and – measured by vessel numbers – largest navy. This begs the question: Has the US now become a militaristic Sparta to China’s more commercially-minded Athens? As we are reminded in Graham Allison’s book, “The Thucydides Trap”, ancient arm wrestle did not end well for the Spartans.

But the focus here is more on the economics and whilst the US still has the largest economy, its lead over China is shrinking fast. Some predict 2026 as the catch-up year, coincidentally the same year India is forecast to overtake China in population size.

COVID had hastened the EU and the UK into China’s camp.

By the end of 2020, only three countries of size traded more with the US than with China: neighbours Canada and Mexico and nearby Colombia. COVID had hastened the EU and the UK into China’s camp.

Hollowing out of Western economies

Perhaps the biggest reason behind this commercial shift is that it suited the profit-seeking raison d’etre of the world’s multinationals: exhibit A is for Apple. Supply chains originating in China (and now broadening out within Asia at large) were and still are built upon low cost yet efficient labour. This in turn has facilitated corporate structures that assured the maximisation of profits and, lest we forget, aided the minimisation of taxes. Once China had joined the WTO in 2001, it would nearly always have been competitive suicide for the purveyors of Western brands NOT to outsource their production to low wage cost China. And whilst some Western multinationals invested directly in Chinese production facilities, many more opted for supply sourced from contract manufacturers, as Apple did from the likes of Taiwanese-owned Foxconn.

The hollowing out of the West’s industrial base quickly followed the establishment of this new production model. Real blue collar wages in the West frequently declined as a result, or worse still, the jobs vanished altogether.

Only Germany and Japan partly insulated themselves against this corrosion, and a good part of this was due to their industrial strength in intermediate and not branded goods. Still, both their auto sectors have also invested heavily in Chinese-based productive capacity. In the past few years, however, there has been growing evidence that – in select areas – even Germany’s über competitive “Mittelstand”1 has felt the chill competitive winds blowing in from China. Battle was first joined in areas like solar panels; Germany’s heroes were soon vanquished so that today 9 out of 10 of the world’s largest panel makers are Chinese (or based in China like Canadian Solar). The same is now happening in respect of wind turbines; Chinese companies make up 6 of the world’s top 10. Looking ahead, Chinese electric battery makers – led by CATL – appear to have won their war even before the first battle has been joined!

Reorientation of global capital markets

So where does all this leave us as global investors? The world of capital markets is still dominated by US equity and bond markets, both of which are of course denominated in the US dollar.

US equities still have a near 60% weighting in MSCI’s flagship global index, the All Country World Index. The yield on the US 10-year treasury is the global reference price – the so-called ‘risk-free rate’ – for calculating the cost of capital. The US dollar is the unchallenged language of capital.

Yet if history is any guide, where trade leads, capital eventually follows: London ceded the crown of being the centre of global finance to New York about the time when World War One broke out. Will today’s capital markets eventually follow trade and reorient themselves towards Asia? With HSBC predicting that East Asia will account for close to 50% of global GDP by 2030, this seems distinctly possible.

So what do the runes say might be in store for global capital as the 21st century moves into adulthood? The map below reveals some telling indications. And recent movements in the Global Financial Centres Index –between 2020 and 2021 – may even capture the emerging story:

  • By 2030, the world’s three big markets will likely be New York, London and Hong Kong … and not necessarily in that order as Hong Kong has already reached four times the share trading volumes of the volumes traded on London’s main exchange.
  • China’s second-tier markets will no doubt still be operational but already Shanghai and Shenzhen are electronically linked to Hong Kong and, in share trading at least, losing ground to it.
  • China’s other markets appear to be falling in behind Hong Kong. From 2020 to 2021, Shenzhen fell from 8 to 16, Shanghai from 3 to 6 and Beijing from 6 to 8. Yet Hong Kong rose from 4 to 3.
  • The reason for this is that Hong Kong has become the international face of Chinese equity trading. This entrepôt status for global capital flows seems set to grow.
  • Shanghai may yet emerge as the prefered market for commodities (gold, oil) and perhaps government bonds: China’s Chicago.
  • Shenzhen may yet retain its standing with emerging companies: China’s NASDAQ.

Global capital markets by 2030: three giants in three time zones

Global capital markets by 2030: three giants in three time zones

Source: Global Financial Centres Index 2021.

That leaves us thinking about the future of the US dollar. Expect its current status to be more durable. Technically, the pound sterling held the crown of being the world’s reserve currency until the early 1950s, more than 50 years after the US overtook the UK in economic size. (Reserve currency refers to a country’s allocation of its foreign exchange reserves in the cash holdings of the currencies of other countries.)

Do not expect the same time delay to characterise the Chinese renminbi’s ascent to top spot. It will likely happen much more quickly, perhaps aided by China’s early championing of the crypto renminbi. But for now and for the balance of this decade, expect the US dollar to rule the currency roost.

Meanwhile, as we are reminded every day, the sun continues to rise in the East and set in the West.

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1 According to Financial Times, “Mittelstand” refers to small and medium-sized companies, which are regarded as the backbone of Germany’s economy.

Authored by

Michael Power
Global Strategist

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