My strategic investment talk with the Hong Kong University Graduate Association on 7 March, 2017 - entitled Implications of a Trump Presidency and Shifts in the World Order - Where to put your money in 2017
In his Paper of February, 2017, Homi Kharas, a senior fellow and deputy director of the Global Economy and Development program at the Brookings Institution, outlines the unprecedented expansion of the global middle-class, 88% in Asia.
The following are extracts from his report -
• There were about 3.2 billion people in the middle class at the end of 2016, 500 million more than .... previously estimated. This implies that in two to three years there might be a tipping point where a majority of the world’s population, for the first time ever, will live in middle-class or rich households.
• The rate of increase of the middle class, in absolute numbers, is approaching its all-time peak. Already, about 140 million are joining the middle class annually and this number could rise to 170 million in five years’ time.
• An overwhelming majority of new entrants into the middle class— ..... 88 percent of the next billion—will live in Asia.
• The absolute market size of middle-class spending is larger than previously estimated. In 2015, middle-class spending was about $35 trillion (in 2011 PPP terms), roughly 12 percent higher than ... previous estimate. It now accounts for one-third of the global economy.
• The global middle-class market is now clearly bifurcated: a slow-growing developed country middle class, and a fast-growing emerging economy middle class—with growth in both instances measured in terms of either numbers of people or total spending.
• The most dynamic segment of the global middle-class market is at the lower end of the scale, among new entrants with comparatively low per capita spending.
• Big geographic distributional shifts in markets are happening, with China and India accounting for an ever-greater market share, while the European and North American middle class basically stagnates.
• At a growth of about 4 percent in real terms, the middle-class market is growing faster than global GDP growth, but not as fast as it did in the 1960s and 1970s, the boom years for the middle class.
A larger middle-class population and market has significant environment and social implications. Naturally, assuming technology does not change, the carbon footprint per person will rise as the middle class expands.
Two mitigating factors could limit the extent of this. First, middle-class growth is associated with migration from rural to urban areas and, for a given level of income, households in urban areas tend to have a smaller carbon footprint than households in rural areas, especially for transport. Second, middle-class households tend to invest more in their children’s education and this, in turn, can reduce fertility rates and decrease the long-term population trajectory for the world.
The social implications of a larger middle class are also important. There is considerable evidence that a larger middle class will also imply a happier population, at least for new entrants into the middle class (Kahneman and Deaton, 2010). But there is little evidence to suggest that this will create pressures for more democratic governance or for better delivery of public services, both of which are required for sustained growth. In fact, governments may find themselves unable to meet the growing expectations for middle-class enhancing programs, such as universal health care, public education, pensions, and affordable housing, without resorting to deeply unpopular tax increases.
Getting the right balance between taxes on the middle class and services to support them likely presents the greatest source of uncertainty for this paper’s forecasts.
According to theFinancial Times, China overtakes the eurozone as world’s biggest bank system, more than double that of the United States. China's bank assets amounted to $33tn at the end of 2016, compared with $31tn for the eurozone, $16tn for the US and $7tn for Japan. The value of China’s banking system is more than 3.1 times the size of the country’s GDP, compared with 2.8 times for the eurozone.
While the status reflects global influence, it also reflects on reliance on debt to fuel the economy.
For perspective, let's not forget the gigantic 247 trillion-dollar derivative risks in the US banking system, according to a report in Infowars, a US online free-speech platform. This represents a much greater systemic risk to the banking systems of the whole world.
All in all, it's perhaps time to re-visit Professors Carmen M Reinhart and Kenneth Rogoff's post-Financial Crisis warning shot - This Time Is Different? - Eight Centuries of Financial Folly, Princeton University Press, 2009.
In Foreign Policy (6 February, 2017), Robert Kagan, Senior Fellow of the Brookings Institution, argues that America must check the assertive, rising powers of Russia and China before it’s too late. Accepting spheres of influence is a recipe for disaster. Click here
His argument is based on the following premises -
(a) that the America-led uni-polar world order including strong ties with US allies remains the only one that works;
(b) that the rising "revisionist" powers of Russia and China will not be satisfied with regional spheres of influence, implying that either or both would seek global dominance;
(c) that China, in particular, may push the United States out of at least East Asia, "not only militarily but politically and economically";
(d) that we are returning to the 19th and 20th centuries when Great Power conflicts for spheres of influence led to global wars; and
(e) that to save the world from a looming WWIII, the United States should build up its military further to restore US hegemony.
Kagan dismisses out-of-hand the viability of Niall Ferguson's "tri-polar world order" jointly led or influenced by the United States, Russia and China with strategic "cooperative rivalry" respecting each other's core interests. He considers such strategic balance unsustainable as both Russia and China are dissatisfied revisionist great powers which are bound to progress from an inch to an ell. Instead, he thinks that the only option is for the United States to redouble her military strength to maintain a US-led world order. This emphasis on military dominance merits a little more thorough think-through.
First, it begs the question whether history inevitably repeats itself. In the Age of the Fourth Industrial Revolution characterized by global interdependence and inter-connectivity, concepts of global hegemony, power exclusivity, and a zero-sum-game mentality may no longer work. For example, why should China push the United States off anywhere economically when American finance, technology, and businesses continue to define the global supply and value chain, much to China's benefit?
Second, Russia has shown relatively limited ambition to achieve dominance beyond her Eurasian "near abroad". Notwithstanding narrower national calculations, she has displayed a more proactive role in maintaining regional peace and stability, as in the case of Syria following years of bloody conflict. Similarly, despite assertiveness in the South China Sea, which are critical sea-lanes central to her economic lifeblood, China continues to defend the global trading system, not to mention the international compact against Climate Change. China has also been fielding the largest peacekeeping contingent among Permanent Members of the UN Security Council. Both rising powers are therefore capable of contributing to the global commons. Unless they are deliberately threatened or provoked militarily, it may be too early to conclude that World War III is inevitable.
Third, the United States military is already by far the strongest in the world, with military expenditure exceeding the rest of the world combined. If this is deployed to coerce Russia or China, both countries are likely and well able to respond. Russia's military remains formidable, including possession of more nuclear warheads than the United States. China's military is no longer a walk-over. Her rapid military modernization and build-up is largely in response to a de facto US encirclement of China's vital economic sea lanes with American military assets, including missile and bomber bases, as described in film-maker John Pilger's new documentary "The Coming War on China". In addition to state-of-the-art inter-continental multi-warhead ballistic nuclear deterrence, China is more than capable of defending core interests in the South China Sea. Such defense includes robust ant-access/area-denial (A2/AD) capabilities both above water (such as mobile anti-ship ballistic missiles (ASBMs)) and under water (such as remote-controlled manoeuvrable sea-mines).
Fourth, any dramatic US military build-up is likely to start a vicious arms race with Russia and China, spreading to many theaters, including space. This would only serve to reinforce their deterrence capabilities, consolidating their positions in a tri-polar world.
Perhaps that's why President Trump seems inclined towards greater rapport with Russia. The recent joint astronaut survival training in Siberia is instructive. America's commercial energy interests in Russia may be part of the reason. So may be calculations for a possible US-Russian detente to balance against China. However, Russia is unlikely to come too close to bed with an fickle nemesis responsible for the collapse of the former USSR. Nor would Russia sacrifice China as her largest energy customer by far, or for that matter, as a strategic hedge against American hegemony.
Perhaps that's also why, despite a worrying initial period of apparent apathy, if not hostility toward China, he has sent a letter to President Xi making amends and holding out an olive branch for constructive, results-based, "win-win" relations.
Ultimately, that is, reality speaks louder than rhetoric.
In considering the following highlights as regards China and Mexico, the leading targets of Trump's possible trade wars, it is important to remember that only 19% of China's exports go to the United States, compared with Mexico's 82%. Moreover, thanks to continuing economic re-structuring, exports now only account for 20% of China's GDP, the rest represented by services, investment and domestic consumption.
The following findings of the Goldman Sachs report are noteworthy -
According to Nicholas Fawcett, Senior Global Economist Goldman Sachs, tariffs of 45% and 35% on China and Mexico respectively would reduce America's GDP by 0.77 % by 2019, compared to China's reduction of 0.3%, taking into account likely retaliations and global spill-overs, all-out trade wars are likely to damage the United States more than China.
Immediate losers will be American consumers, who will face increasing inflationary pressures.
Targeting imports misses the point. For example, one-third of imported auto components (including a large proportion from China) are for car production in the United States. Imposing punitive tariffs on these will only make US-produced exports even less competitive. The same goes for many goods and products in the ubiquitous global production and value chain.
Being mooted is Destination-based taxation with border adjustment (DBTBA) equivalent to an import tariff plus an export subsidy. Instead of taxing companies’ total income net of total costs, it would tax companies only on income earned domestically and allow them to deduct only domestically sourced costs. Net exporters (like aircraft manufacturers) would benefit, while companies with a high net import share (like apparel or computers) would suffer. Importers with smaller margins would be the most vulnerable. The Dollar will get a further boost, perhaps neutralizing some of the advantages given to exports.
Depending on the severity of Trump's tariff wars, China may retaliate possibly even more robustly, targeting America's exports of airplanes, cars, agricultural products and even key US enterprises in China. While unlikely, China may also resort to selling more US Treasury bonds, putting pressure on US interest rates.
Trump's aggressive trade rhetoric is in answer to his electorate's deep-seated grievances in the declining traditional machinery, automobile, furniture, rubber, plastics, textile and clothing sectors. Tariffs alone are unlikely to revive the competitiveness of these industries.
A more likely first tariff salvo is to target China's imports of steel, aluminum, glass, and solar, where there is already huge Chinese excess capacity.
As for currency manipulation, the possibility of some window-dressing initiative cannot be ruled out, for example, enacting a non-country-specific, anti-currency manipulator piece of legislation with fast-track presidential powers.
Looming trade wars are part and parcel of Trump's world viewthat America's championship of global trade is being taken for suckers. Instead, according to Dr. Richard Haass, president of the Council on Foreign Relations, "trade has an important geopolitical dividend. It’s a way of supporting allies and promoting human development around the world, as well as integrating adversaries in a way that makes them think twice before they disrupt the status quo". Similarly, "our investment in the rest of the world is not an act of charity; it’s an act of self-interest.".
In an article "The Twilight of the Liberal World Order" (24 January, 2017), a brief for the Brookings Institution, Robert Kagan hits the nail on the head. What matters most is not ISIS. It's the inflexion point of a possible collapse of the liberal world order that has defined global peace and stability since the Second World War.
There is popular anger that American largess as guarantor of the liberal world order has been taken advantage of by "Others". The Trump Presidency shows every sign of abdicating from America's global responsibilities unless compensated by calculated, short-term transactions.
This is feeding the inevitable revisionism of dissatisfied rising powers, which, together with huge historical grievances, are re-asserting themselves to modify the US-dominated world order to suit their own world view and national interests.
All these hark back to the unstable world order prevalent in the late 19th century, eventually leading to two World Wars.
Kagan rightly points out that US global military dominance is best suited to maintain global security. Neither China nor Russia can be a credible substitute.
However, military coercion cannot overturn what may, after all, be the changing tide of history as Western power and influence are beginning to give way to the rising East.
China has been embedded firmly in the world economic order underpinned by the United States. While America is now backing off, China wants to uphold the status quo. From WTO rules to climate change, it seems that most of the world feel unsettled by America's change of course and begin to think that China may be a force for good.
China in the 21st century is no longer the weak China of previous centuries. It is the world's second largest economy, soon to become the largest as the productivity and ingenuity of a fifth of mankind continue to be unleashed.
China's global strength is not the military. Or economic size. It's her economic connectivity. From mobile phones, cars and household goods, almost everything has China embedded, even if the final product is not marked "Made in China". That's why six of the top eight container ports around the world are in China, including Hong Kong. This "centrality" cannot be reversed easily as no other developing country has the manufacturing scale, capacity and global connectivity.
Global connectivity is very much at the heart of the Zeitgeist of the times defined by the world's Fourth Industrial Revolution. Driven by a combination of technologies and powerful integrated cross-border platforms, it is upending business models, labor markets, socio-political matrix, and is reshaping economic, social, cultural, and human environments.
Nothing illustrates the power of internet-economics better than President Trump’s apparent agreement that Jack Ma’s Alibaba internet-driven global business empire could help create a million American jobs by selling US goods and services to China and the rest of Asia, Trump’s China-bashing and protectionist rhetoric notwithstanding.
China is in no position to replace the United States as the guarantor of a new global order. Nor does she wish to do so, knowing her own many limitations. However, a reformed, rising, and more assertive China is sufficient to challenge an American-First world order.
Russia under Putin is also playing her cards deftly. While the United States looked powerless with the Syrian crisis, Russia is now seen as a more effective problem-solver.
The growing global gravitas of these rising powers cannot be deterred by relying only on brute American military dominance.
As President Trump focuses on America First, prioritizing American jobs, profits, and the military, it begs the question whether the world is not being driven towards another historical inflexion point of global instability.