At the end of May this year, I wrote an article painting three scenarios for the global economy over the next five years.
The first was “Gilded Cage” in which the rich old millions in America, Europe and Japan continued to construct barriers to block the poor young billions in the developing world from migrating to their countries. While this was completely against the spirit of globalisation which entails the free movement of people and goods between nations, the world economy would go on growing, albeit at a much slower rate than last century.
The second scenario was “Bloodbath” in which the US was drawn into a war with Iran, the consequence of which would be millions of Iranians dying as a result of America’s military might. There would also be widespread destruction in the Middle East as the war spilt over into neighbouring territories.
The third scenario was “Forked Lightning” in which the markets had another crash similar to 2008. The probabilities that I attached to those three scenarios were 50%, 30% and 20% respectively. The overall message was that a day of reckoning might be fast approaching.
Since I wrote the article, American stock market indices have hit record highs and stock markets elsewhere have generally done pretty well too. So the question to ask is whether this optimism is justified or not. Let me go through the flags that I identified last time as possible game-changers and see how they have developed.
The religious flag
Since May, the UK has been dragged into a potential conflict by detaining an Iranian oil tanker as it moved past Gibraltar. The Iranians have responded by detaining a British vessel going through the Strait of Hormuz. Meanwhile, an American drone has been shot down by the Iranians and sanctions against Iran have been tightened further by the Americans. The oil price has risen slightly, but not leapt over $100 a barrel, as the market believes there is still a chance of peacefully resolving the whole dispute.
Nevertheless, Donald Trump has revealed how far he is prepared to go in the region by saying that America could kill 10 million people in Afghanistan in one week to finish the war there; although it was an option he was not prepared to pursue at the moment. He might say the same thing about Iran at some stage, especially if they start seriously enriching uranium again.
The red flag
There is as yet no resolution to the trade war between the US and China although talks are underway again.
At the same time, there is a belief in Washington that Russia intends to meddle in the US 2020 presidential election as much as it did in the last one. More importantly, the strategic arms limitation agreements are coming to an end with little prospect of renewal. This time Russia probably has smarter nuclear weapons than America which was not the case in the last century. Another arms race could begin.
Across the Pacific, North Korea has recently tested a short-range missile in protest against South Korean military manoeuvres. In other words, the red flag does not appear to be going down any time soon, but the markets believe otherwise.
The grey flag
Nothing has changed in terms of the ageing of the population in Europe, Japan and China leading to a slowdown of economic growth in those countries. In aggregate, they constitute over 40% of the global economy. Of course this is a long-term flag, which is the reason that the markets ignore it.
The anti-establishment flag
The rise in influence of anti-establishment and populist movements continues apace. Britain now has a leader in Boris Johnson who resembles Trump in his confrontational and bombastic manner. The odds on a no-deal Brexit have risen; and a pamphlet is being prepared by the UK government to give British citizens an idea of what this means for everyday living. The chances of Scotland having another referendum on independence have increased too.
In the US, Trump’s tweets about the “squad” in Congress who oppose him and the harsh conditions in Baltimore are being condemned as racist and are further dividing American society ahead of next year’s election. It appears to be part of a deliberate campaign strategy on his side to polarise the nation. Even China is now having problems with young people in Hong Kong demonstrating for democracy.
Again, the markets are dismissing this form of populism as irrelevant. Inequality between the rich and the poor can be shrugged off along with racial tensions. The thinking is that, as long as the economy continues to grow and unemployment/inflation remains low, companies and their shares will do well. Dividends will continue to flow. Yet it is generally accepted that social harmony is a key characteristic of a winning nation and, if that is endangered, it could harm the wellbeing of the private sector as well.
The green flag
The environment is suffering even more than a few months ago. The Amazon forests are being cut down at a record rate; there are huge fires inside the Arctic Circle in Russia and Alaska, the smoke being equivalent to Sweden’s annual carbon emissions; and Europe has experienced an all-time high in temperatures causing disruptions in travel and posing a health challenge to old and young alike. Elsewhere, the area around New Orleans has been flooded again with torrential rains. In contrast, certain Indian cities have run out of water.
Despite the increasing evidence that Mother Nature is getting really angry, the financial gurus have no desire to include any negative features of the environment in the algorithms which they use to predict the market’s next move. They are relying on electric cars and renewable energy to sort out of the mess. Technology will always come to the rescue.
The national debt flag
It would seem that within the Gilded Cage, there is still an appetite among central banks to pursue cheap money policies and among governments to run ever-increasing fiscal deficits in order to remain popular with their electorates. Austerity is now a dirty word. We have negative interest rates on some government bonds in Europe which means you pay to hold them.
The Keynesian philosophy of high public spending to avoid the next recession is very much in vogue, as witnessed by Boris Johnson making expensive promises all over the UK and Trump being quite happy to run a one trillion dollar annual deficit in the US federal budget over the next few years.
Thus, the reasonable target of national debt not exceeding 60% of GDP is being breached virtually everywhere in the world, which raises the risk of a default on debt repayments by some country somewhere. Yet, the City of London and Wall Street actively encourage this monetary and fiscal behaviour even if it may ultimately lead to the Forked Lightning scenario. It is good for short-term profits and that is what counts in the markets.
I am not about to change the probabilities that I gave to the three scenarios in May. What I will say is that the events that have happened since then confirm the fairly high probability of 30% attached to Bloodbath and 20% to Forked Lightning. Current markets do not reflect these probabilities. Furthermore, there is plenty of discord between and within nations inside the Gilded Cage which does not bode well for the future. So, like the fox, you must keep your eyes open for surprises and your wits about you to act quickly. In any event, your investment portfolio needs to be sufficiently diversified to weather the storms envisaged in the second and third scenarios of either a regional war or another financial crash.
Stock markets are a prime example of crowd-forecasting and foxes always want to be ahead of the crowd!
Article originally published on News24 on 30 July 2019