Before we turn to our 12 things to watch in the global economy in 2020, let us briefly review 2019. The deterioration in the global economic and geopolitical environments continued unabated last year. In a tumultuous year that has now drawn to a close, the global economy experienced its slowest growth rates in a decade, world trade continued its downward trajectory, and so has industrial production (incl. in China), corporate earnings entered into free-fall, while the overall global economic impacts of the trade wars have only just started to show. Moreover, the global USD liquidity shortage continued to cause great trouble, especially in emerging markets and the European banking sector, forcing the US to reinstate quantitative easing (QE) in all but name after a sudden spike in the repo rates in September. Meanwhile, equity markets, not least in the US, are making new highs, solely carried by the continuation of large-scale stock-buybacks, mergers and acquisitions and central banks’ loose monetary policies, while being utterly divorced from the goings-on in the real economy. At the same time, political and geopolitical tensions are on the rise, and an increasing number of countries – including Argentina, Chile, Bolivia, Honduras, France, Spain, Iraq, Lebanon, Algeria, Iran and Hong Kong – are experiencing major political unrest, street protests or even violent uprisings. Last but not least, the renewed great power competition – aptly called ‘The Return of History’ – especially between the US and China/Russia, continues to intensify, signalling not just the emergence of a far more multipolar world order, but at the same time the end of globalisation, even de-globalisation.
All these trends will be carried over and continue to intensify during 2020. Against this pessimistic, but in our view realistic, background, we will now offer our list of the 12 things to watch out for in the global economy during 2020:
- Countries remain unprepared for a more protectionist and de-globalised world.
The world is becoming more chaotic and protectionist by the day: Brexit and ‘America First’; the US-China trade war; severe sanctions regimes against countries, particular projects (Nord Stream 2) or even individuals; military actions in regional crisis theatres, led by, in particular, Turkey, Russia, China, Saudi Arabia and Iran; and domestic political protests, uprisings and a re-emergence of right-wing national chauvinism. All this points towards a more protectionist and less-free trade world economy. This transition towards a more multipolar world of regional trade and geopolitical blocs is taking place without a clear blueprint or broad-based agreement between nations on how to manage this generational transformation of the international order, or even without nations having a clear idea of how to adjust their own domestic economies and systems to ensure competitiveness, economic wellbeing and societal stability. Most governments remain blissfully unaware of how to continue to attract international talent, especially technology experts, or nurture sufficient domestic talent, to close any domestic skills gaps, replace international value chains with domestic or regional production systems, or how to put in place proper financing for small and large projects in domestic markets in order to deal with the breakdown of the Dollar-denominated global monetary and financial system (and given lenders increased reluctance to provide financing to struggling SMEs). While we expect to see more efforts from governments during the course of 2020 to find new ways to source foreign and nurture domestic talent as well as encourage and support the developments of domestic tech start-ups and innovation hubs in order to create the local ecosystems needed in the context of a more protectionist and de-globalised world economy. In the absence of any international agreements on how to manage the shifting world order, and given the lead time for such measures, we do not expect to see any significant impacts on growth and stability of such early-stage initiatives during 2020.
- The decline of multilateralism continues apace.
In an age of ‘America First’ and Brexit, the multilateral liberal international order is dissolving with increasing rapidity. While the 1990s and early 2000s were still characterized by globalization, liberalization, multilateralism and global integration on the back of large-scale multilateral trade deals and a functioning WTO, all these developments have gone into reverse. In addition to the worsening trade wars, international sanctions regimes, increase in bilateral trade deals and currency swap arrangements, of particular importance – and hardly noticed – has been that the WTO has effectively become defunct as of 11th of December 2019 when two out of the three remaining Appellate Body members’ terms expired and were neither renewed nor replaced by new members. This will almost certainly make the trade wars even more acute, with no international body left to at least provide a forum for discussion and adjudication of some sort.
- The trade war between the US and China will escalate further.
Whether or not the US and China will announce a ‘breakthrough’ in their ongoing negotiations and a trade ‘deal’ of sorts, in reality the trade and financial war between the US and China will continue to worsen over 2020. This is because China will never agree to meet the real US demands, which have always been for China to fully open up its capital accounts, liberalise its economy and financial markets and allow its currency to free float against the Dollar. As a result, we anticipate the US to raise tariffs on all imports from China, and to as high as 50% or more across the board, in the course of 2020.
- The US trade war against the EU will start for good in 2020.
The next victim of the US trade war will be Europe. The German manufacturing sector has already felt the side effects of the US–China trade war and the impending Brexit, and select German companies, especially in the important automotive sector but also Deutsche Bank banks and Bayer fell victim to numerous legal cases in the US that have resulted in several punitive fines. Moreover, the Trump administration has imposed tariffs on Boeing’s main challenger in Europe, Airbus, for competition distorting practices and sanctioned European companies that are part of the controversial Nord Stream 2 pipeline project. Trump has also already threatened, however, to increase these tariffs as well as raise punitively high new tariffs on European (read: German) car manufacturers; to raise up to 100% direct tariffs on select EU exports in retaliation for the proposed French and other European Union members’ digital services tax on mainly US tech giants.
- The worsening USD liquidity shortage internationally will claim more victims.
With the Dollar staying strong amidst the unprecedented level of USD-denominated international debts outstanding (currently around $12 trillion) despite the return of QE in the US, unless it weakens markedly, it will claim more victims in 2020. This Dollar debt could easily trigger balance of payment and currency crises in several emerging market economies, and perhaps even lead to another banking crisis in the Eurozone. The widening US budget deficit, the increasing problems in the interbank market, as well as the growing reluctance of the US primary dealers to lend internationally will further worsen the situation, potentially heralding major international private and public sector defaults during 2020.
- The end of austerity and the return of activist fiscal policies in the West.
In 2020 we will see a return to more independent and activist fiscal policies in the West, but especially in Europe. This development comes not least on the back of calls for more urgency (and government spending) on averting a climate change emergency. However, calls for a ‘Green New Deal’ have been heard frequently over the past few years from central bankers, leading New-Keynesian economists and proponents of Modern Monetary Theory, among others, but have so far received only scant public backing from leading European politicians. European policymakers have instead, until recently, continued to follow the German-led austerity mantra in the hope of keeping government deficits and debt in the Eurozone in check. With central banks, economists and policymakers now increasingly worried about the precarious state of the global economy, calls for more expansive fiscal policies by Eurozone governments have become louder in recent months. This is not least in order to complement the ECB’s already highly accommodative monetary policy that appears to have reached its limit in terms of their effectiveness to stimulate markets. We expect to see a significant expansion of government borrowing, not least in Germany, throughout 2020 in order to create new collateral that can be monetized by the ECB, at least temporarily prevent the Eurozone to fall into a deep recession, but which will also significantly increase Eurozone government debt at this late stage in the credit cycle.
- China‘s current account will turn negative on an annualised basis.
Despite all of China’s efforts to re-price its energy and other crucial commodity imports in its own and other, non-USD, currencies in order to escape the US trade and financial war, and to address its own USD debt problem and deteriorating current account, its efforts will not be sufficient and effective enough in the short term to avert its current account turning negative on an annualised basis in 2020. This means that China’s investments, especially in the Belt and Road Initiative, which have been mainly in USDs, will slow down markedly in 2020, causing numerous potential problems for its geopolitical agenda and its efforts to internationalise the yuan. This could also make a more sudden and disruptive Chinese (perhaps in partnership with Russia and several other partners) move away from the USD-dominated financial system even more likely, especially if China manages to successfully introduce a CBDC. Such a more rapid move away from the Dollar could in the worst scenario even take the form of China reneging on some or all of its outstanding USD debts.
- The Hong Kong Dollar’s peg to the USD might come under increasing pressure in 2020, but we do not expect it to break.
Given that Hong Kong is home to a banking system that is levered up to around 850% the size of its economy, a household leverage of over 300% of GDP, a corporate debt-to-GDP ratio of 224% and a house-price-to-income ratio of 18, the combination of continuing domestic political unrest, the ongoing USD liquidity shortage, the trade wars and a continuing global economic slowdown, which have already plunged Hong Kong into recession, could easily spark a financial crisis in the tiny Chinese enclave during 2020. Hong Kong-based banks are issuing unprecedented profit warnings, tourism has collapsed, retail sales are tanking and the threat of an eventual Chinese intervention to put down the protests continues to loom. It is against this backdrop that fears of Hong Kong’s current account turning negative and an eventual balance of payment crisis that could force Hong Kong to end its currency’s longstanding peg against the USD are rising. While it can’t be ruled that this peg will break, we don’t expect this to happen yet during 2020, since Hong Kong still has highly liquid currency reserves. According to Cissy Zhou, writing for South China Morning Post and quoting James Lau, secretary for financial services and the treasury, Hong Kong’s linked exchange rate system “is underpinned by a massive Exchange Fund, which is worth over HK$4 trillion (US$511 billion) and equivalent to 2.5 times the monetary base”. Nonetheless, we don’t expect the political crisis in Hong Kong to resolve itself anytime soon, and thus Hong Kong’s capital outflows and broader financial situation to continue to deteriorate over 2020.
- The multi-currency pricing of energy and other commodities will speed up in 2020.
The increasing multi-currency pricing of energy sources, and other commodities, that we are already observing will speed up markedly in 2020. This trend has gained pace especially since China launched its oil futures contract priced in yuan and backed by gold during 2018. While the renewed US sanctions against oil producers such as Iran and Venezuela have already led to these countries selling their oil in currencies other than the Dollar in order to get around the sanctions, other important oil and commodity producers, especially those experiencing diplomatic crises with the US, might follow suit. Nord Stream 2 in particular could lead Europe to become more independent of the US Dollar, while even the staunch US ally Saudi Arabia might start a more multi-currency pricing of its oil exports in the wake of its Saudi Aramco IPO.
- The first leading global central bank will introduce a digital currency.
According to the Bank for International Settlements (BIS), as many as 70% of the world’s central banks are already exploring the possibility of introducing digital currencies. Since Facebook announced its intention to issue its own digital private currency, Libra, world central banks have used this ‘threat’ to national sovereignty in money as the raison d’être to speed up their efforts at creating central bank digital currencies (CBDC) based only in part on the blockchain distributed ledger technology that has characterized existing private sector, decentralised digital currencies such as Bitcoin or Bitcoin Cash (and numerous others). The country that is alleged to have progressed furthest down the road of introducing a full-fledged CBDC is China, and there have even been some observers who believe that China might already start issuing such a digital yuan sometime in 2020, potentially even making it available throughout Asia and along the New Silk Road.
Two long-tail events:
- A spike in energy prices and the return of inflation
The authors of this paper debated at length (and ultimately disagreed) whether inflation could already make a serious comeback in 2020 despite such powerful countervailing factors as secular stagnation, coming on the back of rapid technological advancements, already dire income and wealth inequalities globally, as well as unprecedented global debt levels. While these factors are all strongly deflationary, and might have outweighed, for now, the factors representing the other, and inflationary, side of the coin, i.e. de-globalisation, negative interest rates and ultra-loose monetary policies globally (as well as the return of more activist fiscal policies) – a situation that could become extremely inflationary for non-reserve currency areas in particular (essentially for all currency areas except for the USD, for now) – the recent killing by the US of the commander of Iran’s Revolutionary Guard’s Quds Force, Qassem Suleimani, might change the dynamics at play. Should Iran respond to this US action in a major way, as it has vowed to do, this latest escalation of tensions could quickly spiral out of control and lead, at the very least, to a serious spike in energy prices, which in turn would have serious inflationary implications for the world economy, especially for net energy importers like the EU, Japan and China.
- A US (and global) stock market crash
As already alluded to, stock markets have continued to make all-time highs despite being increasingly out of sync with developments in the real economy, and even with after-tax profits. It has also become increasingly clear that the S&P 500 (and other US markets) is now almost entirely carried by the return of QE in the US. The behaviour of the S&P 500 since the Fed has revived QE since the repo rate spike in September is entirely in line with the Fed’s renewed expansion of its balance sheet. In the three and a half months since the Fed re-started its purchase of mortgage-backed securities and especially USTs after a short, but fatal, period of quantitative tightening (QT), it has expanded its balance again by over $415 billion. During this period, its balance sheet declined for just one out of 12 weeks, and it was for exactly one week as well that the S&P 500 declined somewhat during the same period. According to an article by Zerohedge, for some reason the Fed has been suggesting that it might seek to slowly start transitioning away from its repo interventions and even that “the calendar of repo operations starting in mid-January could reflect a gradual reduction in active repo operations”. Should the Fed really make good on this ‘promise’, and not replace this liquidity withdrawal with other injections of liquidity, markets might be in for a replay of late 2018, at the very least. Given the overall USD shortage globally, any such actions by the Fed would also quickly feed through to other stock markets around the world.