About this episode long viewNeil Shearing, group chief economist at London-based research firm Capital Economics, discusses where the problems (and strengths) lie in emerging markets and how the upcoming election could impact bond markets. He talked about whether there is a conflict between the two countries and why there is a rift between the United States. and the world market.
Below are excerpts from Mr. Shearing's conversation with Morningstar's Christine Benz and Dan Lefkowitz.
Pockets of difficulty and strength in emerging markets
Christine Benz: I would appreciate it if you could also discuss emerging markets other than China. You were an emerging market economist. If you look at emerging markets today, where do you see other regions besides China that have strengths as well as challenges?
Neil Shearing: Pockets of trouble are an interesting idea in emerging markets. Because 25 years ago, if you said to an emerging market investor, “OK, the Fed just raised interest rates by 500 basis points. What happened to emerging market bond markets and emerging market currencies?” You would have predicted that there would be an absolute apocalypse. But instead, we don't see it. And indeed, in many respects, central banks in emerging economies have been far better at dealing with inflation shocks and inflation than central banks in developed countries.
Part of the reason is because we saw high inflation in the 80s and 90s. And they didn't wait to see whether the inflation of the 2020s was temporary. They just implemented a tightening policy. As a result, they were able to strengthen their currencies and weather inflation a little better than central banks in developed countries. But what has fundamentally changed is that this has been made possible because of the transition from fixed to floating exchange rates, and in the bond market from foreign to local currency denominations. In other words, we are seeing structural improvements in emerging market balance sheets. And this became, in a very general sense, the first real cycle in which it benefited them. There are some weaknesses. Argentina is obvious. Turkey is currently making its own adjustments. And, of course, there are even more dire adjustments and crises underway in sub-Saharan Africa. However, I think the economic outlook for large startups is relatively positive.
The question we get all the time is: In a world of increasing geopolitical competition between the US and China, which emerging economies will emerge from China's shadow and become the next China, the next global growth engine? “Can we do it?” I'm not sure that's the right way to frame the problem or think about it. But of all the major economies we track at Capital Economics, I think India is the most bullish in both the short and long term. Demographics are good. It is in a good position to take advantage of the fallout from the US-China rift. The Modi government has pushed through several economic reforms. They're not particularly aggressive in that regard, but they're moving in the right direction. Putting all this together, I think India's medium-term outlook is among the brightest among the major economies.
Will the bond market enable tax cuts?
Dan Lefkowitz: I saw an article in Capital Economics about the election, “Read my lips: No new tax cuts.” Why won't Trump plan further tax cuts even if he is re-elected?
shear: Well, there's a chance he'll try. I'm almost certain he'll try, and if Republicans control Congress, he might be able to get his way and get the tax cuts done. But I think that would require Republican control of Congress. The question in our minds is whether the bond market will allow this. Some of our thinking here goes back to what happened in the case of the UK government in 2022. As some of you may remember, at the time we had this disastrous so-called mini-budget under Chancellor Liz Truss. Due to a dire budget, she remained alive for all of 44 days. But in those episodes, what the government didn't do was as notable as what it did. Heading into the budget, the market was already pricing in a fairly large tax cut. And while what was actually announced that day was slightly larger, it was not dramatically larger than the market expected. The main thing that spooked markets was how these tax cuts were implemented and how fiscal projections were compiled. As a result, the independent Office for Budget Responsibility was sidelined. The Permanent Secretary, a senior civil servant in the UK Treasury, has been sacked. Bond markets were shaken Friday after Thursday's budget announcement. And the prime minister flew out over the weekend and said: Further large-scale tax cuts are planned in the future. ” And of course, on Monday morning, the pound fell out of bed and the gold price collapsed. And it was about the fact that the government was perceived to have lost any sense of fiscal responsibility.
I think that's the danger when it comes to the situation in the United States. It is not so true that the deficit is large. its big. It is not that the debt burden is large. its big. The risk is that things could deteriorate quickly if the bond market perceives that the government does not take fiscal responsibility seriously and has no plan to fund and reduce the deficit in a credible way. Thing. The word “premium” is starting to catch on. It has already gone from a negative state to an almost neutral state. We are starting to get very strong positive because of the high risk in the bond market. I think that's an important brake on the Trump administration and its ability to push for new tax cuts. Will the bond market allow it? And now there is much less fiscal space for tax cuts than there was in 2016, and part of the reason for that is not only because interest rates are so high, but also, of course, deficits are higher and debt The burden is also increasing.
Is the world deglobalizing?
Lefkowitz: You mentioned global fracturing several times. I know this is also an area where your team has put a lot of effort into it. I often hear about friend-shoring and near-shoring. Do you think globalization is in decline or is it just changing?
shear: To be honest, I think it's both. I'm giving you the classic economist's answer. I think this is a classic way economists get things wrong. If you ask someone his opinion on globalization, he usually falls into one of two camps. Some may think that globalization is impossible to unravel and that it is essentially here to stay. Others may see the world as de-globalizing. That means supply chains will be dismantled and production will move back to the U.S. and Europe and out of emerging markets. I don't think either of those are true. One need only look at examples from history to see that globalization can be quickly rolled back. Look at what happened in the early 20th century. There was a small explosion of globalization after World War II, but it stalled in the 1970s. Recent history is full of examples of disintegration or stagnation. I also do not agree with the idea that the world is deglobalizing. The flagship of the reshoring project was to be a Foxconn factory in Wisconsin. And see how it unfolds.
So I think what's happening now is, rather, as you're suggesting, a rift in the relationship between the United States and China. And why is this happening? It is because China has become more liberal economically, and perhaps even more liberal politically, that it has driven China's integration into the global economy, and the U.S. This was because the idea was that it would become closer to democratic economies and other European economies. Instead, of course, it emerged as a strategic rival to the United States. And we are in an era of geopolitical competition. What this means is that the United States and China are splitting apart because of this geopolitical position, and other countries will have to choose sides. Even countries that want to keep their heads down are forced to choose sides. And decisions within those blocs are increasingly based on geopolitics and national security.
And that's the important part. Because if you're thinking about global supply chains, there's no geopolitical reason not to buy toys and furniture and flat screen TVs from China. But if you're in the U.S., there are very good reasons why you shouldn't make your cell phone in China, or rely heavily on Chinese-made batteries for your electric vehicles, chips, data, or biotech batteries. There are many. There are many manufacturing sectors where you can imagine there would be legitimate reasons to cut ties with China for national security reasons. And that is where deglobalization occurs. And it will never return to the United States. Production in these areas will not return to the United States. It goes to a friendlier country, the idea of friend support. In fact, we're seeing that really starting to play out.
In other words, in my opinion, the world has not deglobalized, but at the same time, the era of hyperglobalization has passed and we are now in a world of fragmentation and division. And that will have really dire effects in some areas and consequences in some areas. However, the impact may be minimal in other sectors, such as toy manufacturing and low-end products. If it's about manufacturing, if Trump becomes president and starts imposing 60% tariffs on Chinese goods, maybe even turning away from Europe and starting to look inward toward the United States, things will get even worse. It can become malicious and cause financial damage.
