G7 Summit Has Broken Globalization and Leaves the U.S. Economy at Risk
Amid the exuberance, the next recession has started to knock at the door. The knocks have the mild but unpleasant sound of a rise in interest rates. And they announce unpleasant changes for the U.S. economy.
But the effect will be the bearish orientation of equity investors and perhaps trade wars, the pessimists say. Should we run and find shelter before the next economic downturn?
At the G7, the dominant theme was the U.S. and an evident shift in its relationship with Europe.
But if the world focused on free trade and its opposite, tariffs, it’s the U.S. economy that is left exposed to the biggest risks.
One of these comes from the massive fiscal stimulus plan launched in December 2017. The tax cuts might have encouraged some investment and created the impression of greater prosperity. By all means, Christmas 2017 saw families earning their first bonuses in years.
The tax cuts may have produced some short-term gains, but they have mostly helped boost the stock market by way of stock buybacks.
Thus, whatever the strength of the stimulus package, the benefits to the U.S. economy will not last long. It could already start losing steam in 2018 and certainly in 2019.
The Honeymoon Is Over
Indeed, the honeymoon period may already be over.
President Donald Trump’s tax cuts have certainly benefited a small handful of Americans. But the U.S. economy, the real economy, has not benefited. And it likely won’t, because few companies have invested in growth.
Indeed, the U.S. economy has already shown signs of a slowdown. Or, if you prefer, the expected growth rate of three or more percent has not lasted.
The U.S. economy grew some 2.2% in the first quarter of 2018. That’s far below Trump’s three-percent target or better, and it’s less than economists’ already more modest expectations of 2.3%. (Source: “First-quarter US GDP revised to 2.2%, vs. 2.3% growth expected,” CNBC, May 30, 2018.)
Therefore, the U.S. economy has a mild chance of experiencing a recession in 2018. There’s a bigger chance of an economic slowdown in 2019.
G7 Was an Omen of Trouble for U.S. Economy
The G7 in Canada was a disaster. G7 meetings—as well as other multilateral ones—do not often produce tangible results. The recent international summit pointed out some of the main forces that are attacking the global economy.
And the U.S. economy cannot thrive if the rest of the world isn’t.
The G7 summit was a virtual loudspeaker, amplifying the already growing global trade tensions. U.S. duties pose a threat to global growth. Trump is playing a game in which the U.S. could end up paying the price.
Trump’s trade tariffs could act as a boomerang and hit the U.S. economy rather than its competitors.
The G7 has exposed the ever-rising strain over global trade. It was the United States that wanted “free trade” in the 1980s and 1990s. It got it.
So far, the tariffs and countermeasures—especially from the EU—have not had enough time to “mature” yet.
U.S. Economy Risks Being Isolated
They will not produce significant macroeconomic effects. Moreover, the unresolved difficulties at the G7 could isolate the United States from international agreements.
For example, relations between the United States and China will be hampered by a lack of conversation on important global and regional issues.
They will focus excessively on the prospects of increased tariffs and, probably, non-tariff measures such as bilateral investment restrictions. The markets, therefore, will be compelled to shift concerns to the growing uncertainty about the future.
And then there are the other risks coming out of the shadows of the world economy.
High oil prices hurt the consumption of non-oil, travel, food, and inflation.
The dollar moves higher, but it’s also generating tensions in some emerging markets and in Europe.
Tariff Walls Are Easier to Build Than Migrant Walls
If tariff walls start emerging, it becomes more important to have control over the value of currency. Thus, the European Central Bank (ECB) could announce a stop to the quantitative easing (QE) policy that has helped mitigate the effects of imbalance within the union.
But the stop to the QE may come a little too soon.
The return of even milder interest rates will put the EU’s role as one of the main locomotives of the world economy in question.
The return of economic nationalism could also bring a collapse of what we might call the “globalization” system.
Major shifts in the way the world works are happening. In investment terms, this will influence approaches that have worked well for the past decade or so.
Globalization Has Reached Its Final Destination
Those who have read Lombardi Letter know that, given the global context, we have expected defense stocks to outperform all others.
By and large, this has been the case. But President Trump’s clear decision to divert his attention from Europe to North Korea—and therefore, Russia and China—heralds a potentially historic change.
Trump seems ready to break the “world order” that emerged from the collapse of the Berlin Wall in 1989. This world order left the United States as the primary military and economic superpower.
And the U.S. economy did impose itself over the rest of the world in the 1990s. Academics and media pundits called it “globalization.”
The U.S. had won—capitalism had won—there was no more conflict of ideas and approaches over how countries and economies should be run.
It was the “end of history,” as Francis Fukuyama called it. Except that it wasn’t.
At the G7 in Charlevoix, Canada, Trump all by himself put a halt to globalization as the world has known it since 1990.
Trump Brings History Back
Trump has responded to Fukuyama: history is back. In fact, history never left, but the world seemed happy to ignore it until Trump was elected to the White House.
It is not a bad thing, in itself. The cheerleaders of globalization, which promoted a one-sided practice of market economics over the past three decades, had relegated history to the basement.
Keeping history in mind, for example, would have informed President Bill Clinton that repealing the Glass-Steagall Act placed the U.S. economy in danger.
The Glass-Steagall Act, adopted in 1933, regulated the banks. In very simple terms, the act prevented commercial banks from engaging in the kinds of risks that investment banks took on.
The idea was to contain speculation and preserve the integrity of average people’s savings.
Thus, the Glass-Steagall Act allowed the U.S. economy to better withstand financial storms such as the 1929 stock market crash since 1933.
Rather, after a period of wild market speculation—the famous “irrational exuberance,” as former Federal Reserve Chair Alan Greenspan described it—the gloves came off the U.S. economy as the world entered the 2000s.
This was a world of financial excess. New electronic and mathematical tools amplified the effects of the Wall Street euphoria worldwide.
Politics and rules were set aside. And of course, the idea of free-trade and its associated concept of delocalization—better known as “outsourcing”—came into full swing.
Is the U.S. Prepared to Handle the End of Globalization?
The 2008 financial crisis and Donald Trump’s election as president in 2016 are respectively its effects and its inevitable result.
Now, Trump appears to want to halt the process. It’s long overdue.
The problem, however, is that the whole world has spent so much time adapting to globalization that dismantling it will bring inevitable pain.
Thus, it’s a question of “how” the system dismantles.
Trump is a politician of the “bull in a china shop” variety.
He does not care for the mechanics or effects of his decisions. And the dismantling of the system has not gotten off on the right foot.
For starters, the U.S. economy continues to produce unparalleled social inequality. Not only are the financial markets at risk, but the social fabric that unites Americans is disintegrating.
Tensions are approaching levels like those that erupted in the U.S. Civil War—which, after all, when stripped down, started over economic causes.
Trump in very few words—and a lot of action (he did not sign the summit’s final agreement)—has effectively told his counterparts that the G7 has become totally irrelevant.
If they want, the G7 can become the G6. But it won’t help them. Trump has changed the game.
Trump has signaled that the system that the World Trade Organization has created needs an update. And the changes will need to be radically updated.
The problem is that Trump has been excellent at the breaking but he does not have a clue how the U.S. economy will fit into this new system.