Peak globalization? Not!

I believe US fiscal deficit and large savings rates in Europe and Asia will keep capital flowing across borders.

Oct 31, 2019 | Krishna Memani

With the trade conflict still at the forefront of the geopolitical scene, it has become quite fashionable to say we have reached peak globalization. By that, the prognosticators mean the flow of goods and services will now likely come down. From a political standpoint once again, given the rhetoric across the world – whether it is tariffs in the US, Brexit in the UK and European Union, or immigration concerns everywhere in the world – it is easy to draw the conclusion that the world wants less, not more, globalization.

But, I believe that is unlikely to happen for some basic economic reasons that are in each country’s self-interests. Furthermore, if politicians across the globe continue to play the 11th-century King Canute, who according to legend, tried to hold back the tides—in this case, the waves of globalization—the economic consequences are going to be severe.

The reason why we can’t be at peak globalization yet is that the saving and borrowing structure of the world has not changed materially. In fact, viewed in terms of magnitudes, the situation is probably getting worse, not better.

You have heard it before, but it bears repeating; there is a persistent savings glut in the world, and the only way it can be resolved is through global trade. Furthermore, as saving rates in Asia continue to outpace that of the US, which is the most significant importer of capital in the world, the overall pool of savings will continue to increase rather than go down.

Over the past few decades, the savings flow has shifted from north-to-south petroleum- and commodity-driven flows to east-to-west finished goods flows. But the underlying story has remained the same. Global trade flows have increased, for the most part, to help close the funding gap in the US.

US savings not enough to fund US fiscal deficit

Let us start with the US. Given that the US fiscal deficit is large—and perhaps increasing to a trillion dollars this year and likely remaining at a similar magnitude for the foreseeable future—it cannot be funded solely by US domestic savings. The US needs to import excess savings from the rest of the world. The mechanism for doing so is global trade flows, in my opinion. But the US economy is mired in a low-growth environment. Those scenarios won’t change unless US savings rise, and that, of course, cannot happen without a significant economic dislocation. The trade route is the only way for the savings gap to be closed. Furthermore, irrespective of who wins the 2020 election, it does not look, at least to me, that the US deficit will go down.

If you examine the data, the US trade deficit in finished goods is close to the combined current account surplus of Europe and Asia. With a persistently high fiscal deficit, the US cannot close the trade deficit, and that means trade flows will continue to increase.

Europe now a formidable exporter of capital

Moving on to Europe, one must recognize that the region is now a formidable exporter of capital, almost on par with Asia. Domestic demand in the euro area has remained significantly lower than the trend rates since the financial crisis. Furthermore, fiscal policies across the continent remain too tight. Despite the pleadings of folks like outgoing European Central Bank (ECB) chair Mario Draghi and his successor, Christine Lagarde, the domestic fiscal policies in Europe are not changing anytime soon. Therefore, if those substantial European savings cannot be absorbed by the domestic economies, it is headed across the Atlantic. Once again, the transmission mechanism is trade flows.

I think the top-level situation in Asia is not that materially different. The largest savings surplus country is China, of course.1 While Chinese savings have come down from over 50% of the economy to now closer to 40%, the savings pool has increased from Chinese economic growth.1 Despite all manners of increased deficits at the local level, Chinese effective savings have actually increased. If Chinese savings, as a percentage of GDP, remain high and China continues to be one of the fastest-growing economies in the world, the Chinese surplus will stay in place and global trade flows will continue to deploy those savings.

The situation is similar in smaller economies like Korea and Taiwan, where a combination of tight fiscal policies and intervention in the currency markets has kept surpluses relatively high. These savings surpluses, too, are unlikely to change in the current policy regime.

If there is one country in the world where things have changed materially, it is Japan. Loose fiscal policies have helped reduce the savings surplus and, as a result, helped stabilize the savings dynamics.

The bottom line is simple—globalization and global trade flows are not likely to peak until the savings picture in various economies balances out. Given the current growth trajectory of various economies and the policy picture in these countries, I am not holding my breath for things to change materially. Global trade will continue to grow, and global flows will continue to dominate the financial markets for quite some time, in my view.

^1.  Source: Organization for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF) as of 6/30/19

Krishna Memani serves as the Vice Chairman of Investments for Invesco.

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The opinions referenced above are those of Krishna Memani as of October 30, 2019.

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