Emerging market currencies and equity markets have been in sharp decline, in large part because of stresses associated with a strengthening dollar. Revised US GDP growth was 4.2% annualised in the second quarter, with an expectation of continuing Federal Reserve policy normalisation. Combined with action and rhetoric from the White House, from tariffs and sanctions to military alliances, it may appear that the rest of the world revolves around Washington.
But tectonic plates are moving below these headlines. A few years before the 2008 financial crisis, journalist Tom Friedman captured the zeitgeist with his argument that ‘the world is flat’, or that all competitors in the global economy have an equal opportunity to succeed. But if it was once possible to argue that (Western-led) politics and technology were creating a flat world, today they are combining to create a more lumpy, multipolar system.
Negotiations on the North American Free Trade Agreement offer a clear example. One interpretation of where talks are heading is towards a more regionally-ordered trading system. The proposed rules of origin standards, with minimum requirements on wages, are likely to increase pressure for more production within Nafta. The proposed terms may accelerate the onshoring of supply chains from Asia to North America for American consumption, particularly for activities that can use new technologies such as automation or 3D printing. Despite President Donald Trump’s efforts to build his wall on the Mexican border, the conclusion is likely to be a more self-contained North American economic unit.
This regional focus is reinforced by Washington’s withdrawal from the Trans-Pacific Partnership. This would have embedded the US in a broader set of economic arrangements. And the threat of US tariffs on imports from Europe would further promote a more regional focus.
The second development that speaks to growing fragmentation is pushback from Europe to the unilateral use of sanctions by the US. One recent example was Washington subjecting European firms to secondary sanctions if they continued doing business with Iran. The US could do this because of its economic weight and centrality to the global financial system.
Heiko Maas, Germany’s foreign minister, recently floated an idea for a separate payments system that would be independent of the US. Although Chancellor Angela Merkel has distanced herself from these comments, there is some support in Europe. French Finance Minister Bruno Le Maire said at the end of August he wants ‘Europe to be a sovereign continent not a vassal, and that means having totally independent financing instruments that do not today exist’.
This is, at best, a long-term journey. The dollar dominates international transactions and comprises around two-thirds of global reserves. As with security arrangements, Europe cannot realistically create a financial system that is independent of the US in the short term. But the fact that this conversation is starting is instructive. It is also consistent with Beijing’s preference for a more diversified global financial system that is less reliant on the dollar.
The third development highlights the growing intersection between economic and political relationships. The ambition of China’s global positioning was apparent when President Xi Jinping announced at the beginning of September an additional $60bn of loans and financing for African countries.
But limitations are apparent. The Australian government found time between unseating another prime minister to ban – on national security grounds – Chinese corporations Huawei and ZTE from participating in the rollout of Australia’s 5G network. The new Malaysian government has cancelled several Chinese infrastructure projects. In India, ministers continue to raise concerns about the extent of Beijing’s influence in Sri Lanka, Pakistan and Bangladesh.
However, the growing intersection of international economics and politics that is clear in China’s rise will reinforce a regional bias to activity, with an increasing share of international commerce being shaped by strategic relationships. Although there are some advantages to a more diversified global system, there will be frictions as global footprints of firms and countries restructure.
This will have a profound effect on markets and economies. Previous episodes of great power transition have led to gradual changes in global institutions from reserve currencies to international trading arrangements. US belligerence and poor quality policy-making are accelerating this process. Although the US remains central to the global system, competition is emerging.
David Skilling is Director of the Landfall Strategy Group, a Singapore-based economic advisory firm.