An air of foreboding is hanging over the world economy, with apparent calm on financial markets masking deeper nervousness about the global economic order. That was the underlying message from a meeting of the OMFIF advisory council on 18 September, assembling 32 participants from six continents.
The meeting, chaired by Lord Norman Lamont, who took over as chairman in May, was the first since the death in July of previous incumbent Lord Meghnad Desai. Delegates remarked how Desai would have enjoyed the prevailing atmosphere of cautionary gloom punctuated by intermittent shafts of optimism.
One participant summed up the historical background by saying the world was reverting to a similar state to the end of the 19th century. ‘We are at a major turning point. We are seeing much of the post-1945 framework being discarded as we move to a more nation state-, political bloc-defined world.’
US President Donald Trump was a symptom, not the cause. ‘The view – or hope – that Trump is an aberration and at the next presidential election the world will revert to its glorious status quo ante is misguide.’
The participant listed the principal points of concern: profound fiscal challenges in most states; a quasi-recessionary economic environment; a demographic challenge; a growing backlash against immigration; and a significant technology revolution. ‘The world is becoming extremely volatile. Current politics fails to deal with these challenges. Hence the fragmentation of the centre-ground and the rise of hard-left and hard-right movements.’
Among striking descriptions of the world economy, one North American former central banker said: ‘We are leaving an era of plenty and entering an era of scarcity’ – bringing inflationary dangers. Another senior participant from Asia opined the world was switching from ‘a bout of opulence’ to ‘a crisis of affordability’.
The meeting covered a wide range of themes.
Large divergence in inflation regimes prevailing across the world
One council member was particularly perturbed by the spectre of potential ‘Latin American’ conditions in the US and Europe – higher, persistent inflation and persistent challenges such as demographics, climate costs and deglobalisation. He projected a future of ‘financial repression’ with governments resorting to capital controls and stringent tactics to force central banks to hold down interest rates to avoid ruinous rises in the cost of servicing government debt.
Another speaker said this scenario was overdone. European Union inflation was 2%, while Switzerland was at 0.2% and China was in deflation. It was pointed out that tariffs might have limited effects on inflation – one of the reasons for sanguinity in financial markets.
Trade and finance: risks might not yet be fully priced in
As one speaker said, ‘It might be too early to fully price risks. Markets initially view trade wars negatively, but bond markets respond differently’.
The response to Trump’s policy was mixed. China can strengthen Asia regionalism, and the EU can boost domestic demand, but it is unlikely to create a strong single market. However, global trade has proven resilient. The meeting was reminded that, ‘We’re in a better position compared to the 1930s, with most trade flows remaining outside tariffs.
One important challenge was digital trade, which was growing fast. ‘But the World Trade Organization remains focused on goods.’
On US industrial policy, the Trump administration’s view of a forthcoming US ‘industrial renaissance’ (in areas like shipbuilding and steel) was denounced as a myth. ‘Manufacturing is less than 10% of gross domestic product and increasingly automated.’
Trump’s subsidies (for companies like Intel, Nippon Steel and MP Materials) were seen as reshaping the government’s relationship with the private sector, with a big impact on corporate governance and the quality and robustness of markets.
Public finance clouded by high and rising debt
Speakers showed alarm over the US fiscal outlook, with debt at over 100% of GDP, rising deficits and Trump’s fiscal bill adding more pressure. The threats to the Federal Reserve’s independence underline risks of fiscal dominance. Rising debt service costs with higher rates would create a vicious circle of moves towards an ever-higher debt overhang.
However, one delegate underlined that societies can make political economy choices to free up scarce capacity. ‘Governments’ spending choices influence debt-to-GDP dynamics, and this is something that can be reshaped.’
The conclusion was that domestic policy, human capital investment and a politically difficult focus on a longer-term agenda would help stave off a debt crisis.
The dollar’s supreme world role is intact – for the time being
Deep and liquid capital markets and a lack of alternatives are the main factors bolstering the US position. However, speakers emphasised how the Trump administration is actively promoting dollar depreciation, and this erosion of trust could weaken its long-term value. One veteran currency official summarised the position: ‘For the Trump administration, the reserve currency status of the dollar is not a privilege but a burden.’ Reconciling weak-dollar policies with reserve status would be a challenge.
There was a discussion on a shake-up of international payments through digital assets. This could lead over time to fresh diversification away form the dollar.
Brics grouping constrained by Russian membership
The Brics group of countries has undeniable ambitions, led by a development bank with around $50bn capitalisation and a contingent reserve arrangement designed as an alternative to the International Monetary Fund for members facing currency shortfalls.
China’s efforts to lead this group towards a meaningful challenge to US leadership were constrained by sanctions on Russia, a lack of systemic integration and continued reliance on the dollar. Transactions in local currencies were minimal. The underlying message was that, in the absence of deeper coordination, the Brics group would remain a ‘paper tiger’.
Risks and opportunities for stablecoins
Stablecoins can provide efficiency in transactions and cross-border payments, but also facilitate tax and regulatory evasion and illicit activity. Lobbying pressure for adoption, one speaker said, could be due to the perception that they are the main entry point into crypto trading.
Another view is that, although stablecoins can boost demand for dollars and US Treasury issuance, there was no overriding reason for a significant increase in usage. One member highlighted divergence. ‘The EU and Asia are moving towards central bank digital currencies; the US is tilting towards stablecoins. There’s a missing framework for interoperability across these systems.’
Blockchain is viewed as a scalable new infrastructure for value exchange. The Guiding and Establishing National Innovation for US Stablecoins Act and forthcoming Clarity Bill are expected to accelerate blockchain scaling. It was pointed out that part of the resilience of the US economy is due to the boom in artificial intelligence.
Geopolitical tensions abound
Geopolitics and institutions are approaching a tipping point amid fragmentation of the global order. The Trump 2.0 administration signals a structural break, which was probably already on its way. Institutions such as the WTO, IMF and United Nations are seen as poorly equipped to handle migration, digital trade or new geopolitical alignments.
The meeting concluded that migration and demographics are both cause and effect of large-scale economic and political perturbations. This is symbolised by a shift from ‘peace dividends to war bills’ and a flight to ‘hard’ crisis-proof assets. For global policy-makers, this is an uncomfortable and unpropitious outlook.
David Marsh is Chairman and Andrea Correa is Senior Economist at OMFIF.
Join OMFIF on 29 September to welcome Ignazio Visco, former governor of Banca d’Italia, to the London School of Economics for his lecture on European fragmentation in an uncertain world.
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