More regionalization, digitalization and taxes.
With Covid-19 very much part of our daily lives, it may seem early to start thinking about what our world will look like after all of this ends. But from a longer-term perspective, we see three emerging trends:
GOODBYE GLOBALIZATION, HELLO REGIONALIZATION
Europe entered this crisis in a weakened state, with Brexit, aging demographics and contentious German elections lurking. The situation may be worse now after Covid. Once they started to see what was happening in Italy as the virus spread, Europeans scattered like straw in the wind, with 27 different countries doing their own thing, i.e., closing borders, competing for PPE and medical equipment, and fighting over just how big to go economically in responding to the crisis. Time will tell if the long-sought dream of European unity will continue to withstand the onslaught of structural factors.
The big question now is whether this crisis will lead to further fragmentation or greater economic and policy cooperation. In the near term, we think we will see more of the former as the economic and health-care impacts of this crisis come to the fore. And assuming the European Union survives, we think the underlying fractiousness exposed by this crisis—and the rise of Eurosceptics and anti-immigration factions across the continent—may strengthen the populist wave that initially swept across Europe over the past decade before heading to foreign shores (the U.S., the Philippines, Brazil, etc.).
Ultimately however, we do see globalization giving way to regionalism—an American block, an Asian sphere and a European zone—delineated along trading, cultural, currency and technological lines. This already was occurring to some extent. And we wouldn’t be surprised to see the emergence—really, the re-emergence—of strong regional currency blocs like we had in the 1980s-90s with Germany’s Deutsche mark in Europe, the Japanese yen in Asia and the dollar in the Americas. Today, the euro has replaced the Deutsche mark, while in Asia, things are a bit more complicated with the recent rise of China. While the yen remains a major global reserve currency, the renminbi is gaining ground fast in spite of it not being fully convertible and the pervasive distrust of China. Over time, China likely will prevail. As for the BRICS (Brazil, Russia, India, China and South Africa)—an antiquated construct as their economies mature—each is likely to align with regional trading partners and new supply chains sprouting from disruptions underway before the crisis. Regionalization of cultural norms and technological standards will follow.
LET’S GET DIGITAL
The crisis is clearly a catalyst for underlying macro trends: digitalization, remote work and the restructuring of supply-chain outsourcing. When it comes to tech, every region or country has a champion. China in hardware, software and certain components of artificial intelligence (AI), the U.S. in those areas as well, and Europe perhaps a little behind the others but still a player. All are experiencing accelerated use of such new technologies as 5G and 3D printing.
From a business owner’s perspective, digitalization and working remotely represent significant opportunities to boost productivity. They lessen the need for costly brick-and-mortar facilities, speed the use of automation (robots don’t get sick—expect more automated fulfillment centers) and accelerate the shift of time- and labor-saving technologies from lower to higher value-add products and services. 3D printing, for example, offers the potential to move overseas factory production to neighborhoods near end-use facilities, helping suppliers fulfill orders at a fraction of the cost and dramatically reshaping and localizing supply chains.
We already are seeing a structural transformation in the way people shop thanks to these advanced technologies, so there’s no reason the same can’t happen to other aspects of our economy and our lives. To be sure, there are privacy and social contract issues. We already are seeing the use of contract-tracing apps come under fire. As automation, robots and 3D printers grow in use, so will the issue of displaced jobs become a rallying cry. Schumpeter would be proud—a creative capitalist economy always destroys jobs as it creates new ones, exposing divisions in the economy.
THE BILLS ULTIMATELY WILL COME DUE
The magnitude and speed to which global governments, both fiscal and monetary, across the globe have responded to this virus has been unprecedented. In the U.S. alone, Congress and the White House have committed more than $2.4 trillion in relief so far and the Federal Reserve through various programs has pledged to pump upwards of $6 trillion of liquidity into the markets. Combined, that represents more than a third of the total size of our economy. This fiscal year alone, the federal budget deficit is expect to reach nearly $4 trillion, pushing overall government debt to more than 100% of gross domestic product. We see the same happening everywhere else in the world.
And we don’t see how this doesn’t eventually lead to increased taxation, more powerful governments and a slower growth as the bill for all this spending comes due. We’re also wondering if, after five to seven years of outperformance, we are nearing a peak in the dollar. We may be further witnessing the reversal of the outperformance of the U.S. market relative to foreign markets—and more specifically, relative to emerging markets (EM) that stand to benefit the most from U.S. dollar weakness. Frankly, the dollar’s strength the past few years has surprised us. But it initially benefitted from the Trump tax cuts, then the trade war, and now the pandemic. But if it follows history and particularly if the dollar sees less interest because of all this debt, this trade will reverse at some point. Maybe not right away, but possibly in 18 months or so. And when that happens, the EM may well be the best place to be—for growth, valuations and diversification—in this new post-Covid world.