Special Report: The battle for globalisation will be lost in Europe

Back in 2000 when I was making a killing in gold markets I spent a lot of time researching and thinking about globalisation. It was the heyday of the anti-globalisation movement which at that stage presented largely as a global push back against corporate power by the young and students. The movement was savaged by the media at the time for being pointlessly anarchistic and incoherent and, in truth, it lacked definition. But it knew what it did not like and wanted to change, even if it was unsure of what to change it to; it hated the faceless corporations that trotted the globe pillaging nations and leaving their peoples no better off and many worse off, and it hated the unaccountable institutions that enabled it.

If that sounds a little familiar it should. It is more or less the same sentiment expressed today by the Britons in the Brexit. Not that much different to the ballot box contempt shown to Malcolm Turnbull and his tax cut for the globetrotting rich. It is in part behind the rise of Donald Trump, Italy’s Five Star Movement and the National Front in France, to name a few more. Globalisation may deliver headline prosperity for nations but within that framework it also concentrates wealth in fewer hands and those that are left behind are increasingly fighting back via these movements, figureheads and demagogues.

Inspired by the anti-globalisation movement of the millennium, I sold my gold holdings and decided instead to deploy the capital into something more productive. I founded The Diplomat magazine as a vehicle through which to explore and contribute to resolving the historic tensions of the age.

Those strains erupted disastrously a few short months later. As my co-founder, Minh Bui, and I prepared for launch, September 11, 2001 struck the world with an anti-globalisation thunderclap that catapulted what was a shoestring pamphlet into a vital national forum through which war and its conduct was debated by the highest minds in the land. Within six months of launch, The Diplomat sat side by side with The Economist and Time in every newsagent in the country with the paranoid latter threatening legal action.

We had certainly gotten it right. Al Qaeda was and is also an anti-globalisation movement. It is an outright rejection of an invading American culture emanating from the consumerism and business liberalism of the Washington Consensus. Al Qaeda wanted no part of a modernity defined by American materialism, nor did it hold much truck with its allies in the oil Sheiks that fed off of it. It sought the absolute safety of puritanical values and the pre-modern sensibility of singular truth.

That is at once globalisation’s great strength and great weakness. It is at root a vast example of the modernist sensibility. There are no gods in a globalised world. No truth even. It is an enlightenment system that slams together manifold culture, capital and peoples into a single marketplace in which nothing is sacred. It is humanism at its most awesome, a system in which no value system can hold sway beyond being emblazoned across the front of a t-shirt.

But of course for those that it leaves behind, and those that cannot find comfort in embracing ‘the other’, it fires up the deepest fears of the cerebellum; the fear of losing one’s tribe, of being abandoned. And so in many, perhaps the majority, it inspires not curiosity but terror and anger.

Deglobalisation round one: United States

As The Diplomat tracked the Al Qaeda wars in first Afghanistan and later Iraq, it become more and more clear that the Western mission to save globalisation was itself only making things worse. First, Afghanistan was not developed. Then the Iraq civil war descended into medieval bloodshed. Australia found itself fighting insurgencies in South East Asia and the Pacific. And still the jihadis multiplied. Today the newest limb of the same horrid creature has grown up in ISIS.

That war also did great harm to globalisation at home. The US economy was bled ceaselessly by the twin deficits that funded its push to protect globalisation. Even its housing bubble stemmed in part from the easy money of Alan Greenspan as he dropped interest rates and refused to hike them to help finance the war. The US was institutionally robust enough to take it but it was pushed to the brink.

Eventually with a new President, a war-weary US withdrew from Iraq and plodded through its post-GFC economic repairs. But we then faced a globalisation that had lost its innocence. Gone were the glory days of a benevolent American Empire ruling over a globe of market states. In its place was a more cyclical animal; a rent-seeking paradise in which the institutions that had managed, prospered and disseminated globalisation contracted into protecting what was left of it for themselves. Central banks printed, governments bailout out and international organisations fought over the scraps. The rich got richer and the poor got stiffed.

This generated yet more losers. Occupy Wall Street did its best. In Australia, the property quango and war on youth was revealed. In Europe a periphery of indebted states tried vainly to live up to the strictures of a disciplinarian centre, literally breaking their standards of living in the process. Again the globalisers had succeeded, but again also again bred their opposites.

Deglobailsation round two: Europe

Then, just last month, someone (rather foolishly) gave a polity its chance to vote on globalisation. It shocked its masters by giving it the flick. The Britons of all people, the original globalists, voted for Brexit from the European Union, one of globalisation’s greatest exemplars, a godless construct designed to hold together peoples with grand histories of enmity.

So, today, the fight to preserve globalisation – which is at heart the fight to preserve global liberal capitalism – has shifted from the US to Europe. Following Brexit there are two more elections. In Italy there is an unremarkable forthcoming constitutional referendum that is now crucial mostly because is marks the rise of the anti-European Five Star Movement. Then again next year France conducts a general election in which the second runner is the anti-immigration, anti-European, anti-euro, National Front.

As if this is not enough, into this melting pot has suddenly been poured the mad warriors of Islamic anti-globalisation inherited from the Al Qaeda wars. The extraordinarily savage attacks in France last week, and over the past eighteen months, are a direct attack upon European unity. Self-evidently there is a danger of more. They will trigger righteous rage within the polity at the psychopaths distorting Islam living in their midst.

Yet, unlike the US, Europe as an institution is a barely fledged chick. It already has a broken wing and nobbled leg. How can it confront the latest offshoot of Islamic anti-globalisation in tandem with its own mushrooming secessionist movements? How can it stop these two colossal forces from crashing together in their enraged populations?

Both Italy and France are now in sore danger of breaking from Europe and/or the euro and if it happens the shock will be immense, far larger than Lehmann brothers. It is far beyond any economic event of our lifetimes. It is the literal disintegration of the second largest reserve currency on earth and there is nothing that central banks or fiscal policy managers can do about it.

It turns out that globalisation is a remarkably fragile entity. It is three things: the free movement of people; the free movement of capital and the free movement of ideas. If the euro fractures then the fallout will include a Balkanisation of capital markets as anyone externally funded will find themselves with zero inflows. It will be end of the free movement of capital. It will include the erection of state borders and barriers to weed out the ill-intentioned meaning the end of the free movement of people. It will include a swing to the most conservative of patriotic sentiment and nationalism and be the end of the free movement of ideas.

Simply put, the forces fighting the war against globalisation have converged in Europe and they are winning.

Australian deglobalisation

How will this transpire Downunder? We don’t need to assume a Black Swan event like European disintegration to know that these trends are set to continue. Everything is pointing that way regardless. Whether anti-globalisation parties will gallop to power or simply force mainstream political parties to adopt their policies, the anti-globalisation movement is winning and will continue to do so.

For Australians this presents a dual risk. Like we did during the world’s last great globalisation movement of the late 19th century, Australia has gone long the world and boomed as a result. The parallels are kind of uncanny when we consider that the pillars of late 19th century prosperity were a commodities boom (in gold), an externally financed property boom, and high immigration. Precisely the same as today.

Australia’s 19th century globalisation boom ended when a series of shocks that undid the globalised flow of finance, people and ideas, crashing the local property boom so deeply that it took Melbourne 70 years to recover. Australia also prefigured a wave of post-colonial (that is, anti-globalisation) movements across the world for the subsequent half century.

I do not think that we face that kind of epochal unwind but the basic tenets are the same when we consider the drivers:

• Australian politics is going to see increasing pressure to curb immigration levels as the globe withdraws steadily into nationalism and fringe parties enjoy credibility imported from other troubled nations;
• the population ponzi model of growth is going to fail as immigration growth falls;
• the cost of financing externally funded economies is going to rise as global savings find it more difficult to move, during shocks and between them;
• Australian growth will stagnate as increasingly protectionist policy further inhibits productivity growth;
• fiscal policy will continue to face the paradoxical problem of very cheap money that it cannot use for fear of losing the clean public balance sheet as a safety net in a volatile world, and
• Australian growth and income will be hard to come by and interest rates continue to fall to zero (or whatever bottom the RBA is comfortable with).

Portfolio implications

Markets did not react at all to the French atrocity. They can’t. They do not know how to discount political risk, have virtually no way to hedge it, and they either won’t or can’t countenance asymmetric risk (that is “Black Swans). Rather quaintly, they believe central banks will protect them. It is not that markets are a good judge of these things, they are not, and you should not believe that no movement in equity or other prices is a guide to the events of Europe being marginal. They are not.

The first point to make about asset allocations in this emerging environment is that it is as much higher risk of asymmetric shocks than the decades that preceded it. Thus the strategic narrative for allocations should reflect that risk. In general terms that will mean:

• avoid leveraged and illiquid assets;
• safe haven assets will trade at a premium, and
• cash and cash-like instruments should occupy a much larger percentage allocation than in the past.

The second way to play deglobalisation is tactical. It is to go long (or short) on authorities response to the breakdown of their hopes and dreams. On that ground we find BofAML’s Michael Hartnett:

We believe the BREXIT vote was the biggest electoral riposte yet to the Age of Inequality. We also suspect the prospect of further electoral success by populists is quietly spurring governments and the corporate sector to activate fiscal stimulus in 2016 to appease voters. Telling examples: Japanese infrastructure spending, a new UK industrial policy, and announcements of higher minimum wages by high-profile US companies. Markets may soon start to discount policy rotation from the exclusive use of QE to stimulate animal spirits (which has failed) to a new policy mix of monetary-stability (central banks keep rates and rate volatility low and stable) and fiscal stimulus.

Tactically, we believe investors looking for exposure to this policy rotation theme should go long global industrials, semis, transportation, Japanese small-cap, TIPS and HY over IG. The duration of this trade will be dependent on the credibility of Japanese/European fiscal stimulus announcements.

Trades for the “War on Inequality”

Our fundamental view is that the need and likelihood of new policies that address the populist desire for a “War on Inequality” remains.

Table 3 outlines the three themes of Redistribution, Protectionism and Helicopter…specifically, the policies entailed, the macro regime induced and the trade ideas for each theme. While we have presented these themes as distinct, in practice there will likely be a degree of overlap.

Redistribution policies would likely boost inflation (TIPS) and low-end consumption (retail, payments, tax services) but at the expense of brokers, luxury, and growth in general; we also like curve flatteners and municipal bonds over taxable fixed income.

Protectionism would suggest an outright deflation portfolio of government bonds, gold, volatility, and quality defensive stocks. We think banks would suffer from capital controls and that multinational companies would be hit hard by trade wars, especially relative to domestically-focused firms.

Helicopter fiscal expansion would likely benefit a reflationary portfolio of TIPS, commodities, banks, and value as growth picks up and the yield curve steepens.

We are likely to oscillate between these various macro regimes as policy is deployed and markets react, but within a larger strategic framework of deflation given this war to hold globalisation together is actually just killing it a little more slowly. As well, I do not see any of these reflationary policies coming to Europe quickly; not at all to the US until we have another bust, they’re already being used and exhausted in China, and Japan is not big enough by itself.

So, for Australian investors I see a persistently deflationary context as commodity prices keep falling (not all but the bulks important to Australia):

• iron ore has far to go yet in its glut as supply keeps coming and China keeps changing;
• for coal, thermal is structurally buggered, coking will follow iron ore, and
• LNG is facing an epic glut that will dislocate its pricing from oil.

The post investment boom volumes will keep flowing for another two years offering support to GDP but income is going remain very hard to come by. After that the volumes will begin to fall as China keeps slowing and changing and incomes will improve a little. But then we’ll face a very difficult challenge of how to grow at all given:

• tradables have been horribly hollowed out;
• services rely on asset inflation that is topped out with peak household debt;
• the residential construction boom will be over and immigration under intensifying pressure, and
• fiscal policy will remain constrained.

Allocations are very dependent upon time frames, risk appetite, stage of life and other factors, and this post is an opinion not advice, but in terms of the deglobalisation trend that I now see as the dominant theme of the decade, I remain comfortable with:

• buying the dips on gold miners and bonds;
• holding off equities until we see a substantial correction and then look to get long dollar-exposed industrials;
• avoid or short banks, miners and the Aussie dollar depdening upon your risk preference;
• reduce property exposure and leverage whenever and wherever possible, and
• long cash.

The main risk to this outlook is that the globalisers panic earlier and harder than I expect. That would mean widespread “helicopter money” likely poured into infrastructure worldwide. That would present a better outlook for Australia as bulk commodities would be in higher demand, holding up prices, interest rates, the Budget and the dollar, as it improves the income outlook of the nation. Even so, I do not expect that to benefit property, it does not change the allocation to cash, bonds would fall but gold would rise.