Is the end of globalization near? On a recent edition of FS Insider Ben Breitholtz of Arbor Research and Trading discussed the trend toward deglobalization and the implications this may have on inflation, interest rates and stock prices.
See Data Shows Globalization In Sharp Decline, Says Ben Breitholtz for audio.
Globalization Breaking Down
The trend toward deglobalization accelerated in 2019 not only in the U.S. but also internationally. This is to be expected thanks to the U.S. – China trade war. Breitholtz pointed out that the deglobalization trend can be tracked back to 2014 at a regional level.
Breitholtz’s work involves finding common indicators that express how national economies are correlated. He looks at several factors such as unemployment and exports and imports that signal how the relationship toward globalization is progressing.
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However, one factor in particular—the correlation in GDP— indicates a change ahead in the globalization dynamic.
“Historically, GDP has really been on nothing but a constant rise since really the 1970s,” Breitholtz said. “This is the first abrupt, large drop in that percentage of variance explained that we've seen in its history… We're getting a breakdown in how GDP is moving on a quarter by quarter basis across the world.”
Globalization and Inflation
There appears to be a correlation between globalization and the raw level of GDP, Breitholtz explained. Historically, as globalization progresses, GDP drops. This may be a coincidental occurrence, he said, but if the correlation holds, it has interesting implications for both GDP and inflation.
If we see the opposite trend take hold—what Breitholtz calls deglobalization—and we see the global economy fracture into a multi-polar arrangement with distinct economic blocks, it appears that GDP will accelerate relative to where it would be if globalization had continued.
The relevant blocks Breitholtz identifies are the North American area, the European area and the Asia Pacific area. These blocks are already seeing their economies become more closely linked internally, as the external linking between these blocks declines.
This trend toward regionalization is likely to continue constraining GDP, but not to the degree that further globalization would have. However, Breitholtz is most interested in the implications for inflation. While GDP will still be constrained, he expects the trend toward deglobalization will drive inflation higher, beginning most noticeably in the U.S.
Drivers of Inflation
The secular, long-term forces that influence inflation are demographics, technology and productivity gains, and globalization. Demographic pressure is already a given, as birth rates continue to decline and technological innovation is relatively predictable in terms of the constant deflationary pressure it creates.
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Globalization has been predictable in a similar way, as it continually drove costs down, holding inflation lower. As the trend reverses and regionalization takes hold, it is intuitive that inflation pressures will reverse. The question is, by how much?
Based on models of each of the blocks and the world economy, Breitholtz expects to see moderately higher inflation, with the U.S. consumer price index projected to hit between 2.5 to 3% over the next two to three years.
Equities will not respond well, and he foresees a 10% draw down in stocks over that timeframe. Likewise, he expects a reversal in Treasury yields, which he projects to rise closer to 2.3% for the 10-year note.
“I think globalization doesn't get talked about enough,” Breitholtz said. Since we’ve talked so much about the threat of inflation in terms of what the consumer's doing, their aptitude or willingness to spend, the actual political issues that are hitting us is something that I think is substantial… If you're looking for where this is going to hit first, it's happening within our borders.”
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