There are no economic and financial seers. No one, as far as we can tell, has access to future facts. At best, we have clever opinions based on imperfect reasoning and partial understanding of even present and past facts. However, we are all obliged to act in some fashion to make or preserve income and wealth. Action entails having some view of the world as it may unfold within an investment horizon. The search for a consensus view is both futile and often most harmful.
The paragraph above establishes the context for this essay, which is an exercise in supposal and conjecture. Suppose certain big things happened in the world economy - what consequences would ensue and what investment actions would then be required?
- EU Fractures: German money is the EU’s cement. Germany, however, is only a middle sized nation with a second tier economy. Germany’s 80 million people cannot bail out Latvia, Estonia, Lithuania, Romania, Bulgaria, Austria, Italy, Greece, Spain, Portugal and Ireland, as well as finance the $145 billion “Germany Fund” to prop up listed companies and also meet continuing large regular payments to the EU. The German economy is contracting even faster than the US economy. Many Germans feel they have atoned enough for the Nazis and German guilt cannot be monetized endlessly by its neighbors. In the absence of a great deal of German money, the EU will crack, then fracture and perhaps split into a small core with one set of rules and a much larger periphery with another set of rules but no common foreign or defense strategies or even alliances. NATO will become a talking club at best. The Euro will cease to exist as nations seek to regain currency/interest rate control as instruments of economic policy. European unemployment will reach the low teens, with some nations seeing unemployment in the high teens.
- China Barely Grows: A heavily export dependent economy cannot be vigorous while global trade is shrinking, domestic fixed investment is falling and consumers are conserving cash. There are no growth drivers. China’s economic growth rate falls to between 1% and 5% per annum for several quarters, resulting in sharply rising rural poverty, urban unemployment, real estate distress and rising violence. This compels the Chinese Communists to turn increasingly and repressively inward, run larger and larger budget deficits, use its SWF and other agents of the State to buy scores of billions of dollars of commodity assets abroad (and use this buying power to further Resource Imperialism) and substantially increase military spending to ensure the loyalty of its military, intimidate neighbors and dominate sea lanes in Asia. The US-China economic nexus frays badly and China becomes increasingly intolerant of US hectoring.
- US Economy Worsens: from a state of rising unemployment, low interest rates and negligible inflation or mild deflation to a multi-quarter period of unemployment above 10%, high interest rates and high inflation as public policy steadily debases the dollar and chokes innovation.
Given the supposals above what might be some of the consequences over the next few years? Those delineated below are illustrative and far from exhaustive.
1. Global Fragmentation: Interference with the free flow of trade, capital and labor increases while global trade compresses significantly. As a result regional, sub-national, linguistic, ethnic, sectarian, cultural and even tribal identities become more attractive for billions of people and several current nation states either become even more decentralized or break up entirely. The number of so called ”sovereign” states grows appreciably as politicians and tribalists exploit fragmentation.
European nations most vulnerable to partial or complete fragmentation include Spain (up to 6 sub-nations), Italy (North splits from the rest), UK (Scotland wanders away), Belgium, and Ukraine. In Asia, Pakistan is an obvious candidate for disintegration while separatism will increase in India and China without a formal break up. Russia and its neighbors may see more “autonomous” regions. In the Middle East, Iraq, Iran, Syria and Turkey will be vulnerable to Kurdish aspirations for more self government and assertion of identity. Lebanon may disappear as a nation. Africa will be subject to more fragmentation since the fracture lines are many and true, long established, nation states are few.
In the New World, disunity will also increase from Canada to Argentina, but actual secession may be unlikely. The US will not be immune from people choosing to emphasize regional, linguistic and cultural identification and loyalty over the Nation. The great risk to the US is that fewer people will have reverence or even a correct understanding for the living Constitution, which is what makes the US the exceptional nation it is. The cultural and geographic divisions within the US may become distressingly pronounced.
The opportunistic reaction to global fragmentation will be to create or recreate superregional “zones of influence”. The AngloSphere has been discussed for many years now as a trading, linguistic (English), and military association anchored by the US in the West and India (now the largest English speaking nation in the world) in the East, with English speaking Africa in the middle, incorporating over a third of the global population. The SinoSphere, anchored by China and including Japan and Siberia (where the illegal and legal Chinese immigrants will soon exceed the native population) is a candidate. Less likely candidates include a large RussoSphere (including Iran and its clients), a SunniSphere, and a HispanoSphere, but smaller versions are feasible. There will be no EuroSphere because there is no European nation around which such a sphere of influence can be organized and sustained.
2. Rise of Haven States: These are a corollary of global fragmentation. There will be 2 kinds of haven states: the failed states that are domiciles for Narco and Islamo-terrorists, and the stable states that are the refuge of private capital and corporations. While Africa and East Asia will provide the failed states, the stable states may well be found in the island nations of the Pacific and Caribbean and the small reconstituted mini-nations of Europe.
The failed states will elicit repeated local but expensive wars of suppression by large nations or spheres and ensure terrorist attacks all over the world will continue for a generation. The stable states will compete among themselves to provide security and anonymity for private capital. The combination of global fragmentation and haven states will allow very large, well organized and very rich multinational criminal organizations to function. In addition to drugs and weapons, of course, there will be organizations that specialize in human trafficking, counterfeiting, commercial espionage, financial fraud and piracy of both physical and intellectual property.
3. Attempts to Create Private Currencies: Private currencies are neither new nor novel. Many have existed in the past, some niche currencies exist today (e.g loyalty points, frequent traveler bonuses, coupons, vendor credits, IOUs) and no doubt there will be more in the future. The motivation will be to seek shelter from debased currencies. The primary impetus will be to find a store or stores of value and the secondary to find a medium of exchange. Physical resources will be the basis for such currencies. These resources will be large, accessible and intrinsically valuable to people in different cultures, polities and spheres of influence. Candidates include oil, natural gas, coal, uranium, iron ore and the perennial gold and silver. Niche private currencies based on electricity or bandwidth may be attempted in limited geographies A basket of such physical resources may offer the best prospect with symbolic representations of these real things serving as exchange medium.
4. More Divergence in Worldwide Birth Rates: Global fertility rates are falling everywhere and quite rapidly but from quite different levels, which means that demographic momentum is very different in different nations. The divergence in fertility rates will increase. Birth rates will fall even further below replacement rates in Europe, Canada, Russia, Japan, South Korea, China, Vietnam, Brazil, Turkey and even Iran (whose total fertility rate is now only slightly above France). Of the advanced economies, the US will continue to be the exception with a fertility rate equal to the replacement rate (but with fertility rates in the South, Southwest and Mountain States markedly higher than in the rest of the country) and immigration providing the population boost. In Africa, the Indian Sub-Continent, Iraq, Afghanistan and Indonesia, however, fertility rates will remain well above replacement rates.
The demographic winter in Europe, Russia, Japan and South Korea will turn bitterly cold in the next 10 years largely because of pessimistic populations while China, several parts of Latin America, Iran and a few Middle Eastern nations will slide into a deepening demographic Autumn, driven by either national pessimism or public policy. The US will continue to enjoy a demographic late Summer while Africa and the Indian Sub–Continent will provide a hugely disproportionate fraction of the world’s babies. Russia will have the worst demographic profile in the world, followed by China, which will only foster greater nationalism, resentment towards other nations and greater willingness to use force in dealing with real or manufactured threats, internal and external. The demographic winter nations will record longer and longer periods of economic stagnation. Russia’s fortunes will depend almost entirely on the price of energy and minerals .Therefore, Russia will pursue a foreign policy of creating instability in world energy and mineral markets to boost the risk premium of its exports and force the pace of its nuclear technology exports.
5. Global South Will Reject US and EU Energy and Environmental Policies : As the economic, military and moral leverage of the West over the Global South declines while China, India and Brazil assume more power, the Global South will decisively reject the energy and environmental policies and prescriptions of the US, Japan and EU. Energy and food security are the two great imperatives of the Global South. Both require enormous and swift increases in electricity production (this will be explored in a subsequent essay). The only massively scalable generation technologies available in the next two decades are coal, natural gas and nuclear. Therefore, coal and nuclear followed by natural gas generation will be extensively deployed across the Global South, led of course by China and India. Indeed the Global South may well seize technological leadership in coal and nuclear generation and advanced very high voltage transmission systems from the West and hence rapidly gain global market share in power generation and transmission markets and also bid engineering and construction management talent away from the West.
6. In the US, Large Declines in Professional Capacity: Professional capacity will shrink by over 50% in finance and real estate (from peak) and by over 25% in the legal, consulting, accounting, retailing, media, fashion, advertising, non-profits and advocacy, fine dining and high end lodging industries. This shrinkage will be net of newly created solo and small group practices or emerging niche firms or freshly constituted small but very specialized and highly skilled, very lucrative, partnerships and LLCs. Some of the surplus professionals will, of course, move on to other opportunities or start small businesses based on their general competence and relationships. Some will leave the country; a few will disappear into the growing underground economy to facilitate the exodus of people fleeing from unfair taxes and unreasonable regulations (bad and expensive government), but many will face years of grinding downward mobility and only episodic employment.
7. In the US, the Emergence of the Home as the Locus of Many Activities: For millions of American families the residence will again gather up several functions that migrated away from the home about 125 years ago. The home, once more, becomes the domicile for income producing work (the home commercial operation-HCO), healthcare, eldercare/aging in place, childcare, schooling/learning/apprenticeships, entertainment, exercise, and even growing food and making wine, depending on size of the property, electricity and natural gas utility tariffs, and zoning. The extended family also enjoys a revival where the personalities and quality of intergenerational relationships permit. The extended family reduces per capita household costs, increases the range of activities that can be undertaken, improves the quality of care, enhances both personal and neighborhood security and allows fairly sophisticated HCOs to function.
Economic and demographic pressures and advances in multiple technologies, software applications and home oriented professional and logistical services converge to facilitate this rebundling of functions. The increasing power and specialization and fallings unit costs of design, collaborative, supply chain, revenue stream and relationship management software; the increasing power and falling costs of home based computing and communications; affordable and compact high “9”s power quality equipment; very potent but compact laser cutting equipment and the impending (3 to 4 years) arrival of practical desktop fabrication makes it possible to undertake a rather large array of high value added commercial and fabrication operations at home while creating quite elaborate and sophisticated but cheap supply, logistics, distribution, marketing and remote work sharing/management networks.
In addition, technology platforms and applications will allow many existing but tiny and inefficient home based businesses to expand to critical mass. HCOs with annual revenues of tens of thousands of dollars to millions of dollars become both attractive and practical. The combination of necessity and feasibility will allow hundreds of thousands of HCOs to exist, taking the home based office or business to a much higher level of economic value added and employment in the US, while also fostering cultural changes that cannot really be anticipated.
The growth of HCOs will be aided and accompanied by the growth of social network financing, micro lending, micro private equity financing, micro M&A, HCO insurance, community banking (as thousands of new community banks are created in the next several years) and special purpose vendor and distribution/marketing channel financing. Home based schooling will also grow markedly given necessity, the availability of family members to teach and the recent emergence of an extensive advocacy and support service infrastructure, particularly in the South.
Home healthcare, aging in place and eldercare will be facilitated and stimulated by the availability of affordable home based defibrillators, dialysis equipment, sophisticated labs on a chip, life support equipment, and remote bio-medical monitoring, sensing, diagnostics and intervention tools, pressure and movement sensors and very inexpensive, long lived, low power, wireless temperature, vibration, moisture and gas sensor webs that can turn a bedroom into a mini life support/life extension facility. Many specialized home healthcare/eldercare services will emerge to provide support services and advice to families.
The home will become an important emerging market for large corporations and HCOs will be diversified and easily accessible sources of supply. In parallel, local community colleges and vocational/technical schools will witness a surge in enrollments while traditional high overhead universities, including elite schools, will see enrollments drop by a fifth to a quarter. Formal, paid, apprenticeship programs will become popular with millions of young people.
The author is no better (and likely worse) at trying to divine consequences than the interested reader. Indeed, the reader should view these consequences as an amusing template and conjure his or her own structures and trajectories. The more actionable these consequences the better the reader will be served in making investment choices. Remember, though, the most significant consequence will be the one we did not foresee. Those tempted by linear extrapolation of the most recent past should remind themselves that we are in an economic episode not an economic change of universe. This too will pass in a few (3 to 4?) years. We are sliding into a deep valley but not an abyss. There is another side which we will reach and then climb up and out. Of course, it will look different on the other side but for many shrewd or merely lucky (and the select few who are both shrewd and lucky) investors, innovators and risk takers it will be a much better place.