Globalization: Keynote Speech in Luxembourg

I had the privilege of delivering the keynote address at the 6th Annual Cross-Border Distribution Conference, sponsored by Deloitte and Elvinger Hoss, and supported by the Financial Times Live, in Luxembourg. What follows is the gist of my remarks not a verbatim duplication of the address.

I began off my speech by citing a number that I recently came across that left an impression.  The number is 10,315.  It is the number of days the Berlin Wall was up, and on February 5, it is the number of days since the Berlin Wall was torn down.  

It is not that globalization began when the Berlin Wall fell, but rather that the Cold War did not derail globalization.  The terrorist attack on the US in 9/11 did not end globalization, like the doomsayers of the day warned.  The Great Financial Crisis did not end globalization.  Globalization with withstand Brexit and it is bigger than the United States.  That is my first and most crucial point:  Globalization is resilient.  

It is true that capital and trade flows are off their pre-crisis peaks, which remember was a bubble.  But despite some creeping protectionism, there is no return to Smoot-Hawley.  

The slowing trade flows coincided with a dramatic drop in prices of commodities, like oil, and swings in exchange rates.  The US, China, and Japan have smaller external imbalances.  Germany is the notable exception.  Last year was the first since the crisis that world trade grew faster than world GDP.  

Populism-nationalism is the biggest threat to our generation's globalization as it was to the earlier attempt a little more than a century ago. The populist-nationalist forces have not won a single national election. The most success enjoyed by that agenda was within the largely two-party systems in the UK and US when the center-right party embraced parts of their program.

Compromises have been made on immigration and there have been some mild forms of protectionism.  There is no trade war.  There is no currency war.  

Since 1995, the US has disavowed using the dollar as a weapon.  This is the meaning of the strong dollar policy.  Subsequently, the G7 and G20 have embraced this principle.  The speed to which the US backed away from what appeared as a violation recently is a testament to is durability.  When Japan's Abe seemed to fly to close to the sun--hinting a currency depreciation to boost its competitiveness in 2012, the G7 insisted on every one recommitting to letting the markets determine exchange rates.  

Washington recently announced tariffs on washing machines and solar panels.  Two countries most directly impacted, China and South Korea did not immediately respond with a tit-for-tat retaliation.  Instead, they strengthened the international rule of law by filing charges at the World Trade Organization. 

The tariffs are not the end of global trade.  Nearly each of Trump's modern predecessors also levied tariffs on some goods   And seemingly all but ignored was last week's decision by the US International Trade Commission that ruled against Boeing and in favor of Canada's Bombardier.  

 The checks and balances are working.  Compare the resistance of the judicial branch to the immigration rules the Trump Administration has tried implementing to the US Supreme Court allowing the internment of Japanese American citizens.   Appreciating the "art of the deal," Trump's bark has been worse than his bite.  

China has not been cited as a currency manipulator.  There has not been an across the board tariff slapped all Chinese goods.  The US has not left the WTO or NATO.  The withdrawal from the TPP was not peculiar to Trump as both Clinton and Sanders were opposed as well.  NAFTA negotiations are proceeding, and are more likely to be extended than cut short.   

The US did not sign the Kyoto Treaty, and Trump withdrew from the Paris Accord.  It might say that the US has an ambivalent view of the environment, and in any case, the checks and balances are working insofar some of the largest US states and municipalities will continue to voluntarily adhere to the accord.  

The US is not the only driver of globalization.  The EU has recently struck trade agreements with Canada and Japan and appears close to a pact with Mercosur.  The Trans-Pacific Partnership multilateral trade agreement is proceeding without the US.  

Cross-border movement of capital has slowed.  The combination of direct and portfolio investment and cross-border bank lending is about 60% below its 2007 peak, which we need to again recall was a bubble.    

Around half of the decline can be traced to bank lending within Europe.  Before 2010, creditor countries would recycle their surplus by buying bonds of the deficit countries in the periphery.  This remains a problem but obscured by the ECB's asset purchases.  The withdrawal of EMU banks, and banks in Switzerland and the US has been blunted by the new efforts by Chinese, Japanese and Canadian banks.  

However, the globalization of savings remains very much intact.  McKinsey Global Institute estimates that 27% of the world's equities are own by foreign investors, up from 17% in 2000.  MGI estimates that 31% of sovereign bonds are owned by foreign investors, up from 18% in 2000.  

The solution of one era causes problems in another era.  One challenge had been to improve the accessibility and efficiency of traditional investment vehicles.  This helped create instruments for passive investment.  Now nearly a third of US ETFs and open-ended mutual funds are passive compared with a fifth in 2010. 

These passive invest vehicles took in an estimated $90 bln a month in 2017.  Assets being managed actively have risen because of appreciation that has offset the mild outflows (~$65 bln a year since 2010).  In the first several years of the noughts, active managers were taking in around $130 bln a month.

Money going to passive investments earning around 70% less fees that associated with active investments.  Show me such a powerful squeeze on margins, and I will show you an industry that will become more concentrated through consolidation.  

Blackrock and Vanguard dominate with a combined $9 trillion of assets under management.  Their market share has doubled in the past 15 years to 30%, and some industry projections have it reaching 50% in the next decade.  This concentration also reinforces the downward pressure on fees.  

The changing regulatory environment challenges the globalization.  MiFID II has begun seemingly without a major disruption.  Research looks to be in flux with different competitive models springing up.  I suspect that less will be produced, creating some inefficiencies and niche opportunities, like in small caps and special situations.  The Trump Administration is unwinding and reducing some of the enforcement of Dodd-Frank and there are other delays in both MiFID II and US Department of Labor rules on advising those with retirement accounts. 

There are some cyclical challenges too.  By various measures, a number of equity markets, notably in the US, is very stretched.  The growth cycle is maturing.  This is especially true in the US, where late cycle economic readings are becoming more common.  Inflation has been subdued, but there are signs that not only has the risk of deflation subsided, but inflation appears to be gradually rising.   

China's debt burden and the US committment to the international order that it was instrumental in constructing are systemic issues that concern many investors.  They seem to have replaced fears of the consequences of monetary union in Europe without political union.  

I am confident that the global system, the evolving rule of law, is resilient and can withstand the cyclical challenges and those represented by populism, nationalism, and protectionism.  But it is not like Athena, the Greek goddess of wisdom that pops out of Zeus' head fully grown and armored.  Globalization takes continued effort, and to borrow a phrase, patience, and persistence.  

I am not so naive as to this globalization is a utopia.  As Nobel-prize winning economist Joseph Stiglitz observed, economists always knew that globalization produced winners and loser.  We just thought that the winners would compensate the losers, and when they don't there is a large political price to pay.  

There are forces of protectionism and national chauvinism.  And there are forces of globalization.  I know which I prefer.  

May the force be with you.  

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