Despite major challenges over the last few years--the covid-19 pandemic, Russia’s full-scale invasion of Ukraine, an energy crisis, geopolitical tensions and increase rate increases--the global economy has been “very resilient,” said Citi’s global chief economist Nathan Sheets during his at the Association of the Luxembourg Fund Industry’s Global Asset Management conference in Kirchberg on 19 March 2024.
There were a few key elements to explain this resilience, Sheets told Delano during an interview after his speech. Early in the pandemic, everything shut down, supply and demand were disrupted, and GDP fell sharply. “But what’s extraordinary is large swaths of the economy quickly adapted to virtual technologies,” said Sheets, highlighting his first point. These technologies had existed before, but “we hadn’t had the incentive to really learn them and deploy them yet.”
The pandemic gave us that incentive, he explained. “The term that economists use to describe it is, it created network externalities.” This refers to how demand for a product depends on the demands of others who are also buying the product. With the pandemic, everybody had to learn to use virtual tools, and “now it’s an embedded part of our culture, of our economy.”
There is a debate as to whether people are working harder or less hard because of those tools, said Sheets, who noted the answer is “probably some of both.” In any case, “it definitely was a big shift. “Had this happened 30 years before, we would have had quarters of terrible GDP growth,” he argued. “That’s really one notable effect.”
European resilience to gas shock
A second illustration of global economic resilience is Europe’s resilience to the “gas shock.” It’s a “phenomenal example,” said Sheets. When Russia started its full-scale war against Ukraine, “my sense was that if Russia shut down the gas, that would have an inestimable negative effect on European economic activity.”
At the start of Russia’s invasion, Vladimir Putin tried to use Europe’s dependence on Russian gas as a weapon to force it to drop its sanctions against Russia. Indeed, say that in 2021, the EU got roughly half of its gas from Russia and half from other sources. But thanks to an in the EU, as well as a shift to liquified natural gas and increased supplies from Norway, the United States and North African countries, the share of Russia’s pipeline gas in EU imports dropped from around 45% in 2021 to 8% in 2023.
“All of that allowed Europe last winter to move through it,” said Sheets. “Was it hard? Yeah. But it was not nearly as bad as what many had expected.” And this winter has been even better, thanks to gas storage and other measures, he noted.
US consumer has been “tireless”
Consumers have been resilient, adding to the overall resilience of the global economy. “We were surprised in a lot of places, including the US. The US consumer has just been tireless,” said Sheets. “And what’s notable is, when you look at indicators of debt and so forth, savings rate, it looks like the sector as a whole may be a little stretched, but not dramatically.”
“There are some more tensions there, amongst lower-income households, the bottom 40% of the income distribution that we’re watching,” he cautioned. “But there are just a number of different places over this period where you can say, ‘Wow. That’s unexpected strength that has emerged, and flexibility and the ability to respond to whatever shocks come.’”
“Green revolution is critical”
The green transition is something to watch in the coming years and decades, said Sheets. But traction is different depending on the region. “Clearly, the commitment in Europe is foremost, front and centre.” On the other hand, “the effort in the United States is more mixed. Some states are trying to vigorously move forward, and some large corporates are trying to vigorously move forward. But there are also others that are--let me put it--emphasising other priorities, and how it all maps out. And I think Asia is probably somewhere in between those two.”
“I think the green revolution is critical, from an environmental and climate standpoint,” he said. But not only that. As new technology is developed, it will not only be “greener,” but it’s also likely to be “better,” “more modern” and include the “latest capacities and abilities.” The importance of green investment is “broader” than just its “greenness,” said Sheets. “It’s also likely to be supportive of productivity growth.”
Major risk to watch out for: inflation
When it comes to risks to keep an eye on, “I think the biggest pain-trade right now would be if inflation were to stay stubbornly high,” said Sheets. “It would be especially painful if it accelerates.” That would make it very hard for central banks to cut interest rates, longer-term yields would stay up and it would hint that “higher inflation might be more likely part of the new normal than what we think.”
“I think the biggest risk out there is that inflation doesn’t come down,” he said. But “a corollary to that is that central banks cut [rates] too soon. And as they take their foot off the brake, that inflation resurges. That’s a variation on that theme that might even be worse, because you’d have the high inflation and you’ve have damaged central bank credibility.”
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Another risk that Sheets is watching is US government debt. “In 2023, through the summer and early fall, we saw whiffs of pressure on government securities markets, due to concerns about the levels of the debt. It’s a US risk, but given that it’s the global safe haven asset, it’s a global risk.”
“Re-balancing” of globalisation
With the pandemic, supply chain issues, shipping disruptions and geopolitical tensions, de-globalisation is a topic that has surfaced in recent times. What are some trends around globalisation--or de-globalisation?
“Our sense is that it’s not right to call what’s happening ‘de-globalisation,’” replied Sheets. “What we’re seeing is rather a re-balancing and a re-profiling of globalisation.”
We’re seeing global linkages be less China-centric
This is seen in two ways. “One, we’re seeing global linkages be less China-centric. Specifically, we see that in trade flows. We see that in foreign direct investment, where foreign direct investment into China is slowing. Instead, it’s going to other parts of Asia; India has been a big winner, Mexico has been a big winner. From a US perspective, we’ve seen some evidence of reshoring.”
This shift away from China is also seen in global financial centres, he added. “It feels like Hong Kong has suffered a bit in its prominence as a financial centre.” But cities like Singapore and Dubai have benefited. “So in a number of different dimensions, it feels less China-centric, more diversified, and in some sense, it’s giving more countries an opportunity to benefit from the potential gains associated with globalisation.”
“The other feature of this is that it feels like it’s becoming less goods-intensive and more services--and specifically digital services--intensive,” he concluded. “When you think about the new technologies that are emerging--AI and virtual technologies and others--they’re going to be data-hungry, they’re going to facilitate communication. It’s going to require a lot of global linkages there and facilitate a lot of global linkages.”