New year, new concerns

We have barely started the year and already a number of issues have surfaced which are likely to impact on the global macro picture. In the first instance, the decision by Donald Trump to order a missile strike that killed Iranian general Qassem Suleimani threatens further destabilisation in an already febrile Middle East. Markets reacted negatively, as is often the way with such events, and although nobody knows for sure what the longer term implications will be, this sort of provocative action has the potential to generate a spiral that nobody can control. At a time when the global economy has already lost momentum, a spike in uncertainty does not bode well for markets, although as I noted a few days ago, markets have developed a habit of defying bad news. 

Nonetheless, equity markets would appear to be due a correction. After a massive rally in 2019 driven by Fed rate cuts, I cannot see this being repeated in 2020. To a large extent, the rally of 2019 felt a bit like the late cycle surge of 1999 when markets were driven by irrational exuberance. With the economy in the industrialised world likely to shift down a gear, and Chinese growth at its slowest since the late-1980s, the fundamentals underpinning the markets appear less favourable. There again, equities remain the asset class of choice so unless we experience some form of major random shock, it might be too pessimistic to expect a bearish correction (in the sense of a decline of 20% or more) but upside is far more limited than a year ago. 

A second issue is climate change, which is rising up the list of things that policy makers should be paying more attention to (although in fairness, European policy makers have done more than most). The pictures splashed across our TV screens showing the extent of the bush fires in Australia are a measure of how the climate appears to be changing, and such issues are likely of be one of the key economic issues of the next decade. As long ago as 2006 the Stern Review set out the economic implications of climate change, pointing out that business as usual practices will lead to increasingly higher economic costs. The report highlighted that although the costs of climate mitigating investment are high, the costs of doing nothing are potentially even greater. When Australia’s prime minister, Scott Morrison, argues that there is no proven link between the bushfires and climate change,  it is clear that politicians have not heeded the message of the Stern Review even after 14 years. And when Donald Trump sees fit to withdraw the US from the Paris Agreement on climate change it is obvious we have a problem. Undoubtedly, we are going to hear a lot more from Greta Thunberg this year and in years to come. 

Central banks have started to make lots of noise about climate issues with Christine Lagarde suggesting it should be a “mission critical” priority for the ECB. Although climate change does not pose an immediate risk to the financial system, there are concerns that rising payouts as a result of climate-related issues could pose solvency problems for insurance companies, or that loans secured against property at risk of flooding could increase the burden of banks’ bad debts. There are those who criticise the actions of central banks’ intervention in this area, arguing that if they get involved in climate issues what is to stop them widening their remit into other areas? Whilst there is some truth in the argument, it is merely another example where central banks are providing a lead on policy issues where governments are unwilling or unable to step up to the plate. 

Above all, politics will remain one of the dominant themes of the year, indeed decade. The big event of 2020 will be the US presidential election. A few months ago I would have said that the odds were in Donald Trump’s favour as he seeks re-election. I am less sure today. A lot will depend on how impeachment proceedings go; how the rest of the world reacts to the US intervention in the Middle East and who Trump’s Democratic opponent is. One thing is highly likely, however: It will be an even nastier campaign than in 2016.

Closer to home, 2020 will be the year that the UK finally leaves the EU – almost four years after the narrow vote in favour of doing so. The Conservatives’ huge parliamentary majority should prevent a repeat of the fractious discourse that characterised 2019 but many battles lie ahead. I still maintain that the economic risks associated with Brexit outweigh any possible economic benefits (which continue to elude me) but the real cost burden will only become evident in the longer term. I suspect that as the year wears on, Boris Johnson’s government will begin to find how difficult it is to deliver the benefits he has long promised. 

One of the issues which will continue to dominate the agenda in 2020 will be that of fake news. Political discourse has blurred the boundaries between fact and fiction and this will be writ large throughout the presidential election campaign. We increasingly appear to live in a series of parallel realities, with the political dimension ever more separated from the rest of the real world. A return to evidence based policy making is not something that I expect to see this year. But without it, I fear the errors that have characterised recent years will continue to mount up. If economics stands for anything it is to aid policy decisions based on the evidence before us. Many of the political debates which invoke economic arguments, notably Brexit but also the US policy on trade, are based on a fundamental misunderstanding of the evidence. Whilst they have not yet significantly impacted on the lives of voters in Europe and the US, sooner or later there will be an economic reckoning. This may not become evident in 2020 but as they fail to deliver the promised benefits the pendulum will start to swing slowly back.