The writer is chief investment officer at Legal & General Investment Management
Of the many risks asset managers need to consider, one has become increasingly prominent in 2022: the shift towards a multipolar world. This has profound implications for companies, policymakers and investors.
Ever since the emergence of China as a superpower, we have been travelling towards a world in which tensions between global powers — and their proxies — appear harder to contain. And Russia’s invasion of Ukraine, together with growing jitters over China-Taiwan relations, shows that the pace of change has only accelerated.
Following the fall of the Berlin Wall and China’s ascension to the World Trade Organization, the world economy reaped the benefits of globalisation. Growth in international trade and the exchange of ideas, supported by a digital and information revolution, lifted global gross domestic product.
Globalisation was the key driver of the stable period of the “Great Moderation” leading up to the 2008 financial crisis, in which companies were able to access low input costs while economic growth benefited from enhanced productivity. Similarly, governments felt comfortable reducing defence budgets and relying on other nations for financial services and energy supplies. Such global efficiencies created the backdrop for low inflation, in turn allowing persistently accommodative monetary policy.
Unfortunately, the significant wealth created by both globalisation and central bank largesse was distributed unevenly, stoking income inequality between and within countries. It is not hard to link this byproduct to recent unpredictable and extreme political outcomes.
The conflict in Ukraine, meanwhile, is only the latest in a series of recent developments to destabilise the decades-old, US-led world order: the ongoing tension between the US and China, rising political populism and the Covid-19 pandemic. As a result, we are experiencing what at the very least can be termed “slowbalisation”, if not outright deglobalisation.
In light of intensifying geopolitical risks and pandemic-induced disruptions, companies are reconsidering where they operate and how they construct global supply chains. Many will face greater costs and tighter margins, with an increasing share of global income going to labour rather than corporate profits.
At the same time, countries are looking at security spending and sources of reliable energy, shifting economic resources and borrowing from future generations via massive fiscal deficits. This points to slower economic growth and higher inflation.
Given their mandates, rising inflation pressure means that central banks are being forced to undermine aggregate demand by tightening monetary policy. Equity and credit investors, therefore, have to deal with lower economic growth, higher input costs and a reduced likelihood that central banks will intervene to support markets in times of turmoil. In other words, lower returns and higher volatility.
And while the dollar is likely to remain the reserve currency of choice for the foreseeable future, we believe it faces a long-term challenge to its position as a haven during risk-off moments and the go-to location for international financing. That’s because more countries are curbing their reliance on the dollar-based financial system, in part to undermine the potency of sanctions such as those imposed on Russia.
That said, there are currently no obvious alternative candidates. For example, the euro bloc is too linked to US policy, while the renminbi is not sufficiently international. Cryptocurrencies may play their part, but they need to be embraced by countries that would be giving up huge power by relinquishing their fiat currencies. Perhaps the clearest conclusion is that currency volatility will rise, requiring investors to diversify yet further.
Against this backdrop, policymakers face an array of challenges that require urgent attention and fresh thinking, from the diplomatic and economic to the environmental and even cultural. To name but a few, there is the need to tackle the squeeze on consumers while achieving energy security, at the same time as averting a climate catastrophe.
As investors, we need to switch our mindset away from chasing asset appreciation in a world of easy money and instead allocate capital to companies that advance the global energy transition, reshore production, provide stable supply chains and bolster global security. In a multipolar world, those that achieve this are likely not just to survive, but to thrive.