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The writer is a financial journalist and author of ‘More: The 10,000-Year Rise of the World Economy’
Investors often get caught up in short-term news and focus on immediate profit warnings or statements from the chair of the US Federal Reserve. However, those who take a long-term view should consider five key factors that drive global economic growth and investment returns: demography, energy supply, debt, inflation, and geopolitics.
These factors interact in complex ways, making accurate forecasting challenging. For example, the aging populations in Western countries make economic growth more difficult to achieve in the future. Japan’s experience demonstrates this, although its gross domestic product per capita has remained relatively stable. Aging populations have historically been associated with low inflation and low interest rates, as baby boomers save for retirement, maintaining a supply of savings while discouraging business investment.
However, Charles Goodhart and Manoj Pradhan argue in their book ‘The Great Demographic Reversal’ that this may change. As older people start spending their accumulated savings, particularly for conditions like dementia care, and the labor force shortage drives up labor bargaining power and real wages, inflation and interest rates may rise.
The recent increase in prices and rates can be attributed to geopolitical and energy supply factors. While geopolitics has caused market fluctuations in the short term, its long-term impact is significant. The global economy would be very different if China had not shifted towards being an export-oriented market economy in the 1980s under Deng Xiaoping’s leadership.
The use of energy supply as a geopolitical weapon, exemplified by the OPEC oil embargo in the 1970s and Russia’s control over European gas supply, also affects global dynamics. Additionally, China’s dominance in electric car battery production and global solar panel production presents another geopolitical challenge, especially in light of its tensions with Taiwan.
China’s development also plays a role in global inflation. Its cheap goods over the past few decades have contributed to keeping inflation low. However, China’s working-age population is declining, and geopolitical tensions have slowed globalization. This reduction in globalization may remove a constraint on inflation.
If the world enters an era of potentially higher inflation, it will have significant implications for markets. Central banks will need to maintain higher interest rates than in the 2010s, impacting asset valuations. Bonds and cash may become more attractive relative to equities due to higher yields.
The high levels of consumer, company, and government debt, combined with low interest rates, pose a significant challenge. The Covid pandemic led to a peak of public and non-financial private sector debt to global GDP in 2020, although it has slightly decreased since then. However, the debt remains more than double its level in the early 1980s when interest rates were high. Refinancing this debt will strain some borrowers, as evidenced by the mini-banking crisis in 2023 and the increasing default rate on bonds and leveraged loans.
In summary, five major factors create long-term headwinds for global markets. Demography indicates slower growth, energy supply disruptions pose challenges, debt becomes costlier with higher inflation and interest rates, and geopolitical shocks exacerbate these issues. While it is still possible to profit from risky assets, it will be more challenging than in the previous decade.
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