Diana Choyleva tells Merryn Somerset Webb what really caused the financial crisis and how the post-globalisation era will unfold under Donald Trump.
I sat down to talk to Diana Choyleva of Enodo Economics just after the US election. I've been reading her excellent analyses for some years now and found her to be very much more often right than wrong. So we started in the obvious place. Does the fact that Donald Trump is soon to be the president of America mean we have to rethink our views on the US economy?
It really just confirms what looked likely anyway, says Choyleva. Globalisation is "unravelling". When we look back in ten years we will see Brexit as the first major nail in the globalisation coffin. Any chance of stopping the reversal went "with the election of Trump as US president". Globalisation now seems certain to fracture into "localisation".
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On paper it's hard to understand why: globalisation, kicked off by the fall of the Berlin Wall, China's entry into the WTO and very rapid technological progress, has improved the living standards of millions of people. However, there is a "fundamental clash" between the needs of a global market, "national sovereignty and identity", and the democratic system.
These three things "don't seem to easily coexist". What's more, in large parts of the developed world the majority of people have started to feel worse off "relative to the owners of assets" in their economies. Add it all up and "the popular revolt against the establishment is understandable".
An excess of saving fuelled the credit bubble
All this was evident even before the financial crisis began to bite, but the crisis should have been "a huge wake-up call", says Choyleva, and one that should have been met with the correct policy response. What would that have been? That's complicated. So much so that there "almost isn't a solution".
The crisis was not really about people in the US, the UK and the periphery economies of the Euro area constantly wanting to borrow and spend excessively. Instead the "key driver" was the way in which people in the likes of China, Japan and northern Europe wanted to "save excessively". The result was credit offered to borrowers at "almost no cost". It was less that the US demanded the ability to borrow than that China waved cheap money in front of it so tantalisingly it was "almost rude to refuse".
Look at it like this, and you can see globalisation as a clash between "China's semi-command saver economy (the high savings rate there is down to financial repression and the lack of welfare provision) and the market economies of the West".
It is unclear what the Fed could have done about this in advance "it wasn't in the driving seat". Post-crisis, however, it did the right thing quantitative easing (QE) was needed to offset deleveraging; without it we could have seen huge deflation. But while QE was initially useful as a counter to deleveraging, very loose monetary policy has now gone on for far too long and its effects are "turning from being benign to malign". That's the case in Europe and in Japan.
What we have really needed is a global solution one that could have co-ordinated fiscal, monetary, structural and regulatory matters to cope with differences between global economics models even as free trade was able to continue. That hasn't happened (and probably never will).
So how has QE turned malign in this environment? Look at Japan, says Choyleva. They have been engaged in a very aggressive new round of QE. But so far the Bank of Japan has been using QE to buy assets only from the banks themselves and the banks haven't been lending it out. With no one wanting to borrow, the money hasn't hit the real economy or caused inflation.
All it has done has weaken the yen. QE doesn't improve the trend growth rate of an economy. It doesn't solve the structural imbalances. "So if you have an avalanche of money hitting, you might eventually get your inflation but you aren't going to see an increase in sustainable growth."
The Bank of Japan isn't the only one easing too much. "The UK didn't need lower interest rates [post-Brexit] and they didn't need QE either." And as for the US, it might not be loosening policy any more. But it certainly isn't "normalising" as fast as it should. There is no excess debt in the household sector and the rise in the public sector debt-to-GDP ratio has been reined in.
The other good news is that much of the improvement in the economy comes from growth in employment rather than just wage growth. That's a much more sustainable kind of support to consumer spending. Recognising this and raising rates would have given the market huge confidence that things are getting back to normal. It would also have given the Fed more of a chance of being ahead rather than behind the "Trumpflation" the new administration is likely to introduce via the president-elect's mega-spending plans.
Localisation replaces globalisation
This brings us back to the end of globalisation. How will it unfold? In this kind of environment, says Choyleva, "big and stable economies have an advantage over small and open ones". China, India and the US fall into that bracket. "The Euro area, unfortunately, doesn't," given the likely political fallout from all the elections over the next year. On the trade front, the US is unlikely to follow through on protectionist plans relating to Mexico. But where Trump might is on his "hard rhetoric vis-a-vis China and that's extremely bad news".
On the plus side, China, "one of the saver economies", has made the right policy decisions in the three years since it changed leader. It's recognised that the huge amount of money it threw at the economy post-financial crisis has left it with inflationary pressures and "a huge build-up of debt". It has reacted by "opening up the financial system and liberalising at a rate that is unprecedented for China" and particularly surprising given that it has been going the other way politically.
Also of interest is how it has been dealing with its currency. In our zero-interest rate world, the "monetary policies of most economies have been played out largely via the exchange rate". But in China the authorities have prevented the currency from depreciating too fast, such that "the only major currency that is overvalued is the yuan". The problem is that it needs to fall more: the adjustment it has to go through "will be that much harder if it has to deal with an overvalued currency on top". And this is where Trump comes in.
It was hard to imagine how Japan and the eurozone would deal with yuan depreciation before Trump (it makes Chinese exports more competitive), but now it is hard to see how America will accept it either. Trump has already branded China a "currency manipulator". And if you think of China and America "as the wings of the world economy" (one wing comes off and the whole thing spirals down), you can see that we are "entering, unfortunately, a very difficult economic and political time".
This isn't a happy picture. The world still has too little demand and a huge overhang of QE all set against a background of a shift in political attitudes. All that needs global solutions. Yet populations are clamouring for national ones. So, while Choyleva is more of an economist than an investment strategist, I ask her what one is supposed to invest in in times such as these. In terms of countries, she points to the ones that can hold their own in relative terms even as globalisation fractures think the US, China and India rather than the smaller, more open economies.
She is also (like us) keen on gold: "Gold is generally a hedge against political uncertainty and it's a hedge against inflation" and we are facing both. Other real assets should do well on a three-year basis too. She also suggests eyeing up unlisted firms, where there is often good value, and reckons that the really good returns are most likely to come from investing in yourself. When she set up Enodo Economics she did so because she thought (I suspect rightly) that "the highest likelihood of me making superior returns is to invest in my own business".
Fact file: Diana Choyleva
Diana Choyleva founded Enodo Economics in 2016 after 15 years at Lombard Street Research. There she built a superb reputation for her accurate analysis of the Chinese economy: she identified its expansion as the key global force pointing to a sustained upswing in commodity prices in the early 2000s, and in 2011 argued against consensus that China's growth would slow to 5% a year (as it has). She also correctly predicted the US credit crunch in early 2007. She has co-authored two books on the global economy and speaks Bulgarian, English, Spanish and Russian fluently.
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