Hello and welcome to our latest video MacroMemo. We’ll be talking about quite a range of subjects this go-round. We’ll, of course, talk about the war in Ukraine. We’ll link that, in fact, to headwinds for globalization that have been mounting for a while but, of course, are more intense in the context of this war and its aftermath.
And we’ll take a look at China and some concerns on Chinese growth. We’ll talk, certainly, about goods-versus-service spending and the idea that it’s critical that we see a shift towards service spending, and perhaps we’re starting to see that. And, similarly, that supply chain problems need to be resolved to fix some of this high inflation, and maybe they’re starting to unstick just a little bit.
And we’ll also touch on the idea of trust and declining trust and the extent to which that might be relevant to the global and to the U.S. economy. And of course, we’ll also spend a moment on the pandemic itself.
And so, let’s begin with Ukraine and the war with Russia. And so that war continues. And it has, indeed, as expected, narrowed significantly to Eastern and Southern Ukraine.
The prospect of a cease-fire, which had looked plausible a few weeks ago, looks now somewhat less likely. In fact, the betting market that we track on that subject now assigns just a 17% chance to a cease-fire by June 1st, which isn’t very good at all; a 56% chance by December 1st, which is significant but, nevertheless, a fair bit lower than the thinking just a few weeks ago. So, a cease-fire looks a bit more difficult, in part, after accusations of atrocities against Russia.
We are seeing a little more sanctions applied to Russia by the West; more restrictions on certain Russian banks, on certain wealthy Russians. Europe talking about potentially closing its ports to Russian ships and possibly blocking the importation of oil and coal from Russia. That last one could be potentially significant, if it took place.
Commodity prices are absolutely elevated in response to all of this. This is still economically primarily a commodity shock, a negative supply shock that’s hurting the global economy. However, oil and gas prices aren’t quite as high as they were. And the oil story is at least, in part, because in the U.S., a million barrels of oil a day is set to be released for the next six months from the strategic petroleum reserve.
And on the gas front, with specific relevance to Europe, Russia hasn’t actually stopped gas exports, and Europe hasn’t stopped buying gas. And so the supply is still there. The price increases are mostly to do with risk premiums, though Russia is now demanding payment in rubles, which may yet create problems in terms of the flow of gas.
One important subject, I think, on the matter of this war in Ukraine is the question of just how many allies Russia has. Russia isn’t completely alone, and it’s not just Russia plus China, if you recognise that China has been somewhat friendly toward Russia.
Actually, if you look at one of the most recent UN votes against Russia as it attacked Ukraine, there are 48 countries in the world that either refuse to criticize Russia or abstained or didn’t participate in some form. And so that’s a significant fraction; that’s about a quarter of the world’s countries were not vehemently against Russia; 27.7% of global GDP represented within those 48 countries, and including China and India and Pakistan, Bangladesh, Vietnam, South Africa, Iraq, countries in Asia and Europe and the Middle East and Africa and South America and North America as well. So, a fair range.
This isn’t a reheated Warsaw Pact kind of alliance, in the sense that all the countries that had been in the Warsaw Pact that was the counter to NATO through the Cold War; all of them actually on the Western side of things this time and are against Russia, so it’s a very different set of countries. Nevertheless, it’s not a trivial group.
And so that brings us to the matter of globalization. And so, clearly, this war is adding an additional fracture into the world. Globalization was already decelerating somewhat over the last decade or two. We weren’t getting trade outpacing GDP growth to the extent it did, say, around the turn of the millennium. That trade had been growing around the same rate as GDP in recent years, which you might describe as globalization in neutral as opposed to globalisation advancing.
We had already seen U.S.-China relations deteriorate to some extent. We’d seen companies wake up and recognize, in the context of the supply chain problems in the world, that they needed greater resiliency in their supply chains, and that was encouraging, some onshoring. So, several forces were already conspiring against globalization, but now, of course, this war with Russia provides another excuse.
It should be conceded, Russia wasn’t a huge part of the globalization story. Its economy isn’t that large outside of its supply of resources. Russia probably does find new markets for its resources, and so, on that front, that limits the extent to which globalization is dimmed by sanctions on Russia.
Russian allies, as much as they are trying to be friendly with Russia, they’d still like, for the most part, to be friendly with the West as well, and for that matter, friendly with China as well. So I wouldn’t describe it as a complete division forming by any means. But in the end, trade does end up a little bit worse from here as a result of this war, and so the global economy loses a half-step as well going forward.
Of course, globalization is famous for helping to pull inflation down over the last several decades as well, and so, you might expect inflation to be a little bit less low on average over the long run going forward, as globalization no longer helps quite so much. But it is important to recognize that maybe globalisation wasn’t quite as depressing on inflation as generally imagined. It might have been chopping a few 10ths of a percentage point off inflation. As a result, we’re just really talking about a few 10ths of a percentage point perhaps back onto inflation.
China merits some attention. It always does. It’s such a big and important economy. But at this particular moment, I would say I’m feeling a little concerned about the Chinese economy. I can’t deny it is presently set to deliver a fiscal and monetary stimulus and government is targeting a pretty healthy 5.5% growth rate.
But I keep thinking, Chinese growth might fail to grow quite as quickly as that. And there are a number of reasons why. I think the most obvious one is the pandemic itself, which is very much circulating in China now; China setting records in terms of daily infections. Concentrated in Shanghai, though not exclusively there.
And really, the issue is one in which this BA.2 subvariant is just so contagious that it’s going to be hard for China’s zero-tolerance policy to fully work. And so, to that effect, we’ve got Shanghai locked down quite profoundly, after Shenzhen did. More than 70 Chinese cities, representing about 40% of its GDP have some restrictions they’ve now had to put in place fairly recently.
And one measure we’re looking at is subway traffic. And subway traffic in China is down by more than half relative to just a few months ago and is actually now almost as low as it was in early 2020. So it would seem some real economic damage may be brewing on that front.
And simultaneously, it’s a bit less pressing as the rest of the world shifts from goods spending to service spending; that’s not great for Chinese manufacturers. And Chinese housing is still quite soft as well, with some measures of home sales still down more than 50% from a year ago. So, the Chinese economy, it should grow. It should grow fairly impressively by any standard, other than that of China, but perhaps not as quickly as 5% a year.
Let’s discuss goods versus services. And so people have been buying more goods through the pandemic. It’s part because services were unavailable and part because they had to create their own gyms at home and do their own cooking at home and those sorts of things, so weren’t able to outsource purchases in a service sense.
A big part of the global supply chain problem is people buying more goods than normal. In turn, that is a big, if not the biggest, part of high inflation. And so we should care a lot about the skew of spending between goods and services.
And, in theory, it should be getting better. People should be feeling fairly sated in terms of their goods buying. We are simultaneously seeing restrictions ease that allow people to consume more high-touch services. We are seeing, we think, evidence of those services being consumed in terms of surging restaurant reservations and rising passengers on flights and rising hotel usage.
Somewhat frustratingly, we can only see a little bit in the official goods-versus-service spending data this pivot, but we do believe there should be an ongoing shift here. And as that happens, it should be quite a helpful thing for supply chains and quite a helpful thing in terms of pulling inflation down over the second half of this year as well. So pay close attention to that.
A little further comment on supply chains. And so, supply chains, of course, hinging in significant part on whether people buy fewer goods and start to buy more services again, since supply chains don’t have to deal with the services side to any significant degree.
We are seeing, we think, some small improvements in manufacturing supply chains. Number of container ships waiting to unload at key ports is now profoundly lower, though not low. The cost of shipping globally is now lower, though still, frankly, quite high. Manufacturers are complaining a little bit less about supplier deliveries.
And we actually were playing around with Google’s news searches recently and we found that searches for the terms, supply chain, shortage, chip shortage, and car shortage, have all diminished quite profoundly over the last several months. They peaked last fall and there are far fewer searches to that effect these days. And so, we do think we’re seeing some improvement in supply chains, though, of course, there are still some pretty serious impediments to that returning all the way to normal.
Let’s talk now about declining trust. I think this is a very important subject. We’ve seen, arguably, trust among fellow people and political trust and trust in the media all decline quite significantly. And so, let’s talk about that.
There’s obviously been a political divide that’s opened up, particularly in the U.S. The fear has always been that of economic damage in the future, either because trust diminishes to the point that commercial transactions become less smooth, because these things are based in large part on trust and not purely on contracts. Because if there were ever to be a significantly disputed election or coup or something as extreme as that, that would increase risk premiums, which would be a costly thing to the economy; or just because public policy drifts so far from the centre, be it to the left or to the right, that it ceases to provide a good foundation for the economy.
And so, these are all concerns. They really haven’t been realized in any significant way. We haven’t seen that much obvious damage from all of this. But nevertheless, we can actually dig our way into various surveys and get some tentative answers. And indeed, we find when we do that that Americans have become somewhat less trusting of other people, of the press, of the government. And more, though still fairly few, believe society must be radically changed.
Now I should emphasize, this trend is not just a U.S. phenomenon. When we look at Canada, the story isn’t all that dissimilar, in the sense that we see decreasing levels of trust, increasing levels of concern, though not to the same extent as the U.S. And so, in the end, Americans do appear to worry more about the likes of corruption, more about the risk of civil war and those sorts of things than Canadians. Not as much as in the developing world, in many cases, which seems fair to the extent there are things like coups and there is a lot of corruption in some developing nations.
But I guess the question is whether we could start to see some economic damage come from this. And so far, corporations have been sufficiently well run. They’ve insulated investors from these kinds of concerns. But we need to watch whether trust is being lost in a way that damages the ability to conduct commercial transactions, in a way that builds risk premiums, and so makes borrowing more costly, say, in a country.
And so, again, so far, we haven’t seen that, but those are the stakes. And it is quite an important matter, and the trend is not a friendly one in terms of societal trust.
Let me finish very briefly on the pandemic. And so this BA.2 wave seemingly has already peaked and is beginning to ebb in Europe. It has generally not proven as problematic as the Omicron wave. It is still building in North America, but we’re assuming it will be a similar story for North America; a similar pattern will be followed, with a peak within the next month or so, and then, presumably, abating into the summer when infections tend to be at a fairly low level.
All right. That’s it. Thanks so much for your time. I hope you found this interesting, and please tune in again next time.