28 January 2021
Joe Biden is now the 46th President of the United States, and Anthony Blinken has been confirmed as the new Secretary of State. President Biden has promised substantive changes in American foreign policy, and initial Executive Orders indicate he will act on this pledge. To be sure, American international policy decisions are not the only driver of financial markets, but investors must anticipate the implications of this new direction. I will highlight how the new Administration’s approach to external affairs impacts the investment strategy conclusions outlined in my November blog “Strategy 2021: V(accine)-Shaped Recovery”.
Foreign Trade: Multilateral Versus Made in America?
In contrast to his predecesor, President Biden advocates American involvement in multi-national institutions and foreign alliances. Multi-lateralism, however, is a tactic not a goal; ultimately, the success of such engagement is measured by its contribution to American prosperity, security, and peace. In this regard, the “America First” rhetoric missed the point that every President, and all countries, give primacy to their national interests. However, history shows that national interests are often advanced through international collaberation. And, as we have seen, the Trumpian, “go it alone” approach resulted in numerous unintended, negative consequences for the USA and its allies.
In this regard, financial markets will be focused particularly on the new Administration’s approach to foreign trade. Much of Biden’s team recognises the contribution of external trade and investment to American (and global) prosperity. However, many believe — especially within the US electorate — the benefits of globalisation have not been widely shared, and trade has contributed to widening American income/wealth inequality. Finding solutions to this problem will be critical to the future political success of both the Democratic and Republican parties, as each seeks support from America’s middle-class workers.
Regaining international support for multi-lateral institutions, especially the World Trade Organisation, will require reforms to ensure that Free trade is indeed Fair trade, which has not always been the case. Furthermore, the Biden Administration correctly aims to prioritise education and training; equipping American workers with the necessary skills to compete and fill the jobs of the future. On the other hand, it’s not yet clear what the “Made in America” and “Trade Deals for the Middle Class” campaigns will involve. I do not anticipate the Biden team will rush into formal Foreign Trade Agreements (FTAs) in its first term.
President Biden’s pragmatic, internationalist approach to foreign policy reenforces the generally positve market outlook outlined in my 2021 Strategy blog. On the one hand, I believe multinational collaberation can make a huge contribution to future prosperity. Meanwhile, more predictable, orthodox American policies reduce global market risks. However, the Chart above illustrates the US equity market has already priced in much of this optimistc appraisal. Therefore, non-US opportunities appear most attractive. Also, America’s twin trade and budget deficits (reflation trade) and poor Covid and climate track records will result in a depreciation of the overvalued US dollar (next Chart).
China: The Elephant in the Room
The emergence of China will be the most important global geo-political challenge in coming decades. America’s success in managing this bilateral relationship will have implications on its interactions with both allies and adversaries world-wide and will dominate thinking on virtually every policy issue. On trade and investment, there is a broad US consensus that China engages in unfair practices on state subsidies, technology transfer, intellectual property, and tariff/non-tariff trade barriers. And why not?! The following Chart illustrates the extreme scale of America’s trade imbalance with China.
Thus, the inauguration of a new US president will not alter America’s resolve to address the issues behind this imbalance. However, I anticipate a change in America’s tactical strategy. During the past 4 years, America’s world-wide trade shortfall widened from $735 billion to $900 billion. To be sure, the Trump Administration’s confrontation, bilateral approach did lead to a smaller bilateral gap with China, but the red ink simply grew with other countries (next Chart). Trade was not expanded, it was diverted. Reducing the bilateral gap with China may advance some political agenda, but it did not (indeed, could never) remedy America’s appetite for imports and dependence on foreign capital inflows.
I believe a multi-lateral approach to China trade will be more effective and easily gain traction world-wide; indeed, every country shares the same frustrations with China’s trading regime. However, to succeed the WTO must do a far better job in policing China’s trade infractions (and those of other nations). Indeed, it’s fair that China no longer enjoy the WTO trade concessions reserved for developing countries.
The Trump Administration’s bilateral China policy produced important unintended, negative consequences. Unreliable US leadership led other countries to pursue independent programs with the Asian giant. For instance, following America’s withdrawal from the Transpacific Partnership (TPP) (which excluded China), Asian nations signed the RCEP regional trade partnership (which includes China and excludes the USA). Likewise, China and the Europan Union recently signed a new bilateral investment agreement. Further, Russia is trying to capitalise on US-Sino tensions to improve relations with China, at America’s expense.
All nations must develop a strategy which offers an alternative to the two prevailing, unattractive options: either objecting to or accommodating the rise of Chinese influence on the regional and world stage. I base a successful alternative strategy on 4 C’s. Cooperation: recognistion that China still represents an enormous commercial opportunity. Competition: World-wide insistence that China provide a “level playing field” — policed by the WTO. I am certain US firms would thrive under these conditions. Conflict: Communicate with China that national interests will inevitably collide, and resolution mechanisms must be established. Confrontation: To be avoided.
An effective multi-lateral approach will take time to emerge. Until then, I expect the Trump tariffs will likely stay in place. The much-heralded Phase 1 US-China trade deal has not produced the promised US export gains (thanks to Chad Brown of PIIE for the great Chart). While Covid disruptions played a role, China must do a better job adhering to its agreements. I expect a meaningful appreciation of the CNY will be part of the near term solution.
Pivoting Back to Asia
The Obama-Biden Administration’s “Asia pivot” recognised the growing importance of the region in the global economy. The Chart above illustrates the bilateral relationship has continue to deepen. The Trump Adminstration, not without reason, tended to focus on impediments to US exports into many Asian nations. Hopefully, WTO reforms will make progress on this front. As a result of inconsistent American leadership in the region, nations have established closer ties with China. To counter the geo-political vacuum left following America’s TPP departure, the Biden Administration will re-pivot back towards Asia.
America’s renewed Asian focus, the region’s relative ability to contain the Coronavirus, the prospect for global and regional economic recovery, a weak US dollar, and low global interest rates all support our overweight stance in the region.
Russia: Dangerous, But Declining
Russia poses more complicated issues for geo-political policymakers than for investors. The Chart above illustrates Russia’s economic performance is diverging secularly both from other Emerging regions (except Latin America) and the USA.
However, despite its fading economic prospects — which will be adversely impacted further by lower oil prices and climate change — Russia retains formidable financial and military resources. Moreover, Russia appears intent to sow division amongst western allies, meddle in foreign elections, and poison critics at home and abroad.
Following the Trump Administration’s inconsistent approach, President Biden is likely to be more assertive. Amongst other tactics, the new President seeks to build a coalition of liberal nations to confront slipping democratic norms world-wide. The Chart above indicates these values have weakened in nearly 70% of the world. Much as the EU did for post-Soviet era Eastern European countries, this club could provide a non-authoritarian destination to which other nations could aspire to belong. Hopefully, recent events at the US Capitol will not be a prolonged setback in this endeavour. The first test for US-Russian relations may come in February when the START nuclear treaty needs to be extended.
From an investment perspective, underweight for now, despite the undervalued Ruble.
Climate Change: Potential Home Run for Investors
In an earlier blog entitled “Climate Change: Who’s Preparing, Who’s Not”, I provided an assessment of each nation’s preparedness for climate change. The USA ranked a disappointing 20th. The Chart below illustrates that Europe is providing leadership, and has made considerable progress towards its goal of cutting emissions by 55% by 2030. The USA lags far behind, but has now rejoined the Paris Climate Accord. If the USA gets serious about reducing emissions, as I expect, historic investment opportunities will emerge.
Covid, Vaccines, and Emerging Markets
Resolving the Covid emergency, of course, will be the Biden Administration’s top domestic policy priority. But, important international considerations will soon emerge. We know that low-income groups have been most vulnerable during the pandemic. And, while everyone celebrates the rollout of life-saving vaccines, the availabilty in the poorest parts of the world has been limited, at best (Chart above).
Likewise, the ability of health care systems to respond to pandemics is weakest in low-income countries, although Thailand shows what’s possible (Chart above). Even top-rated USA (score 73% prepared) has major deficiencies. Strengthing the resilience of global health systems will be a post-pandemic investment theme. While I am constructive on Emerging Markets overall, be selective. Asia’s Covid experience has been far better than Latin America’s. Sadly, I suspect vaccines will not reach certain poor, vulnerable Emerging regions until 2022.
Iran, JCPOA, and Oil
President Biden supports the JCPOA. The Chart below illustrates sanctions have produced a collapse in Iran’s oil production. Likewise, US and Russian petroleum output has slumped also, reflecting weak demand during the pandemic. If Iranian sanctions are eased, there exists considerable world-wide capacity to boost supply. Therefore, even as the global economy recovers, I expect oil prices to remain low or decline (especially as climate change reduces secular demand).
Europe: Rebuilding Trust
To be sure, the failure of European countries to meet their 2% of GDP NATO spending commitment is unacceptable. Any progress the Trump team made is commendable. But, it came at a cost. The previous Administration’s single-minded focus on this topic diverted attention from other key issues, e.g. Iran, climate change, Russian intentions towards front-line European countries, and Russia’s attempts to influence western political events and to create divisions amongst allies. Transatlantic trust has rarely been lower. And, weakened confidence in American leadership has led Europe to act on its own, e.g. the EU’s recent investment deal with China and French support for an independent European defense force.
Restoring trust will take time, but President Biden’s commitment to the transatlantic multilateral partnership is deep, and based on decades of experience. There’s too much at stake. NATO promotes US interests and saves American lives every single day. It’s also easy to forget that the European Union is America’s largest trading partner. And, Europe dominates Foreign Direct Investment flows into/out of the United States (Chart above). There is always room for improvement, but US-European trade imbalances are not excessive (except in Germany, Italy, and Ireland), and US exporters’ access to European markets is in line with the global average (Chart below).
Indeed, transatlantic tensions are not largely responsible for the underperformance of European markets in recent years. However, improved bilateral relations support my overweight recommendation, as European relative valuations are are at historic lows. I must admit, Europe’s slow vaccine rollout is a concern (thanks to Morgan Stanley for the Chart below!).
