The Macroeconomic Outlook – A Tour of the World Economy, Jonathan Wilmot

Where do we stand, in economic terms, ahead of 2024? Is it possible to look with any certainty towards the new year and anticipate how the global economy will perform?

These were the exam questions set by Eden McCallum for Jonathan Wilmot, the distinguished financial markets commentator, co-founder in 2017 of XAI Asset Management (the firm’s research clients manage some $10 trillion of assets) and, for many years before that, Chief Global Strategist at Credit Suisse. In a concise but weighty presentation, Jonathan set out clearly what we might reasonably expect to see unfold in the coming months.

Less Gloomy But Not Confident

At this time last year, economists and business leaders were unusually gloomy and unusually wrong. The consensus was that both the US and Europe were heading for recession, although possibly a mild one; the world was facing a new era of shortages, disrupted supply chains and higher inflation; and the post Covid recovery in China would probably drive oil and natural gas prices even higher. As it turned out, virtually the opposite happened: US growth accelerated, Europe narrowly avoided recession, supply chains improved, inflation fell faster than expected, the Chinese rebound fizzled, and energy prices fell.

This year most economists are leaning towards a soft landing of sorts in which inflation continues to subside and central banks can hold rates steady or even cut them later in 2024.  But as highlighted in the Eden McCallum Business and Economic Outlook survey, business leaders are generally upbeat about their own company’s prospects but not at all confident about the outlook for global economy, or the scope for lower inflation and interest rates. And they are concerned about geo-political risk.

The world still feels like a very uncertain place.

How to Think About the Outlook

A big part of the confusion lies in the fact that two unusual things are going on. We

find ourselves emerging from the last phase of the Covid cycle – in several ways the most violent and disruptive in living memory – and entering the first phase of a “great transformation”:  the arrival at meaningful scale of AI, green energy, and other new technologies that have the potential to disrupt and transform virtually every part of the economy. It’s likely that the eventual impact, unfolding over the next few decades, will be even bigger than previous industrial revolutions and, as with previous economic upheavals, it will be accompanied by a major geo-political reset, centred around the US-China relationship. It also means that some parts of the world economy are seeing exponential growth already, even as others struggle with the spike in energy costs, interest rates, and labour shortages that followed the pandemic.

Over the past year, underlying GDP growth in the US has accelerated from near zero to around 3.5% per annum. But the recovery has been uneven. Spending on new factories (onshoring), electric vehicles, and green energy capacity has soared while oil and gas production hit a new record and housing, private equity, and VC funding have slumped. Meanwhile, just in the last month or two it has become clear that overall growth is slowing again. Poorer consumers have spent their COVID cash, fiscal policy will become less expansionary, jobs growth is gradually slowing, student loan repayments are resuming, and commercial real estate is hurting; all reasons to think that growth will ebb rather than flow in 2024. On the inflation front, Purchasing Managers data show how businesses had been able to pass on cost increases to customers until recently, but are finding it harder now, and suggest that underlying inflation pressures are more or less back to the pre-pandemic norm (which is also true in Europe and the UK).

This side of the Atlantic, the UK is probably the most vulnerable to the lagged effect of higher interest rates. Both corporate debt and household mortgages will continue to be refinanced over the coming months, with uncertain consequences. But significant small business bankruptcies are almost certainly on the way. Still, the consensus is that three of the major western economic zones – the US, Eurozone and (probably) the UK – should see a modest pickup in growth in the second half of next year as inflation finally “normalises”.

Meanwhile, China has its own version of fire and ice. On the one hand it is facing a structural slowdown as its population starts to decline and the highly leveraged legacy of the property boom weighs on local authority revenue and the solvency of the real estate industry.  President Xi’s seeming hostility to private industry and focus on political centralisation has also left consumer and business confidence in tatters, and capital flight is one of the consequences. Even so, parts of Chinese industrial production – solar cells, wind turbines, robots, and chips – have absolutely boomed over the past year, helped by government subsidies and preferential policies. Amidst a raft of reasons to worry about climate change, the most hopeful news is that China is now completely committed to making the green energy transition as fast as they can – motivated as much by the desire for energy security as concern for the planet.

To Cut or Not to Cut?

Central banks face a big dilemma: it may well be that they have tightened rates enough already to get inflation under control. Yet it is also clear that they were too slow to act on inflation in 2021 and that they hugely underestimated the magnitude of the post-COVID inflation shock. By any past standards, labour markets remain tight everywhere, a combination that makes central banks reluctant to even think about rate cuts for now. Central banks are by nature risk averse and currently the least risky thing for them to do is to sit and wait – even if that delay might result in greater economic pain than is necessary.

In practice, how much scope they eventually have to cut rates – and how soft a landing the economy can manage – remains very dependent on avoiding another major energy (and food) price shock or war-related disruption to global supply chains. Which is perhaps the most immediate reason our economic moorings do not feel secure right now, and confidence that interest rates and inflation will actually fall is still low amongst business leaders. For Europe, the critical factor is likely to be the natural gas price – which feeds quickly through to electricity and heating costs for both consumers and businesses. The good news is that inventory levels going into winter are at record levels, which means that another mild winter would be a boon for both the ECB and the wider economy.

Productivity Isn’t Everything But…

It’s nearly everything”, as Paul Krugman once famously observed.

Economists (and central bankers) are generally very bad at predicting productivity growth, and generally default to extrapolating the trend of the past 10 years or so, which has been miserable in the West and slowing in China. But history suggests that productivity alternates between regimes of slower than average growth and faster than average growth. The simplest way to think about the long-term impact of AI is this: “Machine intelligence is to brain power what the steam engine was to horsepower” and that its eventual impact on productivity will match or even exceed the shift to steam. By way of example, in the US that likely means productivity growth of 2.5-3% per annum for a decade versus the 1% trend seen in the post-GFC period. And that really would change nearly everything.

More generally, just as the substitution of cheap (Asian) labour was a major driver of disinflation and growth over the past three decades, the substitution of capital for labour in ways never previously possible will be the story of the next few. Or if you want to put it in Marxist terms, the “reserve army of labour” will be replaced by a reserve army of robots everywhere, not least in China itself. That will be highly disruptive in many ways, but it’s also a reason for retaining a degree of optimism in what can feel like a vast cloud of uncertainty.

Equally, of course, the explosion of interest in AI over the year since Chat GPT, and the lead that US companies have taken in commercialising Large Language Models, adds new urgency to the rivalry between China and the US:  if you’re not an AI superpower you won’t be a military or an economic superpower.

Taiwan, Trump and the Middle-East

Some 2 billion people in 60 countries are going to the polls next year. The two elections that really matter are the presidential elections in Taiwan (mid-January) and the US (November). For military reasons it is US policy to limit China’s access to the high-end chips needed for AI applications, most of which are currently designed by Nvidia and made in Taiwan. A victory for the pro-independence candidate in Taiwan won’t prompt a military invasion any time soon, but China now has the air and sea power, and an increasing incentive, to demonstrate that it could impose a total blockade of Taiwan any time it chooses. Could that happen in 2024? And would it become more likely if Trump beats Biden this time round? It’s too soon to speculate, but not too soon to note that ordinary Americans don’t seem to want either candidate – and that geo-political concerns will escalate mightily if Trump were to pull well ahead in the polls, which is probably a bigger risk than an actual Trump victory. As for the Middle-East, it seems unlikely that the horrific conflict between Israel and Hamas will lead to a huge oil supply shock like 1973/4, not least because Iran sends 80% of its oil exports to China (via Malaysia) but quite possible that it will escalate into greater regional instability, and perhaps into threats to seaborne trade through the Red Sea.

In brief, the world remains a fragile place, despite a better outlook for productivity and inflation.

To view the full presentation, please click here to watch the recording.

To see the slides presented, please click here.