Xi Jinping’s speech throws Alice-in-Wonderland world into sharp relief
Last year was the year when the unthinkable became possible.
Britain’s unexpected decision to leave the European Union (EU) and Donald Trump’s upset victory in the US presidential election marked a watershed for international politics and forced market commentators and investors to rethink their most basic assumptions about how the world is governed.
As 2017 gets under way, this new Alice-in-Wonderland world of politics is becoming more outlandish by the day.
On Tuesday, Xi Jinping, China’s president, delivered a remarkable speech in which he staunchly defended globalisation and free trade, using the platform of the World Economic Forum (WEF) in Davos – the talking shop of the global political, business and financial elite – to reject the protectionism espoused by president-elect Trump.
The spectacle of the leader of the Chinese communist party defending the liberal economic order that is now under threat from, what Francis Fukuyama, a prominent American political scientist, calls “a new age of populist nationalism”, shows the extent to which Brexit and Trump’s victory have turned international politics on its head.
Yet this surreal world pre-dates last year’s twin political shocks and encompasses financial markets.
Despite a tightening in US monetary policy and new forecasts from the Federal Reserve predicting more aggressive increases in interest rates, a significant portion of European and Japanese sovereign bonds still have negative yields, meaning investors lose money if they hold the bonds until they mature.
As far back as March 2015, the veteran bond investor Bill Gross said that ultra-low, and in many cases negative, interest rates were destroying the business models of long-term institutional investors, such as pension funds and insurance companies. “Not even ‘thin gruel’ is being offered to our modern day Oliver Twist investor. You have to pay to come to the dinner table and then sit there staring at an empty plate,” Gross wrote in one of his monthly investment letters.
The ultra-loose monetary policies of central banks have also allowed asset prices to become dangerously detached from underlying economic fundamentals, so much so that economies and financial markets appear to be existing in parallel worlds.
It is worrying enough that yields on short-term government bonds in Germany – the most creditworthy economy in Europe – remain in negative territory. It is preposterous, however, that the 2-year bond yield in Italy, an economy with the second-largest public debt burden in Europe and a banking sector crippled by a vast pile of non-performing loans (NPLs), has been below zero for most of the past year.
The Alice-in-Wonderland financial world is even more conspicuous in the market reaction to Trump’s victory.
Without even knowing the policies that Trump will implement after he takes office on Friday, yet knowing full well that the president-elect is brazenly populist and highly unpredictable, equity investors have been exuberant since Trump’s victory, betting heavily that the next US administration will ignite growth through aggressive tax cuts, deregulation and infrastructure spending. The benchmark S&P 500 index has risen 6 per cent since the US election.
Yet as Convergex, a US brokerage, rightly warned in a report on Tuesday, “since Trump has no track record in government and a very unconventional approach to communicating his thoughts, investors have less information and more questions about the incoming administration than any other prior transition. It’s only a mild stretch to say that ‘nobody knows nothing’.”
Fortunately, investors may not be as irrational and deluded as it appears.
The “Trump rally” is already starting to lose momentum.
Since the start of the trading year, the dollar index, a gauge of the greenback’s performance against a basket of its peers, has fallen 2.5 per cent while the yield on benchmark US 10-year Treasury bonds has dropped nearly 25 basis points since mid-December. The “Trumpflation” trade is being questioned - and rightly so.
The international political landscape, however, is in a state of extreme flux and is the most unpredictable.
On Wednesday, the second day of the WEF, global policymakers agreed that the West faces a major threat from populism but disagreed on its severity and how best to address the problem.
This is what has provided an opening for Xi, the leader of the world’s second-largest economy and its most important emerging market (EM).
Yet China is no champion of unfettered free trade and a liberal economic order.
Xi is merely exploiting the upheaval in western politics to strengthen his hand. For China’s president, populist nationalism, as Fukuyama calls it, has its upside.
Nicholas Spiro is partner of Lauressa Advisory