To kick off 2024, I thought this month’s CEO insights should look at the year ahead and, specifically, the impact that certain global factors may have on the Welsh economy.
Is the Global Economy Fragmenting?
For much of the past 20 years, most developed economies have followed the ebbs and flows of the global economy. In 2023, we have seen some breakdowns with the world’s two biggest economies, the US and China, heading in different directions.
China’s economy is dependent on exports and domestic credit. China has seen a considerable credit expansion over the past decade, and given the amount of state control, it is difficult to imagine that all this money has been borrowed wisely. With weak domestic consumption and the likelihood of declining exports, it is difficult to see how China can avoid a domestic debt implosion in the coming years.
This should have little impact on the global economy as the debt is primarily state and domestic.
Global financial institutions have very little exposure to China.
The exception is the German economy, where China’s struggles impact the export of manufacturing hardware and machinery and where weak energy production impacts the manufacturing sector.
On the other hand, the US has seen GDP growing at around 5% annually, according to the latest figures, driven by oil and gas production and the nearshoring of manufacturing within NAFTA.
If the global economic alignment of the past 20 years is breaking down, who will be the winners and losers in the coming years?
Economic predictions are foolhardy, but based on current macro trends, my prediction for those economies which are likely to perform better in 2024 and ahead is based on a couple of factors: increased production capacity driving up living standards and domestic consumption and those economies which are already the most self-sufficient.
Those countries where we have seen or are seeing an increase in production capacity, which will drive increased domestic wealth and consumption, are Mexico, Poland, Czechia, Vietnam, Indonesia, and the Philippines.
Those countries that are more self-sufficient and could benefit most from deglobalisation are developed economies such as the USA, France, and Japan.
Ones to watch: India and Brazil. Argentina is also worth watching, but for more voyeuristic reasons.
The economies that will most likely struggle are those countries with concentrated export/import risk and exposures, those facing demand challenges, or those with overextended credit: China, Germany, Australia, Canada, and Turkey.
Where does it leave the UK and Wales?
The UK economy is currently in ‘no man’s land’. Excluded from the two closest major trading blocks (the EU and NAFTA) and faced with political uncertainty and constant policy tinkering, the business investment environment and confidence are weak. While GDP has flatlined, GDP per capita is likely falling. There isn’t good regional data, but I suspect it is the same old story of a weak recession already happening in Wales and the regions being offset by a stronger South East and London economy.
Immigration is effectively propping up headline GDP – a significant headache for this government and the reason why anti-immigration measures keep getting announced and then watered down.
Young people drive consumption, so those areas with a younger population will be faring better – Cardiff could be the positive outlier in Wales. Business investment seems to be focused on consolidation and investment in purchasing existing businesses and facilities, not on expanding domestic capacity or improving productivity. However, government borrowing has been better than expected, mainly because of increased tax receipts, which puts its own drain on the economy if the government isn’t investing that extra income productively. It’s difficult to see any economic positives for the year ahead. The odds appear to be moving more towards a shallow recession at best.
Interest Rates and Inflation
Have I changed my mind on inflation and interest rates? Yes and No. A few things are happening which make me think that in the short term, inflation could remain weaker, and central banks will be more tempted to reduce rates.
The US economy is confounding inflation expectations; strong economic growth and increasing government deficit should be filtered back into inflation. However, it is likely that with an ageing population, economic growth is not feeding back into consumption but is driving asset price inflation instead. Hence, equity markets and speculative assets have outperformed, confounding expectations that higher interest rates should depress asset values. This shift will delay retail inflation coming back, but not indefinitely. With an election year ahead, the Fed could be tempted into dropping rates a little this year – and where the Fed goes, others follow – but I’m still more sceptical than the markets.
Another factor keeping inflation low is excess production and capacity in China. China has always prioritised employment, so despite falling demand and increasing competition, China is likely to maintain production and, at the least in the short term, flood markets with cheaper goods at the expense of profitability. We’re seeing this in the electric car market in Europe, where more affordable Chinese-manufactured cars are driving down prices.
Energy production (oil and gas) is stable, and there’s a good chance that Saudi Arabia will reverse its current policy and increase production to try and drive some of the US oil and gas production out of the global market – this will also contribute to dampened inflation in the short term.
In the UK, we are also seeing an increase in savings and a drop in consumption, which has changed my view that inflation may bounce back slower than expected.
Demographics could be making a big difference when looking at previous bouts of inflation as an older population is more able and willing to forgo consumption and increase savings. Longer-term economic pressures still make me believe that we are heading for a period of higher inflation and interest rates than we have seen in the past 20 years and that any significant reduction in interest rates would quickly feed back into inflation; however, I can also now see a scenario where the economy weakens more than expected in 2024 and interest rates do drop back a bit, at least temporarily.
2024 = Continuing Uncertainty
The short answer is that 2024 will likely be a year of continuing uncertainty for the Welsh economy.
Balance sheet strength, cash flow, liquidity, and credit availability remain the things businesses should focus on.