The Great Economic War (GEW) (Part 7: Global depression and deglobalisation)

The Great Economic War (GEW) (Part 7: Global depression and deglobalisation)

Phuah Eng Chye (22 October 2022)

The global economy is exiting a globalised, free market, QE-driven and low-risk environment labelled as the Goldilocks economy. It is entering a new paradigm which is deglobalising, state- and QT-driven and high-risk environment. In the new paradigm, the simultaneous re-appearance of inflation and recession has leads to comparisons with two experiences  – the 1970-1980 US stagflation and the 1990s Japanese depression.

From the 1970-1980 US stagflation, the belief is that inflation can only be overcome by hawkish monetary policies[1] regardless of the economic consequences. But comparisons with the 1980s stagflation may not be meaningful due to structural changes such as the shift in intermediation from bank lending to markets, the over-extended central bank balance sheet bloated by decades of QE and globalised synchronised markets.

The other comparable experience is based on expectations that inflation will soon give way to a prolonged deflationary-type recession comparable to Japan’s lost decades. Again, there are differences.

  • The Japanese depression was benign compared to the immiseration of 1929. It was low-growth, low-inflation, and low-unemployment situation and the welfare of citizens were safeguarded. The unintended takeaway is that the forthcoming economic downturn will be benign despite negative growth and high inflation. We are yet to see how this downturn will play out given the downturn is global (rather than confined to a single economy as in the 1990s) and being reinforced by the pandemic, geopolitical conflicts, monetary disorder and deglobalisation.
  • Japan experimented with various policies in attempts to lift its economy out of doldrums. Abenomics doubled down on QE to generate inflationary pressures on the notion that deflationary conditions were stopping its economy from growing. These policies are generally seen as failing to achieve their goals. In my view, it is not possible for a large trading nation like Japan to independently generate inflation in the global Goldilocks economy (which Japan jointly created with China through massive sterilisation). The re-emergence of inflationary pressures signifies the Goldilocks economy has come to an end. In my view, doubling down on QE and flooding the Japanese system with even more liquidity was unnecessary and is likely to prove to be a terrible policy mistake. 

The new paradigm seems to operate on radically different dynamics. If the two recent experiences are eliminated, then the remaining comparable historical paradigm is the Great Depression of the 1930s.

The global depression paradigm

Current economic conditions seem to satisfy the monetary and Keynesian checklist for a global depression[2]. On the monetary side, asset prices have crashed, demand destruction and debt deflation dynamics have been triggered, the QE spigots are turned off, central bank credibility is evaporating, and balance sheet retrenchment (reduced private borrowing and investments, rising bankruptcies and debt repayments) is ongoing. On the Keynesian side, it ticks off boxes on the  secular stagnation[3] checklist; such as aggregate demand shortfalls, risk aversion, pandemic-induced aging and labour force frictions, and falling productivity.

The dynamics of the new global depression paradigm is being shaped by geopolitical conflict and the need for policy normalisation. The 1930s Great Depression was inherently deflationary. However, the current economic situation is trapped within an inflation-deflation conundrum with geopolitically-driven government intervention and monetary excesses combining to cause mass dislocations in supply chains and financial markets. On one side, inflation is driven by geopolitics. A drop in demand is met by rationing – which increases scarcity. This makes prices and inflation rates sticky downwards. New investments are directed at replicating and relocating plants which aggravates rather than resolves demand-supply imbalances. On the other side, deflation is driven by monetary excesses, high debt levels and deleveraging (and the inability to re-leverage). The rise in interest rates to its current levels of between 3%-5% risks triggering a liquidity implosion and financial contagion. The central banks facing this crisis have their hands tied by out-of-control fiscal spending. Could we have a global depression that is inflationary or will deflation manifest only at the latter stages of economic decline?

The debate on deglobalisation

In the heat of the domestic policy-focused debate between monetarists and Keynesians, the role of deglobalisation in the Great Depression has been understated. In the 1930s Great depression, beggar-thy-neighbour deglobalisation (the 1930 US Smoot–Hawley Tariff Act and retaliatory tariffs), world trade in 1933 collapsed to one third of its level in 1929. This begs the question of whether the economic conditions of the 1930s wouldn’t have been as bad as it was and that economies would have recovered more quickly if there wasn’t a trade war. In other words, did deglobalisation have a pivotal role in causing and prolonging the 1930s Great Depression. In this context, it should not be overlooked the US recovery from its 1980s stagflation and the mildness of Japan’s depression was due to strong global economic growth. In other words, the outcomes would have been worse if not for globalisation. This suggests an economic depression is a global rather than local phenomenon; that deglobalisation is the major cause rather than a mere contributor to a depression and it is impossible for a single country to overcome a depression on its own.

Deglobalisation can be analysed at three levels. First, deglobalisation needs to be defined for the modern economy. Second, to analyse the role and effects of deglobalisation. Third, to review the current debate on whether deglobalisation is taking place and its costs.

First, deglobalisation is multi-dimensional .Nicholas Mulder describes the Depression as “marked by an agrarian crisis, monetary collapse, and a downturn in trade. These developments diminished world exports, fragmented currency blocs, and drove global price deflation for much of the period between 1928 and 1939. On the one hand, this meant that export earnings were lower, as was the cost of decoupling. On the other, it made imports cheaper, ensuring a basic level of continued access to metals, foodstuffs, and energy. Sanctions were deployed in a world of growing autarky, where interdependence between national economies had fallen to its absolutely vital minimum. In the 1930s sanctions thus did only moderate damage to an already battered world economy. But they threatened national livelihoods enough to prompt military escalation”. “The shock of the Great Depression had undermined much of the trust and cooperation that underpinned international political stability. Trade wars escalated into diplomatic disputes, initiating a trend toward the formation of political and economic blocs”.

While there are broad similarities between globalisation and deglobalisation in the 1930s, there are also critical differences in the modern economy. The 1930s economy was industrial and mercantilist while today the channels are broad. As compared to the 1930s, trade tariffs had relatively minimal impact on global trade (as can be seen from the tariff war between US and China).

I argue that deglobalisation is the last and probably most decisive aspect of the 3Ds of a Great Depression[4]; the other two being  deleveraging and deflation (of consumer and asset prices). After all, if globalisation was the main driver of world economic growth, then the reverse logic is that deglobalisation will be the main driving force for a global depression. The forces of deglobalisation are powerful because it works in combination with the reversal of financialisation (monetary disorder) and informationalisation (barriers to information flows and falling transparency). Modern economies are highly financialised (asset price dependent), and liquidity channels are critical to financial stability. Deleveraging (by central banks and funds) will contract global liquidity and trigger a fallout in global asset prices. This will have a substantial spillover impact on financing costs, on the services sector (which accounts for more than half of real GDP in advanced economies), and on the property sector. Informationalisation is the new channel. Economists are just beginning to understand and measure the data economy. It is clear that informationalisation had a major role in globalisation-driven growth through its effect on intangibility, speed, scale and transparency that underpinned innovation, expansion and productivity. The GEW is reversing informationalisation and this will in turn accelerate deglobalisation as there will be a substantial loss of benefits from intangibility, speed, scale and transparency.

Critically, deinformationalisation of the global economy implies a shift from abundance to scarcity. French President Emmanuel Macron[5] warned “the country was at a tipping point as it faced a difficult winter and a new era of instability due to climate change and Russia’s invasion of Ukraine…What we are currently living through is a kind of major tipping point or a great upheaval…we are living the end of what could have seemed an era of abundance…the end of the abundance of products of technologies that seemed always available…the end of the abundance of land and materials including water”. Citizens would feel felt that they’ve been living under a series of crises, “each worse than the last…This overview that I’m giving, the end of abundance, the end of insouciance, the end of assumptions – it’s ultimately a tipping point that we are going through that can lead our citizens to feel a lot of anxiety”.

The reversion from abundance to scarcity arises due to the shift from the intangible to tangible (contraction in the services sector relative to manufacturing), where deflation (the Goldilocks economy) is replaced by inflation as the imbalance between excess monetisation and physical shortages manifests in higher prices. This is where the modern economic downturn differs most with the 1930s Depression. The end of abundance will be accompanied by a reversion to the physical, to brute force to resolve international disputes.

Second, in as much as globalisation had some negatives, the inconvenient truth is that globalisation presented opportunities for nations to tap external resources to grow their own economy. This wove the global interdependencies for mutual prosperity. But as policy-makers focus on geopolitical competition, they are weaponising these independencies through beggar-thy-neighbour policies that seek to hinder the advancement of adversarial economies. Under these circumstances, it is doubtful that economic growth can be sustained.

Michael Every suggests the unravelling of global neoliberalism could open the door to war; global weaponization of commodities and trade; and create “a huge tail risk to the living standards it (fairly or unfairly) enjoys”. He warns “the EU may not be able to go back to normal until its economy has been restructured defensively – literally so; and until geopolitical risks have been resolved by said defensive actions; and that might take years, or even decades. Markets will have to make their peace with the reality of economic war: more state controls on what you can and can’t do; rationing by price or by diktat; MMT; perhaps non-fungible credit; higher structural inflation; higher interest rates; mercantilism in ideological blocs; and a broad reversal of globalisation’s trend of higher asset prices and lower goods prices”.

Third, there are mixed views on the degree to which deglobalisation is taking place and on its costs. Richard Baldwin notes world imports and exports of goods as a percentage of world GDP rose from 29% in 1993 on the back of offshoring expansion to a peak of 50% in 2008 and following the global financial crisis, declined to 42% in 2020. This trend underpinned views of peak globalisation and that it was either stagnating (slowbalisation) or in decline (deglobalisation). However, he thinks the peak globalisation narrative is overly simplistic. He points out “trade in goods as a share of GDP peaked around 2018, but the peak was not synchronised and some of the largest trading economies have not peaked. Sixty percent of the decline was due to a reduction in the value of commodities trade, all of which was due to a decline in prices from the mid-2010s to 2020. The rest was due to unwinding, or reshoring, of international supply chains”. In tandem with this, there was a “massive reorganisation of world manufacturing production has shifted from one equilibrium (where almost all manufacturing was done in G7 nations) to another (where a handful of emerging markets, especially China, have become major manufacturing powers)”. The G7’s share declined from 66% in the late 1990s to 38% in the mid-2010s; albeit the drop has slowed substantially in recent years. Their share was taken up by the six rapidly industrialising emerging economies – China (+16.2), India (+1.5), Korea (+1.5), Indonesia (+1.0), Thailand (+0.5), and Brazil (+0.5).  He argues “the global peak of trade in goods as a share of global GDP…is telling us that globalisation has changed”. While trade in goods has stagnated for a decade and a half, “world trade in services rose from 8% in 1993 to 12% in 2008 and has further risen to 14% in 2019”. “Goods trade is still larger, but services now account for almost a quarter of export earnings globally. It also accounts for many export jobs, especially for women, since producing services is more labour intensive than producing goods. The divergence between the growth of services versus goods happened because digital technology opened the door to trade in intermediate services, and high-income countries have few or no barriers to this sort of exports”.

Uri Dadush notes “the pandemic was associated with a major shock to world merchandise trade, which, at the trough in mid-2020 fell by about 17% in volume terms relative to end 2019, pre-pandemic, and was about 4% higher than the pre-pandemic level in early 2021. The 21% swing in trade volumes in less than a year, huge as it is, refers to an aggregate and does not convey the scale of the disruption”. Despite this, his data “tends to confirm that there has been no large-scale withdrawal from GVCs; indeed, if anything, the evidence at our disposal points in the contrary direction. According to a WTO quarterly report on trade in intermediate products, in the third quarter of 2021, world exports of intermediate goods were 20% higher than pre-pandemic levels in value terms, with Africa and South and Central America reporting growth rates of 40% over pre-pandemic levels…So far, one can say with some confidence – based on data – that the reports of the death of globalization that are found in many journalistic accounts are vastly exaggerated. Without doubt, governments have moved in the direction of trade and investment restrictions and import-substituting industrial policy, and it is possible to envisage a dreadful scenario for GVCs, one where great power tensions transform into open warfare, China and the US decouple, the WTO unravels, and the world descends into a dark age of protectionism. However, this worst-case scenario is unlikely. Besides the fact that nuclear weapons make open warfare among the great powers almost unthinkable, vast opportunities exist to advance global economic integration and nations recognize it; and nations are increasingly compelled to cooperate to deal with global challenges. Globalisation persists because vast arbitrage opportunities remain in the markets for goods, services and capital, and these opportunities are difficult to resist. This is not only because many natural and man-made barriers to exchange still exist. It is also because economic conditions are in constant flux, creating new trade opportunities. Developing countries, home to most of the world population, grow and undergo structural transformation that alters their comparative advantage.  Meanwhile, product and process innovations originating mainly in advanced countries continue – from medicines to software to machinery – which the rest of the world needs… Meanwhile, ICT-based innovations, including remote work, e-commerce, artificial intelligence, blockchain and cryptocurrencies, are reducing trade costs, sometimes dramatically, thus improving the ability to coordinate and exchange, and enabling the operation of GVCs.   Meanwhile, globalisation itself and other structural shifts are continuously raising the stakes for international cooperation, of which trade is an essential part…As an antidote to the frequent pessimism about globalization, it is useful to recall that two World Wars in the twentieth century interrupted economic integration but did not stop it. The rise of communism and the Cold War cut large populations off from the world economy, but it did not stop the advance of economic integration elsewhere”. 

Moisés Naím notes “they say that we have reached the end of globalization. Just look around. Trump’s protectionism, Brexit, supply chain problems created by Covid-19 and Putin’s criminal aggression in Ukraine have all helped derail the wave of global integration that was triggered by the fall of the Berlin Wall in 1989. Surely, with the stock market crashing, interest rates on the rise and a looming global economic slowdown, we have arrived at globalization’s funeral and the bells are tolling”. “While this perspective has become very fashionable of late, it is wrong in almost every way. Mainly from the point of view of the economy, but also from a social and cultural standpoint. Indeed, the surprise of the last two years has been how resilient globalization has turned out to be. In an exceptionally turbulent period, the strength and variety of the connections between countries has been more surprising by its durability than by its fragility…The volume of international trade grew a lot during the period of hyperglobalization (1985-2008), going from around 18% to 31% of the total value of the world economy. With the 2008 crisis, that figure fell to around 28%. And that’s where it has been, more or less, ever since: holding steady despite all the economic shocks and political upheavals of recent years”. The negative impact from Trump’s protectionism and Brexit “have been offset by greater economic integration in East Asia and Africa, where the connections and interdependence between countries continue to deepen and expand”.

Moisés Naím points out globalization goes far beyond trade and other international economic flows. Globalization is based on the global spread of knowledge, ideas, philosophies, politics and people as much as it is based on the trade of goods. And in this broader sense, globalization seems to be speeding up, not slowing down”. The power of globalisation is illustrated by TikTok with 1.4 billion users spread over 150 countries and the booming number of scientific collaborative efforts. “Naturally, globalization is not invulnerable and not all its consequences are positive”. Real and serious threats exist; such as rising inequality, event risks such as war and cybersecurity attacks. “Despite its costs, problems and accidents, integration between countries has not died. The challenge ahead is how to protect ourselves from its defects and make the most of the doors it opens for us”.

To be fair, earlier analysis tended to be more optimistic. Since then, geopolitical conflict has intensified, deglobalisation has deepened, markets have experienced turmoil, and more evidence of economic contraction is emerging. Multilateral organisations such as the UN, IMF and WTO[6] have started to sound warnings; indicating complacency in estimating the extent, risks and effects of deglobalisation.

We can trace the path of deglobalisation geographically. Ironically, the epicenter of the economic crisis is unlikely to be the US and Russia as they are major oil exporters and less externally-dependent. Instead, the shocks are originating from the highly-globalised countries which are being severely hit by high energy and food costs, shortages, and rising US interest rates. Large exporters such as China, EU and Japan and the highly indebted European and developing economies[7] are among the most likely sources of contagion.

As the engine of globalisation, events in China will have a major impact on the rest of the world. Dan Steinbock notes “between 2013 and 2018, it (China) accounted for 28 percent of all growth worldwide on average… pulling along many of the world’s middle- and smaller-size economies in its train…By turning its frictions with China into yet another unwarranted Cold War, the Biden administration has taken the world economy to the edge of the abyss”.

Tyler Durden notes recent pressure on the yuan reflects “poor sentiment and pessimism in the household sector — driven by financial repression, lockdowns and collapses in property prices — new CNY loan growth for households has fallen to at least 13-year lows”. Commentators suggest “China’s growth model is broken, as the loss in demand from the household sector is greater than any gain from the export sector, leading to lower growth overall, and thus greater pressure on the capital account. This is enough to push the yuan lower, but China also faces a mounting risk from its heavy debt load.  China has had the largest rise in private debt levels since 2010, and its debt-service ratio is through the danger level of 20%.

In particular, there are growing fears about the consequences of a fallout in its highly leveraged property sector[8] or by distressed Chinese speculators. Ye Xie notes China’s housing market is regarded as the world’s largest asset class at over $60 trillion. He points out a recent IMF global financial stability report highlighted “declining home sales and a lack of access to financing are worsening the credit crunch among developers…stalled projects lead home buyers to boycott mortgage payments, which puts pressure on banks, which causes them to turn more cautious in lending to the sector. In such a vicious cycle, many developers are on the brink of collapsing. The IMF’s analysis showed that 45% of developers might not be able to cover their debt obligations with earnings, and 20% of them could become insolvent if their inventory value is marked to current property prices. It’s small wonder, then, why about 70% of offshore bonds of developers trade at 40 cents on the dollar or less, suggesting that debt restructuring may be inevitable for a large share of the sector…property developers’ failures could spill over into the banking sector, particularly small banks. If 10% of banks’ exposure to distressed developers and 10% of the mortgages related to unfinished homes become non-performing loans, the IMF estimates that 15% of the banks in its study, which represents 10% of China’s total banking assets, would fail to meet minimum capital requirements and require bailouts…chain reaction…Constrained by falling revenue from land sales, local governments have limited resources to support the real-estate sector…there could be adverse spillovers to the broader corporate sector, where vulnerabilities are already high”.

Some hope China would react with massive stimulus to reflate its anaemic economy[9] and, in so doing, lift the global economy. My view is that China has become more sophisticated in economic management and is likely to selectively plug social and strategic gaps. This is consistent with its dual circulation[10] strategies which are based on pessimism over China’s external relationships. Therefore, China’s economic policies are likely to be defensive and aim to redirect economic dependencies from the West to the domestic market and the Global South. This implies China’s economic growth would be sub-par or possibly even negative. This would have adverse spillover effects on its largest trading partners. It is also unlikely that other countries, such as India, would be able to fill the vacuum left by China’s economic deceleration. These countries would find it difficult to produce at China’s costs and quality. They would also be unable to provide sizeable markets to absorb exports from the rest of the world. In India’s case, its exports are likely to compete with existing Chinese exports – causing supply saturation – while it will continue to curb imports due to its protectionist tendencies.

Europe is under pressure. Michael Every notes “the flood of problems already flowing from energy prices is already staggering: 6 out of 10 British manufacturers may go the wall; experts warn of energy rationing that could see Brits told not to cook until after 8pm, pubs close at 9pm, and three-day weeks at schools; aluminium smelters and steel mills are closing; fertilizer companies are shuttering; the Netherlands warns of a plunge in flowers, fruit, and vegetable output, with that of bricks also tumbling; Spanish output of ceramic tiles has halted; and a slew of Italian firms didn’t come back after the summer break. Regardless of gas storage levels for THIS winter, Europe faces an industrial supply-chain collapse – and just as it is has pledged to re-arm to face a worrying geopolitical future”.

Michael Every adds “the EU may be shifting towards a war economy” by intending to “halt market mechanisms in energy” and further rollouts of price subsidies. He notes a Reuters report that a “so-called internal market emergency instrument, set to be presented on September 13, lays out several stages that open up varying powers to the Commission depending on the situation. Via this new instrument the Commission will reportedly seek emergency powers giving it the right to re-organise supply chains; sequester corporate assets; re-write commercial contracts with suppliers and customers; order companies to stockpile strategic reserves; and force them to prioritise EU orders over exports. This is in effect a mirror of the US Defence Production Act – and the current crisis suggests it is likely to be needed soon, and perhaps on a large scale”.

Globally, there are some bright spots for economic growth such as in India, Vietnam and Mexico (from supply chain diversification) and in the Middle East and Africa (from higher energy prices). There are also prospects for recovery in the pandemic-hit industries such as tourism and entertainment. However, if the export powerhouses like China, EU, Japan, UK, South Korea, Taiwan and ASEAN enter into a recession and financial instability continues unchecked, then the global recession is likely to be entrenched.

While the Great Depression is yet to manifest, there are thus signs of its approach. The globally disruptive consequences of GEW provide a forewarning of what lies ahead if similar sanctions are extended to China and others. In recent weeks, the West has escalated sanctions and the US has tightened its technology chokeholds; signalling it is unwilling to allow threats to its technology leadership. So far, beggar-thy-neighbour policies have generally been imposed by the West. Russia has begun its economic counter-offensive by withholding critical supplies. China is yet to respond directly but in the medium term it is likely to reciprocate by weaponising its chokeholds on Western dependencies and restricting access to its markets just before new OECD capacity comes onstream. Thus, economic warfare is likely to escalate over the next two years.

Events such as the continuation of the pandemic, reckless fiscal spending, China’s socialism big bang[11] and natural disasters are reinforcing supply shortfalls and inflationary pressures. Re-industrialisation, central bank normalisation and de-dollarisation are contracting global economic and liquidity multipliers and increasing financial instability. These developments are accelerating deglobalisation and raising the spectre of a depression returning to haunt the global economy.

Fragmentation rather than outright deglobalisation

Whether we will see a deep and prolonged depression or a recession/mild and relatively short depression depends on the extent and severity of deglobalisation. In this context, there is understanding on the benefits of globalisation and fragmentation is a more likely outcome. The question is whether fragmentation means the economic losses will be smaller and more manageable; i.e. it will not lead to a global depression.

Generally, the degree of deglobalisation will depend on the intensity (e.g. pace of secondary and counter sanctions) and breadth (e.g. coverage) of fragmentation-inducing policy measures. Regardless, the effects are likely to be a net negative because the losses from deglobalisation are likely to be larger than the “second-best” gains from fragmentation.

Diego A. Cerdeiro, Rui Mano, Johannes Eugster, Dirk V Muir and Shanaka J Peiris earlier estimated “technological fragmentation can lead to losses in the order of 5 percent of GDP for many economies”. Economic losses occur across all fragmentation scenarios and are largest when decoupling occurs via preferential attachment – where non-hub countries are forced to align “themselves with the hub they trade most with”. The recent broadening of US sanctions on China’s semiconductor industry is likely to widen the losses.

The baseline scenario is a gradual fracturing of the global economy along the Cold War fault lines. In this scenario, both sides will avoid fully severing their economic relationship due to product and resource dependencies. It also recognises the difficulty of sealing off cross-border flows as boundaries are porous and the incentive for evasion are large.

Fragmentation can be viewed as a “weak” form of deglobalisation where rival superpowers weaponise global integration into a geopolitical contest for supremacy. The formation of spheres is a dynamic process shaped by a continuum of exclusionary strategies such as friendshoring, belt and road development, seizures, export controls and de-dollarisation aimed at confining trade, technology, investment, labour and capital flows within spheres. Fragmentation costs include:

  • Productivity losses. The loss of scale and inefficiencies; the costs and consequences of duplicating capacity and supply chain relocation.
  • Financial costs. Public expenditures such as government subsidies to mitigate, incentives for relocation and other geopolitical related measures, policing costs. Private expenditures such as tariffs and sanctions costs, compliance costs, write-offs from stranded assets, financing costs, and losses from price competition from long-term excess capacity.
  • Market segmentation. The reduction in asset substitutability will lead to pricing differentials in different spheres. For example, between Western-Russian oil, various commodities and minerals, and offshore-onshore currencies. Pricing differentials are a sign of growing market segmentation reflecting economic inefficiencies and market malfunction. Cross-border intermediation will be re-organised to arbitrage price differentials and facilitate evasion. Physical delivery will become more important while futures and derivative trades will become more costly.

Aaron L. Friedberg notes Charles Kindleberger, in his 1973 study The World in Depression, 1929–1939, concluded that world trade collapsed and the international economic system unraveled in 1929 because Britain was unable to take the steps that might have stabilized it (including keeping its domestic market open to imports and continuing to lend money overseas), and the United States was unwilling to do so. The world economy was unstable unless some country stabilized it”. Robert Gilpin and others generalized this insight into the theory of hegemonic stability. “In this view, a hegemon, defined as a state with a disproportionately large portion of the total wealth and power in a given international system, is necessary in order to establish an open global economy and to manage it under normal circumstances, as well as to step in to stabilize it during periods of unusual stress. The hegemon favors openness in large measure because it expects to benefit from it. The size and relative technological sophistication of its industries makes their products highly competitive in both foreign and domestic markets. As a result, the hegemon has little to fear from opening its own economy to imports and much to gain from persuading (or compelling) other countries to open theirs. Access to comparatively inexpensive food, raw materials, and other imported goods will help to raise the standard of living of its domestic consumers while enabling manufacturers to keep their costs down”.

Aaron L. Friedberg notes “as Gilpin explains: In time the diffusion of industry and technology undermines the position of the dominant power…Through the spread of technology and know-how, the industrial leader, over a period of time, loses more and more of its comparative advantages relative to its rising competitors. As a result, a gradual shift takes place in the locus of industrial and other economic activities from the core to the periphery of the international economy…The consequence of this tendency is a gradual redistribution of wealth and power within the international system. A change in the distribution of wealth and power, in turn, will give rise eventually to shifts in the structure and functioning of the global economy. Unless another hegemon emerges with the power to preserve openness, the system will tend to become more closed as states pursue more narrowly nationalistic policies, imposing tariffs, limiting foreign investment, and restricting the export of technology to try to gain or maintain advantage over one another”.

There are different fragmentation models. Aaron L. Friedberg notes Gilpin anticipated that “with the decline of the dominant economic power, the world economy may be…fragmenting into regional trading blocs, each seeking through the exercise of economic power…to increase the benefits of interdependence and decrease the costs. Gilpin’s prediction was premature, but some tendencies in this direction have been evident” such as the European policymakers seeking “to bolster their ability to compete in a globalizing world by creating a unified market and moving toward the adoption of a common currency in 1992. The United States responded in 1994 with the North American Free Trade Agreement”. Aaron L. Friedberg points out “the construction of more sharply defined economic blocs would not only require that the members lower remaining barriers to trade among themselves, but that they raise barriers to non-members. This would involve a departure from the multilateral principle of reciprocity and an end to any pretense of trying to promote a fully open and all-encompassing global trading system. Because China’s putative bloc would contain countries that are now U.S. allies (like Japan, South Korea, and Australia), as well as others wary of being drawn too far into the Chinese embrace (like India, Singapore, and Vietnam), Beijing could face special challenges in getting others to agree to take this large additional step. If it succeeds, however, it will have created a vast aggregation of economic capacity in which it is the dominant player, and from which the United States could find itself largely excluded”.

Aaron L. Friedberg notes the alternative is for “the advanced industrial democracies of Europe, Asia, and the Western Hemisphere band together to form a free trade area and perhaps a full economic bloc. They might be joined in all or part of this endeavor by a few countries that are democratic but less developed (like India), and possibly by a handful of others that are neither democratic nor highly developed (like Vietnam) or highly developed but not democratic (like Singapore). As the label suggests, such a grouping would resemble the partial, Western system that the United States helped to build during the Cold War. Like its predecessor, this bloc would be made up primarily, though not exclusively, of democracies and it would command a considerable fraction of the world’s wealth and technological capacity. Taken together, the countries of the European Union, the United States-Mexico-Canada Agreement, and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, plus India and South Korea, today account for over 60 percent of global GDP, as compared to around 17 percent for China. A new trading bloc organized along these lines would have a number of economic and strategic benefits for the United States and its partners. Although estimates vary, creating a mega free trade agreement made up primarily of advanced industrial democracies would likely increase the growth rates of all of its members while diverting some trade that might otherwise have gone to China. Such an arrangement would thus promote both absolute and relative gains, improving the welfare of the citizens of member states while boosting their rates of growth relative to China’s. This would have strategic significance…Assuming that they can synchronize their negotiating positions, the members of a democratic trading bloc could work together to exert leverage over Beijing, threatening to deny or restrict its access to their common market if it refuses to modify its mercantilist trade and industrial policies. In time, sustained collective pressure could eventually succeed in forcing the changes that patient negotiation and unilateral American action have thus far failed to produce. Although a merging of markets would not be necessary to achieve this end, closer integration would also make it easier for the democracies to coordinate their policies on technology transfer, export controls, and the screening of proposed Chinese investments. Agreed standards regarding freedom of expression, data privacy, cyber espionage, and other malicious activity could also result in the formation of a digital version of the Schengen Agreement, a democratic digital bloc within which data, services, and products can flow freely. Having tried to incorporate China into an open global order in the hope that doing so would cause its behavior to conform more closely to liberal principles, the democracies would, in effect, be falling back to a partial system within the boundaries of which those principles would be adhered to and defended. Economic historian Benn Steil has compared this move, from what he describes as a One World to a Two Worlds model, to the one that the United States and its allies made in the late 1940s once it became clear that the Soviet Union had rejected the basic American vision of a liberal order. Much like its Cold War predecessor, the resulting system would be nested within a larger global economy. In contrast to the Cold War, trade and investment flows between China and the democratic bloc would continue, but they would be constricted and more closely monitored and regulated”.

These scenarios possibly reflect an implicit US strategy to force “unreliable” adversaries with very different ideologies to band together on the logic that this would increase the instability of an adversarial bloc that is incapable of working together and to group “reliable” friends into a Western sphere while seeking to reduce exchanges with adversaries. Time will tell if this strategy works. Nonetheless, it overlooks issues in relation to distribution of fragmentation gains and losses.

  • In my view, the matured OECD economies have more to lose. OECD gains from reindustrialisation pales against the significant losses from shrinking share of the global market, cost inefficiencies and monetary instability. Among OECD members, the US is likely a net beneficiary but its allies will suffer significant collateral damage. Nonetheless, the US is also vulnerable due to its high fiscal deficits, rising debt servicing costs and spillover effects from a global economic downturn. Long-term, the West needs to consider challenges relating to reindustrialisation and its ability to secure access to resources and markets.
  • The China-Russia combination is formidable due to their complementary strengths in resources, finance and manufacturing. Russia’s resilience is due to their low dependency on the global economy but China is exposed to significant losses particularly if they are forsaken by OECD. In this context, a yuan appreciation could hurt its cost-competitiveness and accelerate relocation. Nonetheless, Russia and China have the ability to offer large profit opportunities to businesses and investors and can partially offset their losses by gobbling OECD share of the global south markets[12], including their domestic market.
  • The future geopolitical map will be shaped by the “non-aligned” Global South. ASEAN, the Middle East, Africa and Latin America which are likely to remain non-aligned. In fact, they would not want to remain subordinate to Western interests. India will seek a greater role for itself as it will eventually become the third largest economy in the world.

Generally, fragmentation implies MNCs and intermediation activities will increasingly be confined within spheres. Global economic growth will be negatively impacted by contractions in growth and liquidity multipliers. It is also unlikely that growth among Western countries and in the Global South countries will be sufficient to offset the loss in China’s growth momentum.

Doom and gloom scenario

At the moment, there is complacency as to the potential damage from deglobalisation

and an implicit assumption that we are unlikely to see a decline as severe and as prolonged as in the 1930s Great Depression (i.e. a collapse in global trade, high unemployment, deflation and liquidity trap). I think this underestimates the impact of deglobalisation accelerators which could lead to significant economic losses.

One major accelerator is the GEW escalation. The global economy cannot grow if countries continue to implement vindictive beggar-thy-neighbour policies that are deliberately aimed at stopping growth and destabilising adversarial economies. Not only that, countries are unable to assist in other to meet global economic challenges.

A second accelerator in the pressing need for governments to normalise fiscal and monetary policies to re-establish financial stability. Alasdair Macleod points out rising interest rates are threatening the $600 trillion OTC global derivatives and $100 trillion futures market used by pension funds, insurance companies, hedge funds, banks and shadow banks. Commercial banks everywhere are reacting by reducing “their exposure to falling financial asset values both on their balance sheets and held as loan collateral”. The “consequences for the gilt market in London” provide a warning of other problems to come from contracting bank credit and derivative blow-ups. “Because the Great Unwind is so sudden, it promises to become a far larger crisis than anything seen before. Unfortunately, due to quantitative easing the central banks themselves also have bond losses to contend with, wiping out the values of their balance sheet equity many times over. That a currency-issuing central bank has net liabilities on its balance sheet would not normally matter, because it can always expand credit to finance itself. But we are now envisaging central banks with substantial and growing net liabilities being required to guarantee entire commercial banking networks”. “The ECB and its entire euro system of national central banks, the Bank of Japan, and the US Fed are all deeply in negative equity and in no condition to underwrite the financial system in this rising interest rate environment”.

Mark Dittli argues this is part of a structural shift in the West from “free markets” to an “economy where the government plays a significant role in the allocation of capital”. This is partly due to the high debt levels. “Total private and public sector debt in the US is at 290% of GDP. It’s at a whopping 371% in France and above 250% in many other Western economies, including Japan”. In tandem with this, “the power to control the creation of money has moved from central banks to governments” via the issuance of state guarantees on bank credit. Since February 2020, of new bank loans to corporates in Germany, “40% are guaranteed by the government. In France, it’s 70% of all new loans, and in Italy it’s over 100%, because they migrate old maturing credit to new, government-guaranteed schemes”. “Just recently, Germany has come up with a huge new guarantee scheme to cover the effects of the energy crisis. This is the new normal. For the government, credit guarantees are like the magic money tree: the closest thing to free money. They don’t have to issue more government debt, they don’t need to raise taxes, they just issue credit guarantees to the commercial banks”.

He argues “when governments take control of private credit creation through the banking system by guaranteeing loans, central banks are pushed out of their role” and become impotent. “In a world where large parts of the global economy are in a system of financial repression, there will be all sorts of capital controls… Many investors today still pretend that we’re in the system that we had from 1980 to 2020. We’re not. We’re going through fundamental, lasting changes on many levels”.

In this context, the Goldilocks low-interest and low inflation rate paradigm is behind us. Can the global economy get back on the growth path with interest rates at between 3%-5%? From an output perspective, it is difficult to see what can drive economic growth given the energy (and others) shortfall, the clogging of logistics and the deteriorating conditions in the services sector. Shortages can only be mitigated through rationing. Government subsidies do not address the shortages and only adds to inflationary pressures. At some point, the high debt servicing costs will catch up with governments and they will come under pressure to cut fiscal expenditures or to increase taxes. At some point, deleveraging, and falling asset prices and liquidity will impact on real economic activities. This will be reflected in a contraction in money supply and lending, rising defaults and private sector balance sheet retrenchment.

The economic outlook is becoming gloomier as growth paths via globalisation, financialisation and informationalisation are increasingly being blocked by escalating geopolitical conflict. Countries will increasingly rely on brute force in an attempt to resolve problems but these wars, as demonstrated in Ukraine and elsewhere, are unwinnable and will result in unnecessary destruction. The only hope is that when economic deterioration becomes obvious and populations react, and that policy-makers will realise that the path to a recovery is global rather than local.

The path to global recovery

Nicholas Mulder notes “policymakers today possess everything they need to avoid a repetition of the 1930s. Because the level of economic integration is far greater today, it will take much more disruption for fears of deglobalization to materialize. There are more economies rich enough to provide alternative sources of supply as well as export markets for countries forced to stop trading with Russia. Advanced economies have better fiscal policy tools than they did in the early 20th century and benefit from greater fiscal space than emerging market and developing economies. Whether they use these strengths to compensate for the massive stress that sanctions put on the world economy is ultimately a political choice”.

There is a path of hope but the obstacles are formidable as it requires rival governments to work together.

  • Economic détente and Globalisation 2.0. The global economy can only deteriorate further if governments keep implementing policies attacking each other economies and MNCs. Globalisation is the only path towards reversing economic deterioration. In this context, the old globalisation model has broken down and some aspects of decoupling are irreversible while fragmentation appears inevitable. There is a need for multilateral agencies, “neutral” countries and the private sector to step forward with proposals for an economic détente to create space for geopolitical compromise and to limit the extent and damage from deglobalisation. Clearly, there is a need for a Globalisation 2.0 model that acknowledges the geopolitical realities and institutes guardrails to protect safe space[13] insulated from geopolitical conflict. A second-best fragmentation model would be better than doing nothing to halt the trend towards an all-out economic and possibly military war.
  • Crisis intervention, market clearing and restoring market discipline. The financial fallout is spreading rapidly. Coordinated intervention is urgently needed to contain the financial crisis and contagion. The root problems to address are the overhang of financial products and private sector balance sheet retrenchment. QT is a necessary initial step to drain the excess liquidity parked with money market funds. In current conditions, central banks could be forced to revert to QE. Even then, central banks should opt to intervene at higher interest rates and the intervention should be temporary. Governments need to realise they need to reduce fiscal deficits by either by raising more tax revenues or lowering expenditures. Another priority is to restore market discipline by facilitating market clearing. There needs to be specific initiatives to ensure orderly clearing of the financial product overhang and to allow markets to reprice assets and risks. While there are risks of a hard landing, market clearing will facilitate re-leveraging, minimise debt deflation and liquidity trap risks and position the economy for a quicker recovery.
  • Revive animal spirits. In recent years, governments stepped up to address societal challenges, as they should. But they have gone overboard with intrusive rules, massive fines, Santa Claus largesse and created massive policy uncertainties and contradictions. This is causing the private sector to retreat and to focus on repairing their balance sheets. In the next phase when governments are forced to withdraw fiscal and monetary stimulus, the revitalisation of “animal spirits” is key to an economic recovery. Hence, governments should start to consider establishing limits to intervention and creating a conducive (positive rate of return) environment for risk-taking, foreign investment and capital formation. As a benchmark, government policies should return to their role of promoting competition, innovation and efficiency. Not to be ignored is the strategic relationship between private sector recovery and re-leveraging. In a fragmented global economy, is re-leveraging possible with de-dollarisation? There is more room to increase leverage in non-OECD currencies but it is unclear if this can happen and, even if it does, this may not be sufficient to make up for the economic losses from the deleveraging of OECD currencies.


At the dawn of deglobalisation, the economic rules of the game are seemingly being turned upside down. Consumer countries (OECD) are trying to reposition themselves as producers, producer countries (China) are trying to become consumers. Monetary policy and currency competition are shifting from seeking export competitiveness (weaker currency) to competing for resources (stronger currency). In this economic confusion, there seems to be little upside growth and much downside risks. The shaping of a viable “fragmented” globalisation model will be key to avoiding a global depression.


Alasdair Macleod (15 October 2022) “The great global unwind begins”.

Aaron L. Friedberg (January 2021) “The growing rivalry between America and China and the future of globalization”. Texas National Security Review.

Dan Steinbock (26 August 2022) “The quest to contain China, at the risk of global depression”. China & US Focus.

Diego A. Cerdeiro, Rui Mano, Johannes Eugster, Dirk V Muir, Shanaka J Peiris (12 March 2021) “Sizing up the effects of technological decoupling”. International Monetary Fund (IMF).

Jacob Gunter, Helena Legarda, et al (18 August 2022) “Beyond blocs: Global views on China and US-China relations”. Mercator Institute for China Studies (MERICS).

John Lee (August 2022) “Understanding and countering China’s approach to economic decoupling from the United States”. Hudson Institute.’s+Approach+to+Economic+Decoupling+from+the+United+States+-+John+Lee.pdf

Mark Dittli (16 October 2022) “Central banks are impotent – Russell Napier warns of shift of power that cannot be underestimated“.

Michael Every (6 September 2022) “The EU makes its peace with economic war… and the global neoliberal system is collapsing around us”. Zero Hedge.

Michael Pettis (12 August 2022) “What’s in store for China’s mortgage market?” China Financial Markets.

Michael Pettis (24 August 2022) “China’s overextended real estate sector is a systemic problem”. China Financial Markets.

Michael Pettis (6 October 2022) “How China would respond to lower exports”. China Financial Markets.

Moisés Naím (5 October 2022) “Is globalization over?” The Global Observer Columns.

Nicholas Mulder (June 2022) “The sanctions weapon”. IMF Blog.

Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society.

Phuah Eng Chye (5 June 2021) “Global reset – Two whales in a pond”.

Phuah Eng Chye (2 July 2022) “Theories on war and diplomacy (Part 3: The information realm)”.

Phuah Eng Chye (30 July 2022) “The Great Economic War (GEW) (Part 1: The beginning)”.

Phuah Eng Chye (13 August 2022) “The Great Economic War (GEW) (Part 2: Strategic concepts and implications)”.

Phuah Eng Chye (27 August 2022) “The Great Economic War (GEW) (Part 3: The financial nuclear bomb)”.

Phuah Eng Chye (10 September 2022) “The Great Economic War (GEW) (Part 4: Battles reshaping the global monetary order)”.

Phuah Eng Chye (24 September 2022) “The Great Economic War (GEW) (Part 5: Global economic breakdown and monetary disorder)”.

Phuah Eng Chye (8 October 2022) “The Great Economic War (GEW) (Part 6: Geopolitics, monetary policy challenges and the collapsing tripod)”.

Richard Baldwin (31 August 2022) “The peak globalisation myth: Part 1”. Voxeu.

Richard Baldwin (1 September 2022) “The peak globalisation myth: Part 2 – Why the goods trade ratio declined”. Voxeu.

Richard Baldwin (2 September 2022) “The peak globalisation myth: Part 3 – How global supply chains are unwinding”. Voxeu.

Richard Baldwin (3 September 2022) “The peak globalisation myth: Part 4 – Services trade did not peak”. Voxeu.

Richard Baldwin (August 2022) “Globotics and macroeconomics: Globalisation and automation of the service sector”. NBER.

Richard C. Koo (2015) The escape from balance sheet recession and the QE trap. Wiley

Robin Xing (12 September 2022) “Morgan Stanley asks if China can stabilize global growth this time”. Morgan Stanley.

Satyajit Das (22 September 2022) “Emerging market crisis pathologies”. Naked Capitalism.

Tyler Durden (25 August 2022) “End of abundance: Macron warns of major tipping point and great upheaval as difficult winter approaches”. Zero Hedge.

Tyler Durden (6 September 2022) “China slashes FX deposit requirement to prop up yuan… but only delays the inevitable”. Zero Hedge.

Uri Dadush (April 2022) “The future of global value chains and the role of the WTO”. World Trade Organisation (WTO).

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Ye Xie (13 October 2022) “IMF draws up nightmare scenario of housing crisis”. Bloomberg Markets.

[1] Paul Volcker’s Fed raised interest rates to 20% in 1981.



[4] See Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society.

[5] See Tyler Durden.

[6] See WTO report.

[7] See Satyajit Das.

[8] See Michael Pettis on system risks related to China’s overextended real estate sector and Robin Xing on its impact on economic growth.

[9] Michael Pettis explains how external pressure that results in a contraction of China’s trade surplus must be accommodated by shifts in these internal imbalances.

[10] John Lee provides a US perspective on dual circulation.

[11] See “Global reset – Economic decoupling (Part 1: China’s socialism big bang)”.

[12] See Jacob Gunter and Helena Legarda on global-south perceptions on China.

[13] See “Theories on war and diplomacy (Part 3: The information realm)” and “The Great Economic War (GEW) (Part 2: Strategic concepts and implications)”.