Inside Track – November 2019

▪ Is the recent (slight) improvement in the global economy real and for keeps? Buoyant financial markets and many pundits think so, confident that (1) the un-inversion of the yield curve, (2) the Fed’s three cuts in interest rates, and (3) recent industrial production not as bad as expected (in China, the US, Japan and Germany) are proof that recessionary forces are easing. Not so fast, say those who argue this is wishful thinking, pointing in particular to the sharp contraction in global trade (-1.3% in volume in Sept. – reversing the gains of the previous two months). World recession or not, the following remains certain: in the coming months, global growth will remain subdued, at best.

▪ Growing dissatisfaction within the labour force feeds into this. In the early 1990s, around half of private sector jobs were below the weekly wage; today it’s 63% (for the US, but the conclusions are to a lesser extent the same for OECD countries). This means that even in countries where the quantity of work is abundant, its quality is deficient. Most new jobs are created in low-end services, as in the US where gigs at $15 or less an hour are the fastest growing job category. A ‘bad job’ is better than ‘no job’, but if too many people don’t earn enough to live with a modicum of security, it’s no surprise that Main street growth remains subdued.

▪ The US deteriorating fiscal position should eventually erode confidence in the USD. Today, US defence spending + interest on the federal debt + annual entitlement payments – Medicare, Medicaid and social security – represent 112% of federal tax receipts; vs. 95% two years ago. This unsustainable path prompts the Fed to keep rates as low as required to keep asset price inflation going (a critical source of tax receipts). This may work for a while, but something will have to change (higher taxation or reduced geopolitical role); otherwise rising deficits will hit the brick wall of non-US investors unwilling to fund them.

▪ The ‘Japanification’ of Europe (and possibly of much of the rich world) is depicted as a hopeless combination of no growth, no inflation and insufferable debt levels. This is misleading. When the data is adjusted for demographics, Japan does better than most. Its GDP/capita is high and growing, and since 2007 its real GDP / member of the working age population has risen faster than in any other G7 country. Why? (1) Japan’s labour productivity growth surpasses the average (6.5% since 2010 vs. 5.8% in the G7); (2) It successfully absorbs females and 65+ into the labour force; (3) It has gone further than most in stimulating the economy. A shrinking population doesn’t have to lead to economic oblivion. Japan’s high living standards and wellbeing indicators offer a salutary lesson that there is hope after ageing.

▪ For those countries unwilling/unable to emulate the Japanese example, there is a powerful counter-model: Canada. Short-sellers have been caught out by an economy that is doing much better then expected, and the reason is… immigration.Liberal immigration policies have proven to be an economic boon for the country. By 2030, immigration will account for 100% of Canadian population growth (versus 71% today), with research showing that without immigration and within the same time-horizon, growth would slow from a trend rate of about 2% per year to 1.3%.

▪ The take-away: since economic growth levels equate to change in productivity + change in the labour force, there are two (non- exclusive) models to keep growth going in ageing countries. Japan favours the former (productivity), embedded in an ambitious policy mix, while Canada pushes for the latter. Both work but none is easily transferable. Immigration is politically sensitive: Canada’s skilled labour migration system has been years in the making; while Japan’s success can largely be attributed to idiosyncratic (and elusive) traits like high social trust and cohesion.

▪ The way in which the Japanese society is ageing points to a rising and powerful global investment trend: “Ageing in place”. In Japan, like in the rest of the rich world, elderly people prefer to stay in their home and communities rather than live secluded with others of their own age. Technology (robots in particular) and policy measures (like forward- thinking urban planning and design) have the potential to make this much easier. This significant trend will cause pain to those invested in senior-housing real estate while providing great opportunities to venture capital (USD1bn will be invested this year in the US in ageing in place technologies).

▪ This year, USD200bn+ of green bonds have been issued while tens of billions of USD have been invested in conservation (mostly in forestry and water). These amounts are still tiny, but are growing significantly year on year (one example: this year’s green bonds issuance will increase by around 200%+ compared to 2016). In our view, the ‘off- the-charts’ enthusiastic response to the recent “rhino impact bond” (USD50m) signals thebeginning of an exponential growth in conservation finance. It will be fuelled by the combination of: (1) a renewed interest in the scarcity value of nature; (2) the acceleration of climate change; (3) the understanding that conservation is a critical tool to mitigate the risk of climate emergency; (4) the fast-growing environmental activism of the next generation. All are intertwined, and feed off each other.

▪ A spate of new scientific reports (preceding the COP25 that starts in Madrid on Dec. 2) makes it clear that the initial goal of keeping the increase in global temperature at 1.5°C above pre-industrial average is unattainable, unless global emissions in 2030 are 55% lower than they were in 2018 – a quasi-impossible task. In fact, we are currently heading towards a 3.2°C increase, which will redraw the physical, social, geopolitical and economic map of the world. The most immediate threat will be that of rising waters. Thiswill disproportionately affect Asia.

▪ That climate change is accelerating (a fact, not a conjecture) entails thatthe economic costs of climate change are also accelerating – with a conflation of interrelated tipping points that are likely to create domino effects. Economic losses caused by climate change are already widespread, ranging from food production and property to productivity and growth. One figure among many to illustrate the point: in 2018 in the US, damages from severe weather amounted to USD100bn (50 incurred by insurers and another 50 in uninsured damages). The obvious consequence for business leaders and investors: the race to zero net emissions is on, and with it comes a major boost for all the processes and technologies that underpin it.

Download the full report: November’s Inside Track