The World in Transition


Lex Hall, Content Editor, Morningstar  |   25th Oct 2019  |   5 min read

The world is changing, the levers of central banks no longer have the same power to contain the global economy, and China’s growing presence on the world stage is reshaping geopolitics and markets. These are just some of the observations of Australia’s former chief envoy to the US and now vice-chairman at the Capital Group, Michael Thawley.

Despite the at times grave tone, Thawley, whose chronology includes a stint as international adviser to John Howard, sought to assure the audience at Morningstar Investment Conference that he remained optimistic on the outlook. Among the messages? We’ve had it good for a long time and the next downturn will necessarily present a new set of challenges.

But with these challenges come opportunities to make successful investments, he says. “We need to be more careful than usual to prepare for a situation which is inevitable at some point, maybe in the next year or so,” Thawley says.

“We need to be sure our portfolios are tested to the extent possible against the risks and we need to understand the changed situation facing the companies in which we invest.”

In a sweeping overview of the changing world order, Thawley dropped pins on key areas of concern. Among them the complacency that has developed since the global financial crisis of 2008, and the effect of China’s growing influence. In the decade since the global financial crisis, Thawley argues, asset managers and investors alike have become used to treading a robust growth path, supported by central banks that are willing to “come to rescue” when markets wobble. Particularly in Australia, with its 28-year run of growth.

But this change in mindset must be understood alongside the shift in global order that has been occurring in the past three of four decades. Here, Thawley is referring to the integration of China into the world economy. Whereas Deng Xiaoping was content to accept the prevailing strategic order as being in China’s interest, his successor, Xi Jinping, has other ideas for the Middle Kingdom. And Thawley is unsure the world has fully grasped the repercussions of this evolution.

“No other country can add the same momentum at the same pace as China has done,” he says, “not even India for all its great success and undoubted potential.”

And it’s this momentum that is rippling through geopolitics, its clearest manifestation being the trade row between Xi and his US counterpart Donald Trump. Whether this dispute ¬– which ignited last year and traces its origins back to accusations of intellectual property theft – will resolve is unknown. By Thawley’s reckoning, a deal will be reached. But it won’t be perfect. Nor will it necessarily level the playing field or achieve one of its original aims: to remedy the US trade deficit.

This of course has ramifications for Taiwan – both a bastion of democracy and one of China’s most closely held territories. And here Thawley is concerned. People, he argues, are failing to acknowledge the pressure on Taiwan, particularly its leading edge in IT. If the status quo changes, Thawley warns, so too will the stability in our region.

So, what will the US-China relationship look like? “My answer is that of course there will be an ongoing economic relationship between the two,” Thawley says. “Some modus vivendi will be found, trade will continue, but it will be in the context of areas where there’s no go and it will be limited. And probably, the next generation of Capital Group people will be dealing with the issue.”

And while Thawley welcomes China’s desire to play a greater role financial markets, he is alive to the inherent risk it entails, particularly in bond markets. China needs inflows because there’s a huge amount of debt to deal with. But what happens when its citizens decide to diversify outside the economy? Where will the liquidity be?

On the other side of the world, Thawley sees a diminished role for Europe without the UK – something he says the EU is willing to accept. The flipside, however, is that if Europe no longer plays a key role in the strategic balance, then “free market approaches are going to be much weakened”.

Underpinning this global overview is a warning on central banks, which Thawley no longer sees as having the same flexibility to reduce interestrates, some of which are below zero.

He sees governments as reluctant to resort to quantitative easing because of the effects on income, wealth distribution and asset valuations. Does that mean, however, that fiscal spending is a viable option, especially given so many countries have large deficits?

Part of the answer at least is that central banks may have to help governments manage this by “monetising deficits”.

“A few years ago, this might have been a controversial idea, but I don’t think it is any longer. And in conversations in Washington with people who have been in positions in the central bank it’s very clear that this is what people are expecting.”

That in turn creates uncertainties, which Thawley admits will cause asset managers heartburn. But he insists this is not the outline of a doomsday scenario – and that opportunities will emerge.

“The shifts are already happening,” he says. “And these shifts are our bread and butter because they are what provide the opportunities and the potential for us to make successful investments.”

Originally posted 2019-06-20 10:38:35.

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