Clash of the Themes
Causes and consequences in the global political economy
“When all men think alike, no one thinks very much.” – Walter Lippmann
This year has been a difficult one for most in markets. Few anticipated sustained high inflation, an aggressive Fed followed or matched by other central banks, the sharp rise in real yields and consequent fall in asset prices, the unstoppable rise of the dollar, and the surprising resilience of the US economy amid these stresses. Yet as early as Spring of 2021 I forecast all those events for 2022.
I am often asked how high-level, slow-moving Themes help to make decisions in fast-moving, news-driven markets. Like a compass on a storm-tossed ship, a proper understanding of the themes that got us here help to keep you on course and point to where we are going as swells and gales knock you about. The Thematic Markets framework for understanding the global political economy allows you to better interpret and navigate the fast-moving news flow and anticipate the rocks ahead. I explain here how seven Themes led to the economic and market volatility we experienced this year, the cognitive dissonance behind the consensus’ inability to see these events coming, and where we are going in 2023.
The most important of these themes – because it is uniquely transformational and augmenting or driving the others – is the technological revolution in trade and production: Localization. Localization simultaneously is driving structural divergence in country-level growth, and the supply and demand shocks that are dominating the post-Covid business cycle. Higher real interest rates, trend growth and sustained US outperformance are consequences.
Higher-than-expected inflation stems not only from coincident supply and demand shocks, but crucially a shift in Being is believing expectations that turned “Missingflation” from a negative to a positive trend. That markets and policymakers missed that change – while the masses did not – not only illustrates the former’s collective cognitive dissonance but also a primary driver of the Politics of Rage that is raising political fragility, particularly in the West. Brittle politics and an associated increasing elites’ preference for centralized solutions likely will precipitate the next trauma for markets: a wave of defaults or hyperinflations as they interact with the inevitable consequence of rising real interest rates and divergent trend growth amid historic national debt levels.
Into this already volatile cocktail of structural change, three other key themes are contributing to both collective confusion and risk-management difficulty: Global Entropy, the dissolution of the “rules-based order”; Complexity cascades, the nonlinearities manifest in complex systems when exposed to stress; and Uncertainty, or non-quantifiable risks, the most difficult of ones to manage, particularly amid widespread over reliance on data and quantitative methods. All three are interacting with Localization, Being is believing and the Politics of Rage, in complicated, often re-enforcing feedback loops.