New Era - Responding to the changing geopolitical and economic tensions

Headlines:

1. The complex interplay between economic, technological, and geopolitical factors shaping the global landscape
2. The impact of high government debt levels on inflation and equity returns, the effects of migration on labour markets and welfare spending
3. The energy demands of AI and its potential productivity gains, the challenges faced by Western automakers in competing with Chinese EV manufacturers, and the risks to global supply chains posed by tensions between China and Taiwan over semiconductor production
4. The potential for onshoring manufacturing, the future of hydrocarbons, and the geopolitical implications of these issues

 

Discussion points:

High interest rates and government debt
The implications of high government debt levels, which reached $300 trillion or 349% of global GDP in June 2022, up from 278% before the global financial crisis.

The debt has shifted from banks and corporations to governments, with government debt accounting for 102% of GDP in 2022. This high debt load is likely to drive inflation as governments seek to manage it through inflation.

Data was presented showing that the median free cash flow yield of the S&P 500 companies was below 3.5% at the end of 2023, down from 4.2% in 2019, while the Fed funds rate has increased by 375 basis points. It was suggested that markets may react to higher debt and borrowing costs by tightening lending, reducing corporate capital expenditure, and potentially leading to debt write-downs. Governments may also seek to passively encourage inflation to erode the real value of debt.

Impact of UK migration on labour and welfare
The impact of migration on the UK labour market and welfare spending. Net migration to the UK currently stands at 695,000 people, with different government bodies projecting it to drop to either 300,000 or 350,000 per year.

 It was argued that while net migration has been shown to marginally increase real GDP per person, it could also lead to higher welfare spending, particularly if a Labour government was to increase the living wage. It was also noted that the Office for Budget Responsibility (OBR) forecasts do not account for potential increases in welfare spending due to an aging population and the needs of baby boomers in retirement.

Artificial intelligence and energy demands
Artificial intelligence (AI) and its potential impact on productivity growth and energy use. The exponential growth in computing power required for AI was highlighted, with the International Energy Agency expecting AI energy demand to increase tenfold in the next three years. Goldman Sachs has forecast that data centre usage for AI could account for 3-4% of global power usage by the end of the decade.

This raises concerns about the ability of the world's energy infrastructure to meet this rapidly growing demand, suggesting that nuclear power, battery storage, and renewables may be necessary to address the energy needs of AI.

Electric vehicles and tariffs
The challenges faced by Western automakers in competing with Chinese electric vehicle (EV) manufacturers. It was noted that China produces half of the global EV market and controls significant portions of the lithium mining, refining, and battery manufacturing supply chain.

The US has imposed a 100% tariff on Chinese EVs, while the EU was considering a 38% tariff. The potential impact of these tariffs on the automotive industry, including job losses and supply chain disruptions was cited.

The discussion also touched on the potential for onshoring manufacturing in the US and the associated cost increases, as well as the challenges faced by automakers in meeting EV production targets in the UK.

China, Taiwan, and semiconductor manufacturing
The potential conflict between China and Taiwan over semiconductor manufacturing. It was noted that Taiwan, through companies like TSMC, dominates the production of advanced semiconductors, which are critical for technologies like AI.

Potential implications of a Chinese invasion of Taiwan, including disruptions to global semiconductor supply chains and the efforts of the US and other countries to onshore semiconductor manufacturing through initiatives like the CHIPS and Science Act was then covered. However, the significant cost differential between manufacturing in the US and Taiwan was also highlighted, raising concerns about the inflationary impact of onshoring.

The broader geopolitical tensions between China and the West, as well as the potential for supply chain disruptions and economic consequences if conflict were to arise.

Key takeaways:

• Closely monitor developments related to government debt levels, interest rates, and potential inflationary pressures, as these factors could significantly impact equity returns and corporate borrowing costs.
• Evaluate the potential impact of changes in migration policies and welfare spending on labour markets and economic growth, particularly in the context of an aging population and potential policy shifts under a new government.
• Assess the energy demands and infrastructure requirements associated with the rapid growth of artificial intelligence, and consider potential investment opportunities or risks related to energy production, storage, and distribution.
• Analyse the competitive landscape and supply chain dynamics in the electric vehicle industry, particularly the challenges faced by Western automakers in competing with Chinese manufacturers and the potential impact of tariffs and trade policies.
• Monitor geopolitical tensions between China and Taiwan, as well as the potential implications for global semiconductor supply chains and the efforts to onshore manufacturing in the US and other countries, and assess the associated risks and opportunities for various industries and companies.