Securonomics is fuzzy new lodestar for investors

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The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Refiles to fix style in paragraph four.

By Felix Martin

LONDON, June 2 (Reuters Breakingviews) -“Globalisation, as we once knew it, is dead.” This blunt assessment, delivered last week in Washington by Rachel Reeves, the UK Labour Party’s shadow Chancellor of the Exchequer, is the simplest summary of what has happened to the framework that has governed global economic policy for the past three decades.

The former Bank of England economist also coined the catchiest term for what is taking globalisation’s place: securonomics. In short, it means national security trumps economic efficiency. During the era of free trade and financial liberalisation, the politicians danced to the economists’ tune. Now it’s the other way round. To say this volte-face is important for investors is a colossal understatement. Almost nothing matters more.

The definitive account of the principles governing the new policy landscape was set out by the White House at the end of April. Tellingly, it came not from the U.S. Treasury Secretary or the U.S. Trade Representative, but from the country's top securocrat, Jake Sullivan. President Joe Biden’s National Security Advisor explained that the era of unqualified support for free markets is over.

Domestically, industrial policy is back. The state will explicitly subsidise “specific sectors that are foundational to economic growth (or) strategic from a national security perspective,” Sullivan explained. That principle underpins the Biden administration’s two main pieces of economic legislation of the past twelve months, the CHIPS and Science Act and the Inflation Reduction Act, which aim to bolster the United States’ semiconductor and green energy industries, respectively.

Internationally, meanwhile, free trade is no longer the pole star. Securing supply chains will take priority over minimising costs, and bilateral or regional trade agreements will be designed to support foreign and environmental policy. Friendshoring - the drive to source parts and manufactured goods from friendly countries - will replace offshoring. Sullivan’s 5,000-word speech devoted just three sentences to the World Trade Organization.

What does this all mean for investors? For one, the currencies, bonds, and equity markets of countries which are allied to the Group of Seven rich countries look set to outperform. The promise of friendshoring is one reason the Mexican peso has been the best-performing major emerging-market currency of 2023. Industries and companies exposed to the renewed appetite for defense spending, meanwhile, are also benefiting. Shares in Britain’s BAE Systems BAES.L rose by a third in the first four months of the year. Nor is it too late to bet on the securonomics effect in markets. For example, the Dow Jones US Select Aerospace and Defense Index has merely kept pace with the S&P 500 .SPX benchmark over the past twelve months, and lagged it over three years.

Some argue that the new statism will yield even greater dividends over the longer term. As Jacob Soll argues in "Free Market: The History of an Idea", a timely history of the battle between liberalism and protectionism published in 2022, the era we have just lived through is an exception. As far back as the 17th and 18th centuries, economic policymakers such as Jean-Baptiste Colbert, the French statesman, and Alexander Hamilton, the first U.S. Treasury Secretary, acknowledged the need to temper the efficiency of free markets with government support for industries essential to national security. Soll points out that even Adam Smith, the Scottish economist who famously praised the “invisible hand” of market forces, was in favour of protecting England’s naval industry. Soll, a professor at the University of Southern California, explains that securonomics, not free market liberalism, has underpinned most of the great economic growth stories of the past.

Yet today’s global economy faces challenges Colbert or Hamilton would hardly recognize. One especially obvious question is whether prioritising national security is consistent with the other big economic policy shift of the past two years: the attempt by central banks to normalise monetary policy after more than a decade of ultra-low interest rates.

The shift from market to state in the real economy is happening just as policymakers are attempting to restore market-based allocation in finance. Christine Lagarde, president of the European Central Bank, in April issued a candid assessment of the severe challenges this apparently incoherent combination poses. The enviable record of independent G7 central banks at hitting their targets for low and stable price inflation during the past three decades relied critically on two factors, Lagarde explained.

The first was the relaxation of supply-side constraints due to the relentless march of trade liberalisation and the entry into the global labour force of hundreds of millions of workers from the former Soviet bloc, China, and other emerging markets. That made demand the pinch point for inflation, allowing central banks to modulate it with interest rates. The second factor was the dominance of the U.S. dollar in the world financial system. That sustained a stable international monetary architecture and a predictable transmission mechanism for central bank policy.

Securonomics takes an axe to both these foundations of modern central banking. Hard borders, high tariffs, and snarled-up supply chains have returned trade disruption and labour shortages to the heart of the inflationary process, scrambling the ability of central banks to contain rising prices.

Meanwhile, the dollar-based world financial system is giving way, however gradually, to a more multipolar future. China is on a mission to internationalise the yuan. The decision by the United States and Europe to sanction Russia by weaponising central bank reserves and payment systems has accelerated the development of alternatives. Saudi Arabia has said it may start accepting payment for oil in currencies other than U.S. dollars. None of these developments is about to unseat the greenback. But all of them, at the margin, erode the effectiveness of G7 monetary policy.

Does securonomics augur a new era of investment opportunity, as the newly emboldened politicians assure us, or are the economists behind the old "Washington Consensus" right that it will lead to ruin? Perhaps the answer is both. “It all seems very 17th-18th century,” says Professor Soll, “which ends in economic innovation, growth – and world war.”

Follow @felixmwmartin on Twitter

Semiconductor scramble

Editing by Peter Thal Larsen and Pranav Kiran


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