When investors say “decoupling” what do they mean?

Over the past year, investors have often seen the term “decoupling”. However, it is likely to cause confusion as it had one definition for decades, while it now has another. The two meanings are related, but they are not the same.

The first “decoupling” has its origins decades ago. In the aftermath of World War II, America reigned supreme among the world’s economies and was seen by experts as the engine of global economic growth. In other words, the world economy has not developed without American leadership. But as other countries rebuilt and recovered from the carnage of war, some economists believed there might be a decoupling of the US economy from global growth, with other countries taking the lead in economic growth. .

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Economists have discussed decoupling at length, but it never happened, says Robert Wright, economic historian and senior researcher at the American Institute for Economic Research. “There was no alternative in the United States,” he says. In other words, other economies, like those in Europe and Asia, were not strong enough to fill America’s economic shoes. This meant that global growth had to continue to rely on the United States.

A new decoupling

Currently, “decoupling” is increasingly used to refer to the severing of economic ties with China. This idea appeared to have been sparked by the Chinese government’s lack of transparency regarding the initial viral outbreak of Covid-19 in Wuhan, China, combined with long-standing complaints about human rights violations in China and the alleged massive theft of intellectual property from Western companies.

Even though China says it has taken steps to improve its intellectual property protections, some governments and companies are reconsidering their economic ties with China and finding other trading partners instead.

“This kind of decoupling makes a lot more sense,” says Wright. “Why go to China, which has all these problems and where billionaires go?

The pandemic has also caused governments to turn away from China. Covid-19 has shown governments that there is a critical need for pharmaceuticals and vital health equipment to be produced domestically or from allies, said Peter Tchir, head of macro macro at Academy Securities. In turn, this will likely continue to fuel inflationary pressures.

“People assume that all supply problems are temporary,” he says, but some of them “will be permanent, and this will lead to higher inflation”.

Of course, higher inflation, if it materializes, would likely jeopardize the outlook for equity returns, as the authorities will be more likely to increase the cost of borrowing sooner rather than later.

Others are in preparation

Any decoupling from China would reverse two decades of economic integration, which was boosted when China joined the World Trade Organization in 2001, with the privilege of being able to export goods at low tariffs negotiated by the WTO.

China itself is preparing to reverse this integration. After two decades of moving towards economic freedom, the nation will begin to return to central planning, which means less pressure to trade with the rest of the world.

“I expect more decoupling from the rest of the world as China continues to re-centralize,” Tchir wrote in a recent report.

At the same time, China is likely to project more power abroad. In particular, the nation could try to position itself as the top superpower at the upcoming G-20 summit of major nations in late October, he said. This would likely cause even greater tension between the United States and China.

Mr. Constable is a writer in Edinburgh, Scotland. He can be contacted at [email protected]

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