More and more countries throughout the world are pursuing a protectionist policy. If this development prevails, it would put an end to globalisation. The era of low interest rates would come to an end and inflation would accelerate. In short: protectionist policies are at the cost of growth and prosperity.
World-wide we are currently witnessing a revival of protectionist forces. Populist movements are gaining influence in many countries, often relying on nationalist ideologies and propagating economic and social isolationism. The battle against globalisation is a central theme shared by populists from different countries. US President Donald Trump is a prime example in this regard, but he is by no means alone. In large parts of Europe similar positions are also gaining ground. And where populists are not yet already part of government, they are often setting the parameters of political debate.
Yet it was globalisation that decisively shaped the economic and social trends of the last 25 years or so. The former Warsaw Pact countries in Central and Eastern Europe have been integrated into world trade just as have Asian states. In a very short period of time China has emerged as the world’s second-largest economy. Immense prosperity has been created and hundreds of millions of people have been liberated from great poverty. However, in the industrialised countries there were also many losers of globalisation that were ignored for a long time. The political concepts for integration were missing here and ultimately the breeding ground emerged on which nationalist ideologies and economic and social isolationism flourished.
Today the start of “globalisation” tends to be put at the beginning of the 1990s, in the wake of the fall of the Iron Curtain and the beginning of the reform policy in China. Economic development and global prosperity gains have been exceptional since the beginning of globalisation. The consequences of a spiral of protectionism and an “all against all” policy would be correspondingly negative.
The International Monetary Fund (IMF) computed such a scenario back in October 2016, meaning a few days before Donald Trump was elected US President. The IMF came to the conclusion that after five years the world’s entire economic output would be almost two percent lower than in the base scenario. The assumption was that within three years protectionist measures would increasingly be put in place world-wide in keeping with the motto “I’ll do to you what you do to me”. In this simulation, half of the trade restrictions would consist of customs tariffs and the other half of non-tariff obstacles. In this scenario, after three years import prices would rise by 10 percent worldwide.
In this scenario analysis the customs revenues are forwarded as transfer payments to households. This is a very important assumption, as otherwise the braking effect of the rise in prices on world-wide demand would be far greater. Yet even given this assumption, world trade would in the course of five years probably fall by 15 percent. For Germany, such a development would result in a noticeable cut in economic activity. Growth rates below one percent for a longer period of time would not be ruled out.
Inflation would probably initially accelerate in such an environment. The increase in consumer prices would only slow down noticeably again if, after a few years, there were no further customs tariffs or other accompanying measures. Protectionist policies are therefore at the cost of growth and prosperity, with higher inflation initially.
The globalising of the world economy in recent decades has also made a considerable mark on the capital market: Key lending rates and the level of bond yields in the key industrialised nations are historically speaking both very low. All of this seems to be cast into question given current populism and the resulting trade conflicts. In this context, the inclusion of the emerging markets in world trade has as a whole spurred low inflation in the industrialised nations. The central banks have therefore no longer had to latently hit the brakes to pre-empt possible price dangers. Key lending rates were no longer raised to the degree they were in the past.
If globalisation is unravelled, this could dramatically dent the prosperity of past years. Thus, in the medium term the phase of structurally low yields and historically low key lending rates that has largely prevailed in the capital market since the beginning of the millennium could come to an end. The volatility of macroeconomic factors might increase, leading to general uncertainty among market players.
The risk premiums in the capital market might then rise. If we take the Fed’s assessment of the direct effects, then the global savings glut impacts on US yields by decreasing them by about 80-100 basis points. This effect would then be eliminated. The indirect effects such as low price pressures, historically low key lending rates, and a decrease in risk premiums may have reduced the yield on 10-year paper by another 50-100 basis points.
The yield on US 10-year Treasuries is thus presumed to be about 200 basis points higher than for the average of recent years. A level of just short of 5.0% for 10-year US securities would not be unusual in this setting. Transposed onto the Eurozone, the effects could be of a similar order. Starting from the current level, the yield on 10-year instruments would then at present be more like 2.5%. In a setting with the ECB pursuing a less expansionary monetary policy, a longer-term average level on 10-year government bonds of around of 4.0% would be conceivable.