The Rise and Fall of Nations
If you know which signs to look for, the events won’t come as much of a surprise.
The global economy is an intricate landscape full of hundreds of moving parts and players, each shaping the outcome and future actions of all parties involved. New information is disseminated in the blink of an eye across the globe, from the US to China, the European Union to South America and every location between. The ability for investors to interpret the events and make informed decisions can be a highly complex and daunting task. Ruchir Sharma, an experienced market strategist from Morgan Stanley, argues that if you know which signs to look for, the events won’t come as much of a surprise, and will allow investors to benefit from the opportunities that present themselves in the marketplace. In his book, “The Rise and Fall of Nations: Forces of Change in the Post Crisis World,” Sharma outlines key elements that can help reveal where any nation and economy is heading.
Economic booms and busts have been going on for centuries and while a variety of factors play a role, these cycles tend to run their course in an unconventional manner that upends conventional wisdom. Many times an unplanned or unforeseen series of complex, interwoven events can cause things to quickly change for the better or worse. Thus, “impermanence” is a fundamental aspect of global markets and something investors must always keep in mind as they adapt and search for new opportunities.
“In an impermanent world, the only constant is the turning of the economic and political cycles that govern the future.”
After more than two decades spent working in investment banking, Ruchir Sharma has identified a series of 10 keys to help better diagnose the economic health of a nation in the coming 5 years or less.
Demographics: Population growth and in particular the age structure and working age population is one of the key factors that drives economic growth. When population growth is robust, it tends to be much easier for nations to experience the economic boom part of the cycle as more workers and consumers can be added. Regions with shrinking populations are prone to labor shortages, pension fund deficits and ultimately economic slowdowns. Fewer young people means there are fewer workers to contribute to retirement pensions. Developed nations are trying to address this challenge by increasing the retirement age. Germany for example, recently moved from 65 to 67. In Brazil, many workers retire in their early 50s, thanks to a pension scheme that gives them 90% of their working salaries.
Good Vs. Bad Billionaires: Sharma attempts to simplify the growing income inequality trend. Rather than vilifying the rich, he separates them into two categories: good and bad billionaires. Good billionaires (US is strong here) are the people who have made their fortunes by creating new businesses and advancing technologies which contributes to job growth and even greater innovations. Conversely, bad billionaires (Russia and Saudi Arabia are home to many) come about mainly through inheritance, building and maintaining political connections, or controlling an industry such as fossil fuels. Good services and businesses benefit the economy much more than simply good connections.
Geography: The emergence of new cities are needed to improve the distribution of wealth. Countries where the principal city is dramatically larger (5 or more times the size in terms of population or output) than the next largest city often suffer from levels of economic and political inequality. This can stymie effective overall governance and long-term economic growth for the nation.
Local Investment: Sharma is a big believer in the power of the local residents and believes they are the best indicator of future economic trends for any given region. It is a very bad sign when locals slowdown or flat out refuse to invest in their own country and instead look to outside investment opportunities.
Manufacturing: Manufacturing is a crucial element in the growth of nations and increases in productivity matter. When a factory churns out more products with the same number of workers, the owner can give the workers raises without triggering inflation. China, South Korea, Malaysia and Indonesia are prime examples of countries that have produced sustained growth by using manufacturing as an important driver. In China, more than 30% of the GDP comes from manufacturing. Conversely, if there isn’t enough manufacturing, it can make it very difficult to sustain growth and leads to overcapacity.
Debt: It normally isn’t a promising sign when the amount of private debt is growing at a much faster rate than the growth of the economy. Sharma sees the rapid growth of private debt in China as one of the reasons that they won’t be able to maintain their role as a driver of the global economy. In general when this happens, a slowdown in the economy occurs. The US dollar remains the world’s dominant reserve currency. A good assessment of money flows can begin with a currency’s value against the dollar. When a nation’s current account deficit exceeds 5% of GDP, its growth is in danger and often times a slowdown occurs. The current account shows how much a nation consumes versus how much it produces. The trade balance, which compares imports against exports, forms the largest part of most nations’ current accounts.
Currency: A cheap currency can help to boost as it attracts outside investors and even tourists but only until a certain point. Sharma uses the strength of a nation's currency as a proxy for the level of government interference with monetary policy. A currency that feels cheap is usually one that has been allowed to find its market value, rather than being artificially manipulated by the central bank.
Inflation: High inflation rates are bad for any economy and compounded by the severity that they are outpacing the earnings growth of the population. Large increases in the housing and stock market may mask some of the underlying problems so it is important to keep an eye on the general inflation that includes the price of goods and services.
Government: Governments can obviously play a major role in the economic growth and development of a nation. Political leaders can lose focus of the bigger picture and get caught up in the short game to remain in office or secure a near-sighted victory. Sharma highlights recent economic troubles in Russia and Turkey as examples of what happens when leaders try to hold on to power for too long — economies get stale as innovation and necessary reforms are nowhere to be found. In his early years, Vladimir Putin was a reformer whose policies spurred growth, but as he has transitioned into a populist and militarist, Russia’s growth has suffered.
Hype: The cover story curse. Generally any country that experiences an “economic miracle” and ends up on the cover of Time magazine or other leading publication has already peaked. This honor has unfortunately marked the turning point for multiple economies and as the masses become aware of the success, the bull run has already largely been played out.
Tyler Krebeck
Chief Content Manager
December 13, 2019