Tri Polar World Framework
Very excited to share this recent Real Vision interview clip examining how the Tri Polar World (TPW) thesis can be used throughout the global investment process from asset allocation to regional weightings, country selection, sector determination and stock level opportunity. Further thoughts on how low volatility begets low volatility & how the best global synchronized econ recovery in decades provides the space for CBs to begin normalization.
A Path to the Future: The Tri Polar World View
My contribution to the global growth debate is the Tri Polar World View, which argues that deeper regionalization is the way to catalyze the global economy onto a new growth path. To take a step back, the Tri Polar World (TPW) 1.0 began back in the early 1990s with the creation the North American Free Trade Agreement (NAFTA). NAFTA brought together Canada as the natural resource provider, the US as the consumer and Mexico as the low-cost production center. The Euro’s introduction in the late 1990s can be seen as a strategic reaction to NAFTA as Europe recognized the need to bulk up in order to compete with the Americas pole. The European construct included Russia as the energy provider, Central/Eastern Europe as the low-cost producer and Western Europe as the consumer. The Asian pole was less well defined but oriented around the development of the Chinese economy and its Asian supply chains.
Tri Polar World 2.0
Twenty years on, the Tri Polar World view contains the same three geographic poles, with the Middle East acting as a swing player between Africa and Europe, given its transport and logistics links as well as its role as an energy supplier. As a region, Africa remains a work in progress, a collection of disparate states rather than a regional collective.
What makes today’s TPW so interesting are three new and enduring factors that permeate each region and reinforce the prospects for deeper regional integration. These three factors are each region’s growing ability to: self-finance, self-produce and self-consume. Thus TPW 2.0. All three main regions – the Americas, Europe and Asia – have a growing ability and propensity to self-finance through the growing wealth and savings pools in each region; the capacity to self-produce through advanced manufacturing techniques including robotics, cloud manufacturing and three-D printing; and the ability to self-consume via urbanization, the rise of the service-sector economy and the explosion in e-commerce. Each region’s ability to self-consume leverages trade, reduces the beggar-thy-neighbor risk and reinforces the first two attributes.
Let’s look at each of our three regional poles in turn.
Over the past several years there has been great angst about the European Union’s prospects. Perhaps it’s a good thing for states to give serious consideration to life outside the EU and see what type of stage they will play on. As a regional collective, the EU is one of the world’s largest economic blocs, its economy roughly the size of the US. Individually the economies are much less significant, with perhaps the exception of Germany. Of course, were Germany to exist on its own, its currency would soar in value and its trade surplus would collapse.
Europe’s scope for further integration is huge. On the self-finance front, the ECB's new regional regulator role sets the stage for capital union discussions sure to find support from pension funds and others who seek deeper markets with greater opportunities to meet targeted returns. Imagine a European pension fund trying to generate 5% pa returns with 10-year Bunds yielding 18 basis points! The development of the European corporate bond market over the past decade is just one illustration of how this process can deepen between now and 2025.
Europe’s self-manufacturing opportunities include a potential energy union to reduce dependence on Russian natural gas, meet climate change targets and reduce costs. The collapse in US energy costs has rendered Europe uncompetitive on the energy front. The European Fund for Strategic Investment (EFSI) to build out Europe’s infrastructure is another example of a potential economic and regional deepener. Issues around capital charges and other concerns need to be cleared up for private-sector financial institutions to fully participate, but given the yield and maturity attractions, there is much to play for.
The self-consumption component is one Europe struggles with at present, given very high unemployment, very low inflation and weak overall economic activity. On the plus side, Europe’s crisis suggests there should be significant pent-up demand and replacement potential. Investors are clearly betting on this, as one look at the European auto stocks will demonstrate. Unemployment is at 3-year lows and falling, while credit is becoming more plentiful. Regional financial market integration drives down costs, while the Junker plan build-out generates jobs, leaving the consumption angle to take care of itself.
Currently Europe runs a large current account surplus, made even larger by oil’s price collapse. Germany is responsible for the bulk of this surplus, which generates a capital glut that is one of Europe’s and the globe’s main challenges. Unlocking this capital to help build out the infrastructure plan, energy union, capital union etc. are all issues for Europe’s political leaders to focus on. Their reward will be to return Europe to growth, generate jobs, turn back the populist tide and help revitalize the global economy.
Asia faces many challenges – inter-state rivalries (China and Japan, Japan and Korea, India and China), the Iron Triangle of a weak yen, a slowing China and a strong dollar, and the 3 Ds of debt, deflation & demographics. Given Asia’s role in generating much of the world’s post-GFC growth, how the region responds to these issues should be of concern to policymakers and investors everywhere. Asia can go down the path of rivalry and conflict, of my-gain-is-your-loss, of every-country-for-itself, or it can work to make the promise of the Asian Century a tangible prospect by leveraging its massive savings, putting its people to work, deepening its integration and furthering the world’s growth prospects.
The potential exists: the opportunity to deepen regional supply chains emanating from China into ASEAN (Association of South East Asian Nations), the development of ASEAN’s own Economic Community and the growing recognition that no country, not even China, is big enough to go it alone. China seems to understand this and is taking an increasingly proactive role in regional development, toning down its rhetoric, meeting with Japan and South Korea to discuss economic and security issues, building ties with India. Initiatives such as the overland and maritime Silk Road projects and the launching of the Asian Infrastructure Investment Bank (AIIB) are examples of regional significance that should serve as wake-up calls for both Europe and the Americas.
Looking first at Asia’s ability to self-finance, one notes China’s $4 trillion in reserves, the growing usage of the RMB and the potential for an Asian currency bloc. Already one can see the Asian currencies working closely off the RMB – a real-time example of which might come about if China decides to devalue its currency. The explosion of the Asian bond market over the past few years is another example of regional financial capacity, as is China’s growing role as a capital exporter (just talk to realtors in Auckland and Sydney). Sovereign wealth funds, the reallocation of Japan’s savings and China’s reserves suggest huge pools of capital that can be put to work to stimulate regional and global growth. Absent being put to work, they are simply more capital gluts.
Self-manufacturing is clearly in Asia’s wheelhouse, with the region now responsible for roughly 45% of global manufactures. The advent of technology and the rush to e-commerce is most visible in China but will increasingly to be seen in the ASEAN countries as well. This web of connections, what The Economist has called Factory Asia, is a well-integrated process now spreading from China into Vietnam, Laos and Cambodia. Asia’s regional supply chains are a great competitive advantage and regional integrator that neither the Americas nor Europe can compete with at present.
For Asia to self-consume is the dream not only of those in Asia but also in much of the rest of the world. Ecommerce, urbanization and the growth of the service-sector economy are three main drivers of the selfconsume process, and Asia is rapidly growing in all three segments. Today, China is the consumerdemand center around which the rest of Asia orbits – the apparent failure to recognize this is one reason why the Trans Pacific Partnership (TPP) is in such trouble. ASEAN demand is the future prize; private capital is already funding technology companies that provide a vehicle into this space, as illustrated by Ontario Teachers taking a stake in Garena, a Singaporean mobile gaming company.
Asia has a choice – it can let its individual rivalries and geo-political ambitions keep it separate or choose to integrate more deeply to benefit all its countries and citizens. The path to global power lies in the latter, not the former.
What’s most interesting about the Americas is that the region has not managed to deepen its integration over the past twenty years. Europe has been reactive but is clearly more of a regional actor today than twenty years ago. Asia, led by China, is increasingly proactive in this regard. However, Europe still labors under a difficult economic environment, while Asian rivalries threaten its progress. The Americas have none of these problems, yet very little has been done to strengthen the first-mover advantage generated by NAFTA. It’s as if the Americas Project stopped at Mexico’s southern border. There is no Silk Road Initiative as in Asia, no regional capital or energy union discussions as in Europe.
US leadership on both sides of the aisle seems intent on focusing everywhere but its own backyard – the Asian pivot, the focus on the Middle East at a time when its import is arguably less that it has been in over 100 years. One wonders if the self-embraced role of US as global superpower has blinded it both to the increasing futility of that role as well as to the golden opportunity to focus southward.
Within NAFTA, from northern Canada to Southern Mexico, regional integration seems to be making headway, especially in terms of energy and manufacturing. Today, pipelines are able to move gas from Canada to Mexico, while Mexican manufacturing platforms are increasingly integrated into the US production process in the auto and white-goods sectors, in particular. While the North American supply chain has yet to mirror Factory Asia, it is deeper and more regionalized than ever before.
South and Central America represent the missing piece – the opportunity and the need. Central America, with its youthful demographic and recent propensity to send youths across the US border, has drawn the attention of the Obama administration. South America – Brazil, Argentina, Venezuela, Chile, Peru, etc. – has been off the radar screen for the most part, enjoying the China-related commodity boom in the first part of the new century before feeling the hangover in the past few years. A process of integration, not only with the North but also amongst themselves, is past due – there is vast potential for the Mercosur and Pacific Alliance to come together via infrastructure build-outs to create jobs, cut costs, put capital to work and revitalize the regional and world economy.
The ability to self-finance in the Americas should almost go without saying, given Canada’s huge and very active pension funds, the vast pools of private capital in the US and the significant pension fund growth in much of South America. Brazil, for example, has the 4th largest pool of institutional assets in the world, over $1 trillion, almost all of it invested domestically. Pension plans in Mexico, Chile, Peru and elsewhere are outgrowing their domestic capital markets, creating pressure and opportunity to regionalize South America’s capital markets in order to deepen their investment space.
Self-manufacturing in the Americas also has much going for it. Reshoring back to the Americas is well underway. Advanced manufacturing techniques foster mass customization, which stimulates locating production not where labor is cheapest but where the end-consumer is. Mexico’s vast number of trade relationships make it an ideal production platform, something the auto sector is well aware of. The need to shift away from raw commodity production has become self-evident in the past three years for Chile, Brazil and Peru, among others. The time is ripe to make a push in this direction.
The capacity to self-consume is all over the America’s map, from raw excess in the US to food and diaper lines in Caracas. Brazilians have shopped till they dropped, while the Argentines await a new administration and guidance on the way forward. Regionalization can leverage the next steps in South and Central America, and the US can help lead that process. Capital, labor, raw materials exist in abundance throughout the region – all it takes is political will. The upcoming Americas Summit would be a great place to start.
TPW 2.0 – A Global Growth Model
The Tri Polar World 2.0 represents a possible model for the global economy. It stems from a belief that not enough thinking is underway to develop new growth paradigms and thus there is both a political and an investment opportunity to lead this process. It suggests that over the next ten and twenty years, the thrust of economic activity, of political and business leadership, of cultural and social engagement, will be regional integration. This thesis leverages the growing power of proximity, of technology, of e-commerce. It proposes that regional integration can drive global growth via infrastructure projects funded by capital gluts.
Every-country-for-itself is not a global strategy; muddling along as we have been risks upheaval on both Wall Street and Main Street; and globalization as we knew it is over. Who gets it? Who are the new leaders, where are the statesmen? It is time to act rather than react, to move in a new direction, to create a new global growth model – Tri Polar World 2.0.
Jay Pelosky, CIO & Co-Founder
TPW Investment Management
Source: Itau BBA. This article was originally written while Jay Pelosky was a consultant for Itau BBA.
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