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July 2016

I participated in the annual meeting of the Bretton Woods Committee last week in Washington (for those not familiar with it, the group defines itself as: "a non partisan network of prominent global citizens which works to establish the value of international economic cooperation"). In other words, the antithesis of the views which Mr Trump, Marine Le Pen, etc, are espousing. Among the attendees were Secretary of the Treasury Jacob Lew, US Trade Representative Michael Froman, and senior officials from the World Bank and the International Monetary Fund. As the discussion took place in the immediate aftermath of the Brexit vote I thought it might be worth sharing some of my thoughts and observations.

I came away impressed by Froman, less so by Lew. Lew's most interesting comments focused on China which he believes understands the needs and the challenges required to restructure their economy, but is concerned that they may not have the political will to overcome them. He characterized their economy as having lots of private sector borrowings, but little public debt. Like others, he emphasized the importance and benefits of global cooperation, especially in the context of the headwinds created by Brexit, but was short on specific policy recommendations.

Froman, was more political, clearly trying to sell the Trans-Pacific Partnership (TPP). He cited the potential benefits of the pact to the American consumer, saying it would provide a savings of approximately $700 per family, and noted that current US tariffs average only 1.5%. He also touted the benefits of international trade to the US economy, making the point that export related jobs pay 18% more, and cited automation as being more of a threat to job growth than free trade. Not surprisingly, he warned against the evils of protectionism, blaming it for having been one of the causes of the Great Depression. Finally, he feels that if the US fails to take the lead in tariff reduction and trade agreements, the Chinese will fill the void.

There was a vigorous discussion of the causes of the current economic malaise. Among the long term headwinds the global economy is facing are: the demographics of an aging population -- especially in the West; the negative impact of climate change, and the world wide growth of refugees and displaced persons, which now number close to 65 million. Collectively, these issues are having a significant depressive effect on the world economy. Unfortunately, these structural issues seem to get little attention, with most analysis focusing on day to day problems. In general, there was a sense of speaking to the converted in the room, rather than of searching for solutions. Surprisingly there seemed to be little sense of urgency about the political ramifications of the current populist, anti-global wave.

Going forward, it seems to me that two avenues need to be pursued by groups like these. One is that the benefits of free trade and globalization need to be communicated more effectively. Worldwide there can be little doubt that hundreds of millions of people have been lifted out of poverty by its benefits, yet all we ever seem to hear about are its costs. If policy makers want to continue on the course toward greater globalization and free trade, they need to make a more compelling case to support it. Secondly, the distribution of its benefits needs to more even handed. There can be little doubt that these trends have tended to disproportionately benefit the elite. Income inequality continues to fuel much of the populist discontent, and whether it is training for those dispossessed, or the implementation of more egalitarian fiscal policies, the legitimate causes of this unhappiness need to be addressed. If policy makers take some of the lessons to heart, and formulate appropriate responses, there can be a positive outcome. Globalization, free trade and international cooperation are requirements for continued global economic growth and upwardly moving financial markets. The elite represented in meetings like Bretton Woods need to realize there is a problem and to take action to address it.

Lastly, in terms of markets, as I noted in my recent commentary, these trends, culminating with the leave vote in the UK, are likely to cause some economic disruption, with the UK and Europe feeling the pinch more than others. Thus far, equity markets have been surprisingly resilient, recognizing that the financial impact of Brexit is limited, and does not represent a systemic risk. Though I fear there maybe an element of complacency here, expectations of lower interest rates, combined with the lack of alternatives, are making investors hesitant about investing in other asset classes. For example, how many of us find bonds attractive when the 10 Year US Treasury Note is yielding a paltry 1.3%? Interestingly, emerging markets may be one of the comparative beneficiaries if rates stay lower for longer. Regardless, the markets appear to have weathered the storm for the time being, although valuations remain uninspiring, particularly for this stage in the economic cycle. Consequently, we continue to believe that for the short term stocks, especially in the US, lack a catalyst to propel them forward. Longer term, they appear to be the main game in town.

I look forward to your comments.