The Shift Toward De-globalization is Bullish for Gold

You can see signs of de-globalization everywhere. Just look at the intense shareholder opposition to Prudential PLC's proposed takeover of the Asian operations of American International Group Inc. (NYSE: AIG).

And that's just one example.

The market scare on news that North Korea had, indeed, sunk a South Korean Naval vessel was another. The "flight to safety" in U.S. Treasuries – sparked by the increasing concern about the future of the euro and the viability of Greek government finances – is a third.

All over the world, little by little, the apparently inexorable tide of "globalization" – making the world "flat" in the words of Thomas L. Friedman – is retreating.  If a full-scale financial crisis breaks out in the next few months, that retreat will become a rout. And the world will become de-globalized.

Prior Periods of De-globalization

De-globalization has happened before. In the 50 years before 1914, the world had become increasingly globalized. That trend included some developments that are hard to imagine today.

Passports had become unnecessary for most travel. Tariffs in some countries – most notably the United States and Kaiser Wilhelm II's Germany – remained punishingly high. But there was a system of global finance very much like the one we have today. That system provided ready capital to the "emerging markets" of that era. And that, for example, transformed Argentina into one of the world's 10 richest countries.

New barriers against trade and finance were followed by a world war and protectionist policies.

Then came the Great Depression. Before any real recovery had occurred, that global downturn caused most countries to raise barriers to imports. The international capital markets disappeared. And the volume of international trade declined by two thirds.

During the quarter century from 1950 to 1975, the world remained largely atomized. One-third of the world's population lived under political systems that did not allow markets to operate. Even outside the Russia/China bloc, international capital markets were very limited even for debt. And exchange controls in most countries outside the United States prevented all but a sliver of international equity investment.

Globalization Returns

The forces that would finally cause world-capital and world-trade markets to open got their start in 1979 with the emergence of British Prime Minister Margaret Thatcher (who that year removed British price controls). The election of Ronald W. Reagan as U.S. president shortly thereafter also was key, as was the fall of Communism a decade later.

In the 1990s, most countries were open to world trade, with free-price mechanisms and relatively low tariffs. Public and private equity investments in the "emerging markets" soared in popularity, in spite of the "Asian contagion" and Russian financial crises of 1997-98.

These developments were justified by the formerly socialist intellectuals as a new, moderate "Washington consensus," under which governments retained a role in moderating the forces of the market. The Washington consensus tended to fall apart under stress, as it did in Argentina, because of the excessive government spending to which it led. But it didn't hinder globalization in the form of free trade and free movement of capital.

With the 2008 financial-system crash, the "Washington consensus" fell apart. The intellectuals had been getting very bored with free markets and had moved on to "global warming" environmentalism. They seized the opportunity to blame free markets for the crash. That change in philosophy allowed protectionist forces in most countries to raise barriers in the form of subsidies and "anti-dumping" actions.

It also gave rise to the "stimulus" – thumping big increases in public spending and budget deficits, all of which were pushed through panicky legislatures. Banking systems were bailed out in a big way. But little was done to address the excessive leverage and ultra-low interest rates that had caused the problem.
We are now seeing the results. Trade barriers, in the form of anti-dumping actions and ecological subsidies, are far higher than they were a few years ago. Government finances are a mess. And investors are becoming more and more nervous about taking on foreign risk. Banks and hedge funds used cheap money to invest aggressively once the initial crisis was past. Now they're scared again.

Moves to Make, Moves to Avoid

There is right now a strong flow of funds into U.S. Treasury bonds. But investors will soon discover that "safe haven" is one of the world's more dangerous investments.

If the panic over government debt leads to another financial crisis like that of 2008, further bailouts of the financial system are inevitable. And if that happens, be assured that we will move even closer to de-globalization.

Further trade barriers will appear, reducing the interchange between economies that is a major engine of world efficiency. But that's only part of the damage. Even worse will be the huge decline in international investing activity. Governments will either limit such investor activity, or investors will be unwilling to do so due to the perceived risk.

Investment will be largely domestic, but the United States will have lost much of its cheap capital advantage over other countries because of its persistent balance-of-payments shortfalls and budget deficits.

In that case, many of the economic advances that globalization has brought to the United States – and the world as a whole – will be reversed. The world economy will have to adapt to a much lower level of efficiency, with higher manufacturing costs and less outsourcing. Both inflation and unemployment will be high. The result: We'll be looking at a decade of inflationary recession, with declining living standards.

We have already traveled a considerable distance toward de-globalization and should work towards reversing this trend. We should keep trade barriers down and international capital markets open. As protection against the possibility that governments and markets will fail in this attempt, investors should look in one direction – at gold.

In a world of inflationary recession, in which international investment opportunities are blocked and government bonds are dangerous, gold remains the most reliable store of value. Others will realize this. So investors with gold in their portfolios will at least have the satisfaction of increasing their capital, while others are losing theirs.

[Editor's Note: Money Morning readers are often amazed by Martin Hutchinson's profit-focused instincts – as evidenced by his unerring ability to paint a picture of what's to come. He's able to show us the big profit opportunities that are still over the horizon – while also warning us about the potentially ruinous pitfalls hidden just around the corner.

So it's no surprise that Hutchinson has pulled off a string of forecasting successes in the face of the worst financial crisis since the Great Depression – a financial crisis that, not surprisingly, Hutchinson is widely credited for having predicted and warned about well ahead of time.

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News and Related Story Links:

• Money Morning Special Report:
  U.S. Treasury Bonds: The Not-So-Safe "Safe Haven."
• Reuters:
  Prudential, AIG in talks to cut AIA deal size – WSJ.
• Wikipedia:
  Deglobalization.
• The New Yorker Think Tank Feature:
  De-Globalization.
• The BBC Historic Figures Guide:
  Kaiser Wilhelm II.
• Investopedia:
  What is an emerging markets economy?
• The Free Dictionary:
  Atomized.
• The BBC:
  The Wall Street Crash and the Great Depression.
• WhiteHouse.gov:
  Ronald W. Reagan.
• The BBC Historic Figures Guide:
  Margaret Thatcher.
• Wikipedia:
  Asian Financial Crisis.
• Library of Economics and Liberty:
  Balance of Payments.