The current situation in politics, the economy, the stock markets and the price of gold

What do current and foreseeable future events in geopolitics and the economy mean for the capital markets?

Executive Summary:

Tariffs and fewer immigrants would drive up inflation rates if Donald Trump were to win the election. Tariffs also weaken purchasing power. In any case, recession risks are underestimated in the US; share prices have never risen in the US, China or the eurozone while leading economic indicators have fallen, except since 2022. These problems, such as rising inflation rates and rising government debt, are well recognized on the gold market, but ignored on the stock market. For this reason, you should currently own fewer shares, especially fewer US shares, than in normal times, but hold on to a high proportion of gold at wealth .  

A look at the shares of the 10 economically strongest countries in the world over the last 200 years shows the remarkable rise of the USA up to 1950 (chart 1, economic performance is measured by the purchasing power of the respective currencies, not just the exchange rate). Russia and Japan also temporarily rose to become the second strongest economic power until the 1960s and 1970s respectively, while at the same time China and India, which were initially still the leading countries, lost much of their importance. Since then, the picture has changed drastically. China and India seem to be rising inexorably, while the USA and European countries are slowly losing ground. As a result, the US and China could find themselves in the so-called Thucydides Trap (the leading world power tends to fight a rising rival, e.g. Trump's trade war against China from 2016. Source: Wirtschaftsdienst, 103rd year, 2023, issue 3).

In fact, part of the current geopolitical tensions arose because Donald Trump convinced Americans before his presidency from 2016 onwards that he had to seal off the US economy through trade restrictions and tariffs, particularly against rival China, in order to stop the decline of US industry. However, the extent of the trade restrictions was still very small compared to Trump's current plans in the event of his re-election (Figure 2). The current economic policy uncertainty is correspondingly high in China and even more so in Europe, where Trump's election victory could increase military risks due to the war in Ukraine if he stops supporting the Ukrainian army (chart 3).

Not only the USA, but also China is increasingly plagued by fears of decline. If we look not at purchasing power parity, but only at economic output measured in US dollars, China has not yet overtaken the US and is unlikely to do so (chart 4). The increased threats to attack Taiwan, underlined by military maneuvers, may serve as a distraction from China's increasingly difficult economic situation due to the bursting of the Chinese real estate bubble (see in detail the capital market outlooks of November 2021(here), September 2022(here) or June 2023(here)).

Japan also experienced a major real estate bubble in the early 1990s and an even bigger equity bubble at the same time; the Japanese share price index did not return to its December 1989 level until 2023, while the US share price index has risen 16-fold and the German share price index 6-fold since then (source: MSCI, Trading Economics, October 2024). In the future, China will face another problem that also affected Japan after the bubbles burst. The proportion of people of working age in Japan has been falling since the early 1990s (chart 5). In China, this figure also passed its peak a few years ago, as did the real estate market, and will fall much more sharply in the coming decades than in the eurozone (chart 6). By contrast, the USA has a massive advantage in this respect, as the number of people of working age there will continue to rise moderately. Only if Trump actually stops immigration or even chases well-integrated immigrant workers out of the country will the US also have to accept a decline in the number of workers with a corresponding negative impact on economic output. However, the low level of economic policy uncertainty in the USA (chart 3) does not reflect this risk. Apparently, this scenario is considered unlikely.

China's demographic problems are compounded by the fact that corporate and household debt has reached a new record high of 205.1% of national income. This is exactly the level at the beginning of the Japanese crisis in 1990 (red circle in chart 7). The Japanese government then had to increase its debt (then 62% of national income) to its current level of 263% in order to support the over-indebted private sector (chart 8). In China, the increase in government debt began a few years ago and has accelerated since then (charts 8 and 10).

The reason is the same as in Japan; the economy needs massive and permanent state aid after the real estate crash. The further course of events in China is likely to be the same as in Japan from 1991 onwards. Total government, household and corporate debt rose sharply in both China and Japan between 1991 and 2023 (chart 9, Germany, the US and the UK are also shown for comparison). Japan recorded a similarly strong increase in debt between 1964 and 1991 (light gray bar in chart 9). During this period, Japan also achieved strong real economic growth (light blue bar in the middle of chart 10), almost congruent with China's growth both from 1964 to 1991 and from 1991 to 2023. However, the renewed extremely strong increase in Japan's debt from 1991 to 2023 was suddenly offset by remarkably low real economic growth (dark blue bar in the middle of chart 10). Suddenly, therefore, debt - especially government debt - continued to rise massively from 1991 onwards (orange line in chart 8), but growth had collapsed. From 1991, the new debt in Japan was only used to pay interest and repay the old loans, as rental income was far too low to service the loans. In China, rental income is often zero because countless properties are vacant. Here, too, indebted property owners will either go bankrupt or have to keep getting new loans from the banks, which will require state aid.

China has now reached exactly the point that Japan reached in the early 1990s. The Chinese economy is no longer growing faster than the US economy, but debt growth is much higher (charts 11 and 12). China has passed its zenith.

The comparatively low level of economic policy uncertainty in the US could be boosted by another of Donald Trump's ideas, namely his desire to end the independence of the US Federal Reserve. This is likely to increase inflation risks in the US (chart 13), especially if the central bank can then no longer raise interest rates to reduce inflation without bringing the state to the brink of insolvency. Trump also wants to cut taxes further, which will increase the national debt, but even under a President Kamala Harris there will only be a slightly smaller increase in debt (see the capital market outlook from September 2024, which you can find here ). The International Monetary Fund pointed out a few days ago that global government debt has exceeded the 100 trillion US dollar mark (= 100,000 billion) and that this will lead to growing problems. The pressure on central banks to help their respective governments by printing money is likely to increase further in view of the widespread unwillingness to save. In the US, a dependent central bank would be very practical for Trump.

It is probably no coincidence that the issue of government debt is now being used by a highly respected institution, namely Bank of America, to predict a further rise in the price of gold to USD 3,000 per ounce (31.1035 grams). There is a growing risk that the capital markets may soon no longer be prepared to buy the growing volume of government bonds. This problem is exacerbated by the higher interest rates that governments now have to pay on their existing debt compared to the zero interest rate years. The real gold price has now surpassed the previous record set in 1980 (chart 14, red line).

Furthermore, the economic outlook is not good enough to expect significant growth in government revenues. The highly accurate Leading Economic Indicator (LEI) from US research firm The Conference Board has fallen more sharply in the US since December 2021 than ever before outside a recession (chart 15). The only sector of the US economy that has reliably contracted in the four quarters before a recession since 1947 is residential construction, while the other sectors (consumption, net exports, government spending and other investment) continue to rise until the start of a recession (chart 16), as they will in 2024. By contrast, housing starts have been falling since April 2022; they have also fallen by 10% in the last 12 months (chart 17).

In view of the low feasibility of house purchases due to the rise in mortgage interest rates (chart 18), record-high house prices (chart 19) and the disproportionately low rise in employee incomes over the past 40 years (chart 20), residential construction activity is unlikely to pick up and the risk of recession will increase.

A boom is also unlikely in China and the eurozone, the world's two other major economic areas.

In China, as in the US, the LEI is falling unusually sharply (chart 21). Here, too, the main cause is the residential real estate sector, although new construction activity has slumped by a massive 68% since 2020 instead of 26% as in the US (chart 22). Accordingly, the mood of many Chinese consumers is at rock bottom (chart 23), especially if they have bought apartments that are now vacant.

In the eurozone, it is not the real estate market that is the main cause of the falling LEI (chart 24), but industry, whose capacity utilization has only been lower than today during the global financial and coronavirus crises (2008 and 2020 respectively) since the collapse of the European Monetary System in autumn 1992 (chart 25). One of the reasons for this is the growing competition from Chinese industry and the declining imports of the Chinese due to their weak consumption, another is the very high price of electricity (chart 26).

The current problem of weakening LEIs in the three major economic areas - the USA, China and the eurozone - coincides with the long-term problem of very high debt levels overall, with the eurozone showing a comparatively moderate picture (chart 27). However, should a recession actually occur, a further sharp rise in government debt could be imminent. Chart 28 shows that while US government debt was very low in the 1970s, it also remained very low during the recessions of the time. Since the financial crisis of 2008, however, the increase in government debt has been extraordinarily high, starting from a level twice as high as in 1980. At the current level of government debt, not only Trump, but also a recession in the US could trigger a further significant increase in debt and thus fuel fears about the creditworthiness of government bonds. This could lead to higher interest rate demands from buyers of US government bonds, causing interest rates to rise despite the weak economy and putting considerable pressure on the US economy and the stock market.

In view of all these risks, the lack of concern among investors worldwide is impressive. The LEIs and thus the growth prospects for the economy have been falling in the US and the eurozone for over two years and in China for almost a year, while share prices have risen sharply everywhere during this time. This ignorance of weak leading indicators has never been seen before - in the US since 1969, after all. The LEIs continued to decline in September 2024.

The reason for the two-year rise in share prices in the US is the growing hope that US technology companies have found a new profitable business area in connection with the enormous investments in artificial intelligence (AI).

However, this story overlooks some problem areas:

1. the AI divisions of the major technology companies are making massive losses
2. there are no network effects (you use products from one provider because many others also use them, e.g. Amazon or Microsoft) in the AI business, unlike today's successful Internet companies
3. the energy consumption when using AI is extremely high, and a lot of data for training AI models is stolen
4. High-tech has not prevented the decline in economic growth for 70 years (Figure 32).

In addition, too little attention is paid to the fact that not only technology companies or start-ups that offer successful AI business models benefit from AI, but also the users. It was exactly the same during the internet bubble 25 years ago. Back then, people overestimated the Internet companies and underestimated the fact that all other companies began to use the Internet and often improved their business models as a result.

The second story that has been told since the US Federal Reserve cut interest rates in September is that the start of rate cuts will prevent a recession and therefore allow US share prices to continue to rise. If this story is true this time, it would be the first time in at least 65 years. The 4 green arrows in chart 33 show the 4 rate cuts by the Fed that were not followed by a recession (gray bars). In all 4 cases, the red line (the US Leading Economic Indicator) went up at the same time; the economic outlook improved. The 9 red arrows show all interest rate cuts that started shortly before or right at the beginning of a recession and only ended at the end of the respective recession or even afterwards. In all cases, the LEI was trending downwards during these rate cuts. So if this time no recession follows falling interest rates with a worsening outlook, it would be the first time.

Chart 34 shows what is extraordinary about the current valuation of US equities. From 1974 to 2016, European equities were almost always valued slightly higher than US equities. Since then, the valuation of US equities has inflated to almost the record level seen during the internet and telecoms bubble of the early 2000s. By contrast, European and Japanese equities are currently valued far below their valuations at that time and also below the current valuation of US equities (for further valuation models showing a massive overvaluation of the US equity market, see the Capital Market Outlook from August 2024, which you can find here ). Following a familiar-sounding story, Japanese equities were as extremely overvalued as US equities are today until December 1989, falling by 60% in € terms over the following 20 years, only to return to 1989 levels almost 34 years later in September 2023. The short version of the story at the time, which was told, heard and believed on the capital markets around the world, was: in future, high technology can only come from Japan. Does that sound familiar to you?

Conclusion (= Executive Summary):

If Donald Trump is re-elected as US president, the introduction of high tariffs on foreign goods is likely to have a negative impact on the US economy, as many goods in the US will become more expensive, inflation will rise and consumption will be impacted. If Trump also implements his plan to strip the US central bank of its independence, inflation risks are likely to rise even further, especially as Trump wants to significantly expand the national deficit through tax cuts, thus increasingly jeopardizing the US's creditworthiness as a debtor. For Europe, an end to US support for Ukraine would be associated with a significant increase in geopolitical risks. Economic risks will also increase, which will put additional pressure on public finances. These risks are certainly seen on the gold market and are one reason for the record gold price, which has risen by 34% in US dollar terms since the beginning of the year.

In China, which helped to revive the global economy after the financial crisis with its real estate boom, enormous total debt has been accumulated at an unusually high rate, especially since the financial crisis, and now significantly exceeds that of the richer regions of the USA and Europe. As the collapse of this debt-induced real estate boom has hit Chinese homebuyers hard, the mood of many consumers is at rock bottom. China will actually harm the European economy in particular by exporting at government-facilitated dumping prices. The economic outlook is darkening in all three of the world's major economic regions - the USA, China and the eurozone. However, this is being ignored on the US stock market in particular, as people here are expecting miracles from artificial intelligence and interest rate cuts that are unlikely to materialize. The same risks that are clearly seen in the gold market are being ignored in the equity market. Therefore, one should currently own fewer shares, especially fewer US shares, than in normal times, but hold on to high gold holdings in wealth .  

Finally, our key statements from the October 2021 Capital Market Outlook, which you can find here can be found here:

Three years ago, we examined the valuation on the German real estate market and came to the conclusion that real estate was still extremely undervalued in view of the extremely low interest rates in the fall of 2021 despite the significant rise in inflation. It was unclear to what extent the central banks would be able to raise interest rates at all in view of the sharp rise in government debt as a result of the coronavirus aid. Overall, we saw a favorable long-term environment for gold, equities and real estate, although the latter later suffered a noticeable price decline when the central banks implemented fairly substantial interest rate hikes from spring 2022 onwards

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