Geoeconomics Bi-Weekly: Investors Flee China, Aid Comes to Ukraine, and Turkey Holds Steady

Happy Friday everyone! It was a busy two weeks in the world of geoeconomics, so without further ado, on to the update!  

Macroeconomic Update 

Last month the International Monetary Fund released a somewhat optimistic update to its World Economic Outlook, with the headline reading, “the risks to global growth are broadly balanced and a soft landing is a possibility.” After years of high inflation, hope for a “soft landing”—a tightening of fiscal policy that decreases inflation without triggering a recession—is increasing. 

Indeed, the possibility of a soft landing has captured much attention in the United States, where inflation is trending towards the Fed’s 2% target. Annualized PCE inflation, the Fed’s preferred inflation gauge, remained steady at 2.6% in December, while annual core PCE inflation, which strips out volatile food and energy prices, fell from 3.2% to 2.9%. Meanwhile, the U.S. economy seems to be booming. GDP grew 3.3% annually in Q3 2024, which was followed by a surprisingly strong January jobs report. The U.S. added 353,000 jobs in January, while the unemployment rate continued at 3.7%. Still, the Fed remains hesitant to declare the fight against inflation over. The strong jobs report lowered expectations of an interest rate cut in March, with most investors now expecting cuts to come in May at the earliest.  

Elsewhere, hopes are a bit more muted. In Europe, inflation is inching down, yet growth remains tepid. Annual CPI and core CPI inflation in the Eurozone fell to 2.8% and 3.3% respectively, both down 0.1% from the month before, while annual GDP growth in Q4 2023 was 0.1%. And in China, despite claims of 5.2% GDP growth last year (which some experts doubt), notable headwinds remain, which we cover below. 

Stories of the Week 

Mexico surpasses China as U.S.’ top importer for first time in two decades: Mexico has always been closely tied with the United States, though the current geopolitical climate is magnifying the relationship’s importance. This importance was reinforced this week, as the U.S. Census reported Wednesday that imports from Mexico reached $476 billion in 2023, while imports from China dropped to $427 billion (a 20% decline from 2022). Mexico has benefited greatly from “nearshoring”—an economic trend where companies manage geopolitical risk by investing in countries located near their end market. However, while the plunge in imports from China indicates that U.S.-China economic integration is declining, investment data paints a more nuanced picture. China has doubled its investments in Mexico since 2018, suggesting that many products bound for the United States may still be made in Chinese-owned factories or require key inputs from China. 

Investors appear to pull out of China as the world’s second largest economy continues to rattle: The decades-long trend of steady investment into China is being challenged. In the first three quarters of 2023, China's net direct investment (e.g., foreign investment in local enterprises) and net portfolio investments (e.g., stocks and bonds) were both negative, suggesting that the country’s increased economic and geopolitical issues are spooking investors. Foreign direct investment fell to a three year low, and equity markets lost up to $2 trillion in market capitalization in January. Meanwhile, the country faces a major housing market downturn and price deflation hit its highest level in 15 years. National authorities are now considering significant financial measures to boost market confidence and prevent a self-reinforcing spiral. 

European Union approves €50 billion aid package for Ukraine: The European Union reached a deal last week approving €50 billion ($54 billion) in aid to Ukraine. The agreement comes at a critical juncture in the conflict, as shortages of military supplies impede Ukraine's battlefield capabilities while U.S. aid stalls in Washington. While the aid package was unanimously agreed to, a major point of contention remains: what to do with the €260 billion in Russian assets currently frozen in Western financial institutions. As using the seized assets directly carries notable risks, policymakers are getting more creative. One option broached in the aid agreement is financing the package with the profits generated from these frozen Russian assets, which now exceed over €5.5 billion. Another option gaining momentum amongst G7 members is borrowing against these assets to fund Ukraine’s defense, as this would postpone some legal and financial risks. 

Severe drought slows shipping through Panama Canal: While the world’s attention is turned to the Red Sea and the Suez Canal, another critical artery in the global economic system is being strained. A severe drought that began last summer has forced the Panama Canal Authority to slash shipping through the canal by as much as 36%. The canal operates via a system of locks that uses millions of gallons of water, so low water levels impede how many ships can move through the canal. The slowdown further highlights the reliance of global commerce on a few critical chokepoints, along with the potential risks of climate change. Approximately 5% of global maritime trade traverses the canal, including 40% of U.S. container traffic. Panama relies on the canal for upwards of $4 billion in annual revenue, though it estimates that it will lose out on $500-$700 million in 2024 due to reduced traffic.  

Turkey attempts to hold a steady course amid array of economic crises: Conventional economic policies are conventional for a reason. In 2018, Turkish President Recep Tayyip Erdogan went against convention by continually lowering interest rates despite high inflation and a weakening currency. Unsurprisingly, things got worse. Turkey quickly entered a cost-of-living crisis as annual inflation soared to over 65% and the value of Turkey’s currency plummeted. But Erdogan is now attempting to right the ship. Led by a new team trained at elite American institutions, the Turkish central bank has raised interest rates from 8.5% to 45% since June. While certainly painful, Turkey appears committed to this path. Following the abrupt resignation of central bank chief Hafize Gaye Erkan this week, Erdogan quickly appointed deputy governor Fatih Karahan to the top job to signal policy stability. After years of being spooked by Erdogan’s economic policies, investors are increasingly optimistic about Turkey’s future. 

What we’re watching 

  • Feb 14 – Citizens of Indonesia, the world’s 16th largest economy and 4th most populous country, head to the polls to elect a new president. Indonesia possesses abundant natural resources and a growing consumer base, prompting the United States and China to contend for economic influence in the strategically located nation. If no candidate surpasses 50% of the vote, a run-off will be held in June. 

  • Feb 19 – Israel releases the first estimate of its 2023 Q4 GDP. Estimates for Israeli GDP growth in 2023 and 2024 were slashed following October 7, which is affecting Israeli’s tech sector particularly hard. The labor force has shrunk as reservists have been called up to serve, and venture capital investment has plummeted

Kirti Gupta
Senior Adviser (Non-resident), Renewing American Innovation Project
Chris Borges
Program Manager and Associate Fellow, Geoeconomics Center