IT’S already six years since the Great Recession. Yet the world economy remains stuck in the doldrums – set on a course that is uncertain and unsustainable.
Demand is still weak, as reflected in falling oil and commodity prices as the once dynamic emerging markets’ slowdown fuels concern for the global outlook. The global system remains dysfunctional. The euro-crisis was simply papered over, with certain underlying problems remaining unresolved. Many have since resurfaced.
Much of the mess is of policymakers’ own making: in particular, the premature rush to fiscal austerity and the “kick-the-can-down-the-road” attitude in handling the series of euro crises. The pathway for this lopsided global economy to sustainable growth remains unclear.
Recent updates by Asian Development Bank and World Bank cut their forecasts for East Asia. International Monetary Fund’s (IMF) Oct 7 release: World Economic Outlook – Legacies, Clouds, Uncertainties discusses the need to address legacies from past crises in the face of a cloudy future, as the interplay among them had resulted in the downgrading of the global outlook. Growing uncertainties bring on new risks, including risks linked to the search for higher yields; widening geopolitical risks, and risks that demand could further weaken as eurozone growth stalls. The upshot: “Only a modest pick-up is forecast for 2015 as the outlook for potential growth has been pared down,” according to IMF’s Lagarde, warning that the recovery is “brittle, uneven and beset by risks.” Her sombre outlook seems more realistic for once.
After all, IMF had to make “several downward revisions to the forecast during the past three years,” now termed: “serial disappointments” in growth. My own feeling is that even the downgraded forecasts are optimistic and likely to be marked down come April 2015, reflecting Harvard Larry Summers’ lament that rich nations now face secular stagnation.
IMF expects global growth to rise by 3.8% in 2015, better than 2014’s estimated pace of 3.3% (it had expected 3.6% in April 2014). Prospects for eurozone’s three largest economies remain poor. Eurozone is headed for its third consecutive year of recession and IMF now warns that odds of it re-entering a recession within six months have doubled to 38%. It sees disappointing prospects for Japan and lower growth outcomes in some big emerging economies, notably Brazil and Russia.
In contrast, the outlook in US – fresh from strong job reports in early October, was revised up to 2.2% (from 1.7% in July). For 2015, US growth will rise by 3.1% – outpacing all major “rich” nations and a number of emerging markets as well. US will also lead in corporate profitability and global competitiveness. Hence, the chase for US dollar, betting it is now its turn to perform: against seven of the world’s most heavily traded currencies, US dollar was up 6% since July 1; it recently hit a 6-year high against yen (up 5%) and a 2-year high against euro (up 6.4%), and up against wobbly currencies like Russia’s ruble (+19.7%) & Brazil’s real (+11.7%).
Ringgit weakened 2.3%. On most metrics, US dollar has rallied faster than expected. China’s growth is forecast to slow down to around 6.5% by 2016 because of domestic rebalancing and reform, from 7.4% in 2014 and 7.1% expected in 2015. However, growth in Brazil will slacken to only 1.4% in 2015 (practically no growth this year) reflecting poor policies. Russia will fare worse.
Growth in eurozone, plagued with prospect of deflation, will slacken to 0.8% in 2014 (still optimistic I think) from 1.1% forecast in July 2014. For 2015, growth will rise by 1.3% (again, optimistic). Europe’s “extended stagnation” remains a major stumbling block. The real problem lies in Europe still not coming to terms with the legacies from the financial crisis – saddled with high public and household debts, poor banks’ balance sheets, and persistently high unemployment.
Italy has been in recession for two years and France’s economy is at a standstill for months. With Germany also in trouble, the chance of a Japanese-style deflationary spiral rises each week. In addition, divergent monetary policies between US and Europe perpetuate the growth gap on both sides of the Atlantic. Europe can’t cut (stick with austerity) and grow. Germany is being pigheaded in insisting that growth and fiscal discipline can go together.
As a result, Europe is simply left behind. Germany’s now slowing economy is no longer able to pull eurozone out of the mud. IMF downgraded Germany’s growth to 1.4% (from 1.9% earlier), and persisting at around 1.5% in 2015. Germany needs to do more to stoke growth by stepping up spending on infrastructure to stimulate private demand. Already there is a rift between Germany, and France and Italy on how to revive growth – amid IMF’s warning that Europe risks a “lost decade” of low growth and low inflation but with high debt and high unemployment. It is clear eurozone continues to suffer from lack of demand. It’s also clear that monetary policy can’t do the heavy lifting alone.
What is now needed is a co-ordinated push involving aggressive US-style quantitative easing (QE) by the European Central Bank (ECB), and higher investment spending by Germany and European Union institutions (especially the European Investment Bank), and firm commitments to bolder reform measures in France and Italy.
For nearly two years, there has been “a disconnect” between what’s happening in the markets and progress in the real economy. Spurred by expansive QE measures, financial and commodity markets have enjoyed their moment of magic especially in 2013: Wall Street’s S&P 500 index rose by 30% and Japan’s Nikkei, 57%. By February 2014, some of the shine had worn off when some US$3 trillion was wiped off global shares in early 2014. Even so, by mid-August, S&P 500 was still trading at 15-16x, against an average of 14x.
The Chicago Board of Options Exchange Volatility Index (or VIX, Wall Street’s fear index) which is based on options prices on S&P 500, had been unusually low (<20) for a long period reflecting a market that had experienced few hiccups over the past two years. But by mid-October, rampant market fears appeared to overwhelm all previous greed. There was a flight to safety to haven bonds. Yields on 10-year US Treasury bonds slumped below 1.9% and similar maturity yen bonds, to as low as 0.47%. The slide in the Dow Jones industrial index and S&P 500 was swift and erased all of this year’s gains. Volatility was back; VIX>30. Similarly, European stocks tumbled.
Relative calm returned on Oct 17. Still the markets “lost” for the week. Nevertheless, the domestic US economy has been steadily improving. The negative vibes that had since emerged reflected markets catching up with the data, much of which investors don’t even want to hear, including: (i) tumbling oil and commodity prices reflecting continuing weak demand; (ii) low inflation and prospects of it falling lower still; (iii) Europe going once more into recession; (iv) frenzy over the spread of the Ebola virus, and other geopolitical risks; and (v) prospect of higher interest rates. The fear that any of them could provoke another market convulsion is real. The underlying problems haven’t gone away. So after a week of turmoil and then some calm, uncertainty is back.
What then, are we to do
The bleak outlook for the global economy is reviving divisions among governments on their limited policy options: (i) greater flexibility in managing fiscal budgets in the short run, including spending in infrastructure to boost demand and create jobs; (ii) immediately implement reforms, including opening up economies and labour markets; (iii) ECB to adopt US/UK/Japan-style QE by buying government bonds directly (bound to be resisted by inflation-adverse Germany); and (iv) IMF mantra “to pursue bold and ambitious measures to revive growth, cut debt levels and ensure stability in financial markets.” For six years, policymakers have tried but failed to make significant progress on all of them. Indeed, they have less tools at their disposal today than they did in prior bouts of stress. Early fiscal stimuli have led to rising debt loads which the public now finds hard to live with, given years of slow growth and slow job creation. Even ECB’s Draghi couldn’t make good on his “do whatever it takes” to preserve the euro. All these have been the consequence of underestimating the deep underlying weakening that has taken place. In the end, Europe needs a compromise package deal: some fiscal stimulus, some reforms, some QEs, and some infrastructure spending. The chairman of IMF’s international monetary and finance committee sums it up best: “To solve today’s growth problems we have to lift potential growth…if we don’t address tomorrow’s growth problems today, we will be left with today’s problems tomorrow.”
Yet, a lot can go wrong. Still, get on with it. Voters are angered by years of austerity and stagnant real wages. Already politicians find it harder and harder to ward-off calls for greater protectionism – the last thing the world needs now.
I worry that central banks continue to deliberately push down to zero the cost of capital – that’s price control not monetary policy management. The consequences: they push up stock prices as well as bond and property prices. So many people are richer today because of officially sponsored “bull” markets. Investors benefit big time; but savers suffer (for too long, I think), unfortunately in silence. Lest we forget, interest rate is a price. It functions as traffic lights for the market economy; it calibrates risk and reward. Analysts use it to establish benchmarks to guide investment decision making, and to discount projected future cash flows to determine the viability of projects.
When the rate is suppressed to zero (Keynes “liquidity trap” sets in – rate can’t be lowered further to induce higher investment), it acts to misdirect investments and screws up the market as the efficient allocator of resources. So, price signals in the market place get badly misaligned. Students are taught that true prices are discovered in the market place – not administered. That’s why price control of any kind is a no-no. The market price discovery mechanism is sacrosanct.
When Libor was manipulated, the world was rightly outraged. Profligate banks and broking houses were (again rightly) fined billions. The system was reformed to prevent future repeats. Yet, why are central banks not censured for manipulating money market interest rates and bond rates? Just because they are well intended? Surely, being legal does not make their actions less subversive. Where is the red line between normal monetary policy and price (interest rate) manipulation – or for that matter, currency manipulation as the US is being accused by China, Brazil and others.
Well, is the system stupid! – which is, unfortunately, asymmetrical and dysfunctional. But, it’s the only one we have. I know it sucks! Now you know too why the world is so screwed-up today!
(Note: Lin See-Yan wrote this column on Oct 18.)
Former banker, Tan Sri Lin See-Yan is a Harvard-educated economist and a British chartered scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: firstname.lastname@example.org.
Did you find this article insightful?