Poised between fear and hope
The world economy appears to be at a fork in the road. On one path, 2016 appears likely to witness a deterioration from the mediocre to the miserable; on the other is a happy continuation of the normalisation from the 2008-09 financial crisis, with a more balanced and sustainable global economy. No one is sure which path the world will follow; nor whether policy is sufficiently strong to influence the outcome.
There is little doubt that the eyes of the world are sharply focused on the risks and challenges. Fears rose precipitously in the summer after China devalued its currency, highlighting concerns that the country’s economic prospects are deteriorating rapidly and recessions deepened in other former stars of the global economy such as Brazil and Russia. Global equity markets have just endured their worst quarter since 2011.
Alongside weak financial markets, capital has retreated towards havens in the developed world, commodity prices have plummeted and world trade growth remains stalled. China, not long ago the reliable engine of the world economy, is now seen as its greatest vulnerability, representing, as it does, 16 per cent of world output and almost 30 per cent of expected growth. “The key risk to global growth is a larger-than-expected slowdown in China,” according to the Organisation for Economic Co-operation and
With some investment banks such as Citi forecasting a global recession in 2016, officials are keen not to be caught napping as they were before the 2008 downturn.
Christine Lagarde, head of the IMF, says policies to address problems among the world’s leading economies are urgently needed at a “difficult and complex” time, since “downside risks to the outlook have increased, particularly for emerging market economies”.
Andy Haldane, chief economist of the Bank of England, warns that the troubles in China are signs that “we may now be entering the early stages of part three of the [global crisis] trilogy, the ‘emerging market’ crisis of 2015 onwards”.
A third crisis scenario — following that in the US and UK economies in 2008-09 and the eurozone in 2011-12 — would stem from dangers posed by the rise in Chinese debt since 2008. Private, non-financial debt reached 160 per cent of gross domestic product in the US in 2007 and almost 200 per cent in the UK before households and companies tightened their belts. China has already surpassed these levels, according to data from the Bank for International Settlements.
With growth slowing, perhaps far more rapidly than official Chinese statistics show, the ability to service and sustain such debt is in question. Defaults and huge losses could follow, sparking a vicious circle of fragility and bankruptcy in the financial sector, a squeeze on credit and yet weaker economic prospects. The rest of the world would not be able to ignore such a crisis, given China’s size, trade links and financial connections with other countries.
Beijing’s mixed messages and failed attempts to prevent its stock market bubble bursting over the summer have not inspired confidence that it is uniquely placed to avoid disaster.
But for all these genuine and plausible fears, the world is not yet being buffeted by another economic storm. Despite contested Chinese economic statistics showing growth still at an annual rate of 7 per cent, there is undeniable rebalancing under way in China from construction and heavy machinery investment towards consumption and services. In many of the other large world economies, the picture and the economic data are far from disastrous.
Still the world’s most important economy, the US is contemplating raising interest rates for the first time in a decade. This reflects the maturity of its economic recovery and its success in generating employment growth. The unemployment rate has fallen to historically normal levels. Janet Yellen, Federal Reserve chair, explained the decision not to raise rates in September as reflecting increased uncertainty in the global economy. Ms Yellen has made it clear that she sees strong prospects when she looks at the US, as do her colleagues on the Federal Open Market Committee, which sets interest rates.
“Most FOMC participants, including myself, currently anticipate that achieving these conditions [of maximum employment and stable inflation] will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening,” Ms Yellen said in September. In Europe, many economic indicators are looking more positive than at any time since the eurozone crisis started in 2011. Greece showed this year that it no longer has the power to derail the rest of the single currency area and consumers are enjoying a rare increase in their net incomes following the decline in commodity prices across the world.
Monetary and fiscal policy is standing by, ready to react to slower global growth prospects, with further monetary stimulus likely in coming months.
As a big oil and metals importer, China gains from the fall in commodity prices, as does India — the world’s fastest growing big economy. Many of the better managed commodity-exporting economies have benefited from currency depreciation, offsetting the domestic hit from lower prices without raising inflation significantly.
Julian Jessop of analysts Capital Economics thinks that the shocked market reaction to the events of the summer has been far too sudden and excessive: “The upshot is that rather than the turmoil being a new threat, we think that the consensus is playing catch-up with trends in place for several years.”
If true, rather than the world entering a third leg of a global financial crisis, it is more a continuation of global growth at roughly the average level of the past 30 years, with some countries doing better than others: normality rather than extraordinary times. As for China, if this pragmatic view holds true, the authorities will make errors but also progress in rebalancing the economy from investment towards consumption.
The world in 2016 does not need to take an extreme path, says Erik Nielsen, chief economist at UniCredit — though there are many options available.
“We economists love to forecast smooth paths, while drama queens and headline grabbers love to predict imminent collapse,” he says.