The global econ­omy is look­ing very 1990s

The Pak Banker - - OPINION - Justin Fox

Oil prices are fall­ing, seem­ingly in­ex­orably. Emerg­ing mar­ket coun­tries are hav­ing cur­rency crises. A pre­vi­ously un­stop­pable East Asian eco­nomic power -- the world's sec­ond-largest econ­omy -- is slow­ing, and the coun­try's lead­ers at times seem to have lost the plot. Rus­sia is an eco­nomic mess. Europe's econ­omy is be­ing held back by Ger­man po­lit­i­cal de­ci­sions and doubts about the com­mon cur­rency. The U.S. econ­omy is rel­a­tively strong, but is be­set by a pro­duc­tiv­ity para­dox in which re­mark­able Sil­i­con Val­ley in­no­va­tions don't seem to be hav­ing an im­pact on the eco­nomic data.

Is this year start­ing to feel like it be­longs in the 1990s, or what? I'm not go­ing to even get into all the pop-cul­ture re­sem­blances, or the fact that a Clin­ton and a Bush are run­ning for pres­i­dent and Al Gore has re­port­edly been think­ing about it. In eco­nomic terms alone, there are a lot of par­al­lels be­tween the cur­rent sit­u­a­tion and that of the mid-1990s in par­tic­u­lar.

I think all the par­al­lels I men­tion in the first para­graph are self-ex­plana­tory ex­cept per­haps the one about Ger­man pol­i­tics. So here goes: The 1990 de­ci­sion by Chan­cel­lor Hel­mut Kohl to let East Ger­mans ex­change their largely worth­less Ost­marks for Deutschmarks at a 1:1 ex­change rate gave the re­uni­fied na­tion an eco­nomic hang­over that lasted for years and af­fected its neigh­bors too. In re­cent years aus­ter­ity mea­sures forced on south­ern Euro­pean coun­tries in part by Ger­man politi­cians have ar­guably again held back growth in the euro area.

Now, there are also lots of things go­ing on in 2015 that shouldn't re­mind any­one of 1995. History doesn't re­peat. I'm not even sure it rhymes. But there do seem to be some sim­i­lar eco­nomic forces at work.

One is that com­mod­ity prices are fall­ing, as they did in the 1990s. The other is that the U.S. econ­omy has gone back to be­ing the main driver of global growth, which has brought with it a big strength­en­ing of the dol­lar. These two are re­lated. Even with the re­cent boom in do­mes­tic oil pro­duc­tion, the U.S. is a net im­porter of com­modi­ties, so fall­ing prices tend to boost growth. This is also true for the world's other big economies -- Western Europe, Ja­pan and China -- but all these places are fac­ing eco­nomic head­winds that the U.S. is not. So the U.S. share of global eco­nomic out­put has been on the rise. Dur­ing the long run the U.S. share is shrink­ing as other coun­tries catch up in af­flu­ence. But there's been a strong cycli­cal el­e­ment as well. Now it looks as if the cy­cle may have turned, and if that's the case we're likely to see a few more years of the U.S. gain­ing eco­nomic share just as it did in the sec­ond half of the 1990s.

Much of this gain will sim­ply be the work of a strength­en­ing dol­lar, which will put pres­sure on coun­tries that link their cur­ren­cies to the dol­lar, as was the case in the late 1990s. That will mean more emerg­ing-mar­ket cur­ren- cy crashes and per­haps fi­nan­cial crises. In the late 1990s those crises would scare in­vestors in the U.S. and usu­ally bring a tem­po­rary de­cline in as­set prices, but in the end the re­sult was al­ways more money flow­ing into the U.S., and con­tin­ued eco­nomic growth. It fi­nally took a home­grown stock mar­ket bub­ble and crash to bring the fun to an end.

Alan Greenspan's Fed­eral Re­serve of course played a role in all of this -- hold­ing back on rais­ing in­ter­est rates in 1995 be­cause of a (cor­rect) hunch that a pro­duc­tiv­ity boom­let was com­ing (cur­rent Fed Chair Janet Yellen was a Fed gover­nor at the time and sup­ported this ap­proach), then cut­ting them in late 1998 in re­sponse to a Rus­sian debt de­fault and the sub­se­quent col­lapse of the hedge fund LongTerm Cap­i­tal Man­age­ment. Cut­ting rates will be a lot harder to do this time around with the cur­rent ef­fec­tive fed­eral funds rate at 0.15 per­cent, and there's wide­spread con­cern that, af­ter spend­ing the past six years try­ing to keep the econ­omy afloat af­ter a his­toric fi­nan­cial cri­sis, the Fed doesn't have a lot of am­mu­ni­tion left.

So that's one big dif­fer­ence from the 1990s. Another is that the slow­ing East Asian jug­ger­naut -- China this time in­stead of Ja­pan -- ac­counts for a much big­ger share of the global econ­omy but is also a lot poorer on a per capita ba­sis, which could have all sorts of eco­nomic and po­lit­i­cal ram­i­fi­ca­tions.

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