World econ­omy is shaky, funny money won’t fix it

The Pak Banker - - OPINION - Liam Hal­li­gan

SO that was "jar­ring Jan­uary". Since the start of the year, over £4?tril­lion has been wiped off the value of global eq­ui­ties - that's four, fol­lowed by 12 ze­roes. US stocks en­dured a steeper first-week de­cline in 2016 than in any year since be­fore the First World War. Mar­ket volatil­ity drove the MSCI World In­dex of lead­ing shares down 8pc in Jan­uary - a de­gree of de­cline usu­ally seen dur­ing sys­temic crises, such as the 2008 Lehman Brothers col­lapse or the 2001 dot.com bust.

While pol­i­cy­mak­ers main­tain that "the fun­da­men­tals are sound", many large in­vestors now think oth­er­wise. We're get­ting caught in the dreaded "neg­a­tive feed­back loop" - when mar­ket tur­bu­lence brings about the very eco­nomic slow­down it fears, with in­vestor anx­i­ety it­self be­com­ing the cat­a­lyst for a re­newed slump. The world econ­omy is "still ex­pand­ing" but growth is "weak and un­even" ad­mit­ted Mau­rice Ob­st­feld, the In­ter­na­tional Mon­e­tary Fund's chief econ­o­mist, last week. "This com­ing year will be one of great chal­lenges and pol­i­cy­mak­ers should be think­ing about short­term re­silience," he said.

Hav­ing down­graded its global growth fore­cast for 2016 by an­other 0.2pc, to 3.4pc, the IMF is ac­knowl­edg­ing the world econ­omy is shaky. US bank­ing gi­ant Mor­gan Stan­ley goes fur­ther, point­ing to a one-in-five chance the world econ­omy will re-en­ter re­ces­sion this year - de­fined as growth below the 2.5pc rate needed to match world-wide pop­u­la­tion gains. This last hap­pened in the im­me­di­ate af­ter­math of the Lehman Brothers col­lapse. The rea­sons be­hind re­cent stom­ach-churn­ing falls on glob- al mar­kets are many and var­ied. The most sig­nif­i­cant, in my view, was brought into fo­cus by the quar­ter point rise in US in­ter­est rates in De­cem­ber, the first in al­most a decade.

Since late-2008, Western stock mar­kets have been pumped up by quan­ti­ta­tive eas­ing (QE), with the Fed­eral Re­serve in­creas­ing its bal­ance sheet more than three-fold since 2009 - ably as­sisted in such bub­ble-blow­ing by the Bank of Eng­land and the Bank of Ja­pan. Yes - some ex­tra liq­uid­ity was needed in the dark­est days of the credit crunch. But QE has gone way be­yond that. Nec­es­sary emer­gency mea­sures have been trans­formed, at the be­hest of pow­er­ful fi­nanciers and my­opic politi­cians, into a stock-boost­ing life­style choice, the fi­nan­cial equiv­a­lent of crack co­caine.

With US money-print­ing now on hold and rates seem­ingly on the up, many fi­nan­cial as­sets - from eq­ui­ties to bonds - look over­val­ued, not just in Amer­ica but across the world. That's the sin­gle most im­por­tant rea­son global mar­kets are so jumpy - be­cause in­vestors know, in their bones, that the strong gains of re­cent years have been built on debt and QE. De­spite mas­sive mon­e­tary and fis­cal stim­u­lus, the US econ­omy has not only been un­able to stage a sus­tained re­cov­ery, but is now show­ing wor­ry­ing signs of re­ver­sal. The big­gest econ­omy on earth is fail­ing to fire on all cylin­ders and pro­duce any­thing like the growth that could jus­tify cur­rent stock prices.

Amer­ica's all-im­por­tant con­sumers are now rein­ing in their spend­ing, with retail sales fall­ing 0.1pc in De­cem­ber, mark­ing the end of the weak­est con­sumer year since 2009. In­dus­trial pro­duc­tion was 0.4pc down, hav­ing dropped 0.9pc the month be­fore, with the US man­u­fac­tur­ing sec­tor now of­fi­cially in re­ces­sion. Sur­vey data re­leased last week points to an alarm­ing slow­down in Amer­ica's ser­vice sec­tor, which ac­counts for two-thirds of the econ­omy. The in­flu­en­tial pur­chas­ing man­agers' in­dex dropped to 53.2 in Jan­uary - a 27-month low.

While still ex­pand­ing, growth in US ser­vices is now slow­ing, with fi­nan­cial volatil­ity tak­ing its toll on deal-mak­ing and spend­ing across a range of sec­tors, as the feed-back loop tight­ens. Rather than a "nor­mal­i­sa­tion" of pol­icy-mak­ing, then, this US rate rise, and the spas­modic re­sponse of fi­nan­cial mar­kets and the broader econ­omy to it, in­di­cates the Fed's weak­ness.

Hav­ing boldly pointed to four rate rises dur­ing 2016, US pol­i­cy­mak­ers have changed their tune - with fu­tures mar­kets now pric­ing in no US rates hikes un­til next year at the ear­li­est. I main­tain that fi­nan­cial volatil­ity will prove so desta­bil­is­ing, and cause such dam­age to Amer­ica's econ­omy that we'll see yet more US QE - and per­haps even a re­ver­sal of De­cem­ber's rate in­crease. Rather than pla­cat­ing the mar­kets, that could do more harm than good.

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