Dan­ger signs flash­ing for global econ­omy

The Pak Banker - - BUSINESS -

Eight years af­ter the fi­nan­cial cri­sis, the world is com­ing to grips with an un­pleas­ant re­al­i­sa­tion: se­ri­ous weak­nesses still plague the global econ­omy, and emer­gency help may not be on the way.

Sink­ing stock prices, flat in­fla­tion, and the bizarre phe­nom­e­non of neg­a­tive in­ter­est rates have cou­pled with a down­turn in emerg­ing mar­kets to raise wor­ries that the econ­omy is be­ing stalked by threats that cen­tral banks - the sav­iors dur­ing the cri­sis - may strug­gle to cope with.

Mean­while, com­mer­cial banks are again a source of con­cern, es­pe­cially in Europe. Banks were the epi­cen­tre of the 2007-9 cri­sis, which started over ex­ces­sive loans to home­own­ers with shaky credit in the United States and then swept the globe into re­ces­sion.

"You have pretty slug­gish growth glob­ally. You don't re­ally have any in­fla­tion. And you have a lot of un­cer­tainty," says David Le­bovitz, who ad­vises on mar­ket strate­gies for JP Mor­gan Funds. Some of the re­cent tu­mult may be an over­re­ac­tion by jit­tery in­vestors. And the rock-bot­tom in­ter­est rates are partly a re­sult of easy money poli­cies by cen­tral banks do­ing their best to stim­u­late growth in the years since the cri­sis.

Un­em­ploy­ment is low in sev­eral ma­jor economies, 4.9 per cent in the United States and 4.5 per cent in Ger­many. The IMF fore­casts growth pick­ing up from 3.1 per cent last year to 3.4 per cent this year. But that's still far short of the 5.1 per cent growth in 2007, be­fore the cri­sis. The re­al­iza­tion is dawn­ing that growth may con­tinue to un­der­per­form, and that re­cent tur­moil may be more than just nor­mal mar­ket volatil­ity.

In Ja­pan, the yield on 10-year bonds briefly turned neg­a­tive, mean­ing bond­hold­ers were will­ing to pay the govern­ment for the priv­i­lege of be­ing its cred­i­tor - for years. In the United States, long-term mar­ket rates are slid­ing again, even though the Fed­eral Re­serve has be­gun push­ing them higher. Many govern­ment bonds is­sued by Euro­pean coun­tries trade at yields that are neg­a­tive or close to zero. That's alarm­ing be­cause such low and even neg­a­tive rates are way out the or­di­nary. For one thing, they sug­gest bond in­vestors don't ex­pect enough eco­nomic growth for cen­tral banks to raise rates.

Along with that have come sharp drops in global stocks. The Stan­dard and Poor's 500 in­dex is off 10.5 per cent for the year; Ja­pan's Nikkei 225 is down 16 per cent; the Shang­hai com­pos­ite in­dex 22 per cent; Ger­many's DAX over 14 per cent. A sharp slow­down in China threat­ens to re­move a pil­lar of global growth. Slack­en­ing de­mand for raw ma­te­ri­als there is hit­ting pro­duc­ers of oil and me­tals in other coun­tries. En­ergy ex­porter Rus­sia, for in­stance, slid into re­ces­sion and its cur­rency has plunged.

Ger­man au­tomaker Daim­ler made a record op­er­at­ing profit of 13.8 bil­lion euros last year, helped by a 41 per cent surged in sales in China for its MercedesBenz lux­ury cars. But its shares fell when it an­nounced a cau­tious out­look for only a slight profit in­crease for 2016 and "more mod­er­ate" growth in China. CEO Di­eter Zetsche cau­tioned that he saw "more risks than op­por­tu­ni­ties" amid "re­strained" global growth. Money is flow­ing out of so-called emerg­ing mar­kets like Brazil, Rus­sia, South Africa and Turkey. In­vestors pulled $735 bil­lion out such coun­tries in 2015 - the first year of net out­flows since 1988, ac­cord­ing to the In­sti­tute of In­ter­na­tional Fi­nance.

And emerg­ing mar­kets aren't so emerg­ing any more: they pro­vide 70 per cent of ex­pected global growth. Cen­tral banks led by the US Fed re­sponded to the global re­ces­sion by slash­ing in­ter­est rates and print­ing money. That en­cour­aged in­vestors in search of higher re­turns to place their money in emerg­ing mar­kets.

Now the Fed is try­ing to push up its in­ter­est rates, and those flows have gone into re­verse, caus­ing fi­nan­cial mar­kets and cur­ren­cies in emerg­ing mar­kets to sag. Debt be­comes harder to re­pay. IMF chief Chris­tine La­garde has warned of "spill­back" ef­fects from emerg­ing mar­kets on more ad­vanced economies. Stephen Lewis, chief econ­o­mist at ADM In­vestor Ser­vices In­ter­na­tional, says there's lit­tle the Fed can do but go ahead with rais­ing rates to a more nor­mal level.

"Un­less we're go­ing to par­a­lyze mon­e­tary pol­icy in the ad­vanced economies forever­more, it is in­evitable that the funds that have gone into emerg­ing mar­kets are go­ing to come back out of them," he said. The other pil­lar of the global econ­omy be­sides China, the US, is also now show­ing signs of weak­ness. Maybe not a re­ces­sion, yet. But growth was a weak 0.7 an­nu­ally dur­ing the fourth quar­ter. Fac­tory out­put has de­clined. Though un­em­ploy­ment has dropped, wages have not re­cov­ered quickly and com­pa­nies ap­pear to be un­set­tled by the global jit­ters.

A ris­ing dol­lar - a side ef­fect of ex­pected Fed in­ter­est rate in­creases - could hurt ex­porters. That's one rea­son the Fed may in fact hold off rais­ing rates again soon. Banks stocks have been plung­ing in the US and Europe. In the US, low oil prices may mean com­pa­nies in­volved in ex­pen­sive oil and gas ex­trac­tion will be un­able to re­pay loans made to dig wells that are no longer prof­itable. In Europe, bank shares have been shaken by the bailout of four Ital­ian lenders and fears about 1.2 tril­lion euros ($1.35 tril­lion) in bad loans across the 19 coun­try cur­rency union. John Cryan, co-CEO of Deutsche Bank, had to take the un­usual step of pub­licly re­as­sur­ing that the bank's fi­nances were "rock-solid" af­ter in­vestors pounded the bank's stock.

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