2016 will be a year of liv­ing dan­ger­ously for the global econ­omy

The Star (St. Lucia) - - COMMENT - By Larry El­liott

Eco­nomic fore­cast­ing is a mug’s game. One thing learned from the fi­nan­cial cri­sis and Great Re­ces­sion is that even those equipped with the most so­phis­ti­cated mod­els get it wrong, some­times spec­tac­u­larly.

So it is with both hu­mil­ity and trep­i­da­tion that I will try to make pre­dic­tions for what is go­ing to hap­pen in 2016. In all hon­esty, the fu­ture is un­know­able and any­body who says oth­er­wise is ly­ing.

So, with that caveat, here’s what I think might hap­pen. At some point, a re­cov­ery built on boom­ing as­set prices, weak growth in earn­ings and ris­ing per­sonal debt is go­ing to lead to an­other huge fi­nan­cial cri­sis - but not in the next 12 months. In­stead, 2016 will be a year of liv­ing dan­ger­ously, pa­per­ing over cracks and buy­ing time be­fore all the old prob­lems resur­face.

Here’s why. The big story of the past month has been the col­lapse in oil prices, which has taken the price of crude back to lev­els last seen in 2004. This has two ben­e­fi­cial ef­fects for the global econ­omy. It pro­vides ad­di­tional spend­ing power for house­holds and busi­nesses that con­sume en­ergy, and it bears down on in­fla­tion.

There is al­ways a bit of a de­lay be­tween oil prices fall­ing and spend­ing go­ing up, in part be­cause peo­ple want to be sure that the lower costs are go­ing to stick. It is, how­ever, now 16 months since crude be­gan its de­cline from its Au­gust 2014 peak of $115 a bar­rel, and there is a good chance it will fall a bit fur­ther from its cur­rent level in the mid-$30 a bar­rel range. With no sign that the oil car­tel, OPEC, has the po­lit­i­cal will to agree pro­duc­tion curbs, it is quite pos­si­ble that prices could fall be­low $30 a bar­rel in the early months of the year.

The im­pact of that will be to keep in­fla­tion lower than any of the world’s ma­jor cen­tral banks are an­tic­i­pat­ing. Pol­i­cy­mak­ers at the US Fed­eral Re­serve, the Bank of Eng­land and the Euro­pean Cen­tral Bank (ECB) in­sist they “look through” rises and falls in oil and other com­mod­ity prices and make their in­ter­est rate judg­ments on the ba­sis of what is hap­pen­ing to core in­fla­tion, which ex­cludes en­ergy and food costs.

But it is harder to raise in­ter­est rates if, for what­ever rea­son, in­fla­tion con­tin­ues to un­der­shoot of­fi­cial fore­casts. More im­por­tantly, there is ev­i­dence that a fall in in­fla­tion caused by cheaper oil has an ef­fect on wage bar­gain­ing. When, in the pre-cri­sis years, UK in­fla­tion reg­u­larly hit the gov­ern­ment’s 2% tar­get, em­ploy­ers used to of­fer pay awards of 4%. Now that in­fla­tion is zero they see no rea­son to of­fer more than 2%. That mat­ters be­cause cen­tral banks are look­ing for signs of wage in­fla­tion pick­ing up as a re­sult of years of steady growth and fall­ing un­em­ploy­ment. If wage in­fla­tion does not go up, there is less of a rea­son to raise the cost of bor­row­ing.

So pre­dic­tion num­ber one for next year is that both in­fla­tion and in­ter­est rates will stay lower for longer than cur­rently an­tic­i­pated. The Fed raised in­ter­est rates for the first time in al­most a decade ear­lier this month, but will be ex­tremely cau­tious about its next move. The Bank of Eng­land will hold off from its first move. Cheap money will boost both bor­row­ing and – for a time – growth.

In China in 2016 the ques­tion is not whether the pace of growth will slacken, but by how much. Ex­pert opin­ion dif­fers about the state of the world’s sec­ond big­gest econ­omy. Some an­a­lysts say Beijing has ev­ery­thing un­der con­trol, oth­ers that the coun­try isal­ready hav­ing a hard land­ing from years of over-in­vest­ment in un­pro­duc­tive man­u­fac­tur­ing plant and spec­u­la­tive real es­tate. It is hard to know ex­actly what is hap­pen­ing in China, a big coun­try with a rep­u­ta­tion for un­re­li­able eco­nomic sta­tis­tics. Of­fi­cial data says the econ­omy is grow­ing by 7% a year, yet data for elec­tric­ity consumption and rail freight sug­gest the ac­tual fig­ure is lower.

Whereas of­fi­cial in­ter­est rates are zero or there­abouts in the ma­jor de­vel­oped coun­tries of the west, in China they are still above 4%. This gives the Peo­ple’s Bank of China scope to cut the cost of bor­row­ing if it wants to stim­u­late growth, a scope it will al­most cer­tainly use if the gov­ern­ment thinks the econ­omy is slow­ing too rapidly. The ex­change rate can also be cut to make Chi­nese ex­ports cheaper, and the coun­try also has the op­tion of rais­ing pub­lic spend­ing.

The risk, of course, is that China cleans up the mess caused by one col­laps­ing bub­ble by in­flat­ing an­other, which is what Alan Greenspan did in the US in the early 2000s. Here, then, is a sec­ond pre­dic­tion. China will slow in 2016 but pol­icy eas­ing will pre­vent a col­lapse.

Over the past six years, the Eu­ro­zone has shown an unerring abil­ity to snatch de­feat from the jaws of vic­tory. Ev­ery time the cri­sis has ap­peared to be over, some­thing nasty has hap­pened. In 2016, that “some­thing” could be Greece, caught in a debt and aus­ter­ity trap, it could be rud­der­less Spain or mori­bund France. There are a couple of rea­sons, how­ever, why the Eu­ro­zone might stum­ble through to 2017 be­fore there is fresh trou­ble. The first is that it will ben­e­fit from the de­lay in tight­en­ing pol­icy in the US and the UK, and from pro-growth mea­sures in China. The sec­ond is that the ECB will keep us­ing quan­ti­ta­tive eas­ing in the hope that an in­crease in the sup­ply of money will get the banks lend­ing. The ECB is also keen to drive down the value of the euro to boost ex­ports but this may prove more dif­fi­cult if the Fed raises in­ter­est rates more slowly than the mar­kets cur­rently ex­pect. There is a good chance the dol­lar will fall rather than rise against the euro.

The big­gest im­me­di­ate risk to the global econ­omy comes from the emerg­ing world, es­pe­cially parts af­fected by the crash in the cost of com­modi­ties. Brazil is the coun­try to watch out for. It is the big­gest econ­omy in Latin Amer­ica and in se­ri­ous trou­ble. The econ­omy is con­tract­ing at its fastest rate since the 1930s, in­fla­tion is above 10%, the cur­rency has col­lapsed and the fi­nance min­is­ter has just re­signed. A visit from the IMF may be un­avoid­able.

This is a case of history threat­en­ing to re­peat it­self, be­cause the buildup to the 2008 cri­sis be­gan on the pe­riph­ery of the global econ­omy. So, here is my fi­nal pre­dic­tion: there will be no explosion in 2016, but a fuse will be lit.

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