FU­TURES IM­PER­FECT

If the next con­trac­tion of the world econ­omy comes sooner than ex­pected, what will be left in the kitty to fend it off?

Financial Mail - Investors Monthly - - Contents - RON DERBY

Ron Derby col­umn

When the most re­cent global re­ces­sion oc­curred, the re­sponses of the world’s cen­tral bankers were based on the ex­pe­ri­ences of the Great De­pres­sion of the early twen­ti­eth cen­tury. They ap­plied all sorts of mon­e­tary pol­icy mea­sures to keep liq­uid­ity in fi­nan­cial mar­kets and en­sure a re­turn to growth. Es­pe­cially in de­vel­oped climes, rates dropped to record lows — to near zero lev­els in the US. The Bank of Eng­land re­sponded in a sim­i­lar man­ner and even­tu­ally, so did the Euro­pean Cen­tral Bank.

It is about six years since that cri­sis, and in that time we’ve been in­tro­duced to the Ja­pan-in­spired ex­per­i­ment of quan­ti­ta­tive eas­ing (QE) to boost ail­ing economies. For the most part, the at­tempts have saved us from the worst of the re­ces­sion; the US econ­omy is now on a stronger tra­jec­tory, and the UK’s as well. But there’s an un­com­fort­able ques­tion: what tools are left in the vaults of the world’s lead­ing cen­tral banks to res­cue the global econ­omy should the next con­trac­tion come sooner than ex­pected?

It’s clear that this world is not im­mune to bouts of con­trac­tion. Econ­o­mists who sug­gested in the early part of the new cen­tury that the days of eco­nomic booms and busts were a thing of the past were greatly mis­taken. So when the next bust comes, what will be left in the kitty to fend it off?

Chief global econ­o­mist at HSBC Stephen King asks this ques­tion in his re­port ti­tled “The World Econ­omy’s Ti­tanic Prob­lem”. In it, he ar­gues that although the US econ­omy has been driv­ing along, there isn’t much in the way of in­sur­ance for it when it crashes.

And if his­tory is a guide, King says, the world’s big­gest econ­omy is closer to the next re­ces­sion than we care to think.

The trig­gers sin­gled out in his re­port are a rise in US wages lead­ing to a fall­ing profit share and a ma­jor stock mar­ket decline, sys­temic fail­ures within the non-bank fi­nan­cial sec­tor, ma­jor weak­en­ing of the Chi­nese econ­omy and a pre­ma­ture at­tempt by the Fed­eral Re­serve to nor­malise mon­e­tary pol­icy.

Th­ese are threats that are very real. We’ve seen Chi­nese num­bers, and what we have to con­sider is what mon­e­tary pol­icy can now do to save the econ­omy from this even­tu­al­ity. The bazookas have been fired.

With rates at near zero, it’s no longer pos­si­ble for a sim­i­lar re­sponse to the ones used in the 2008 dip or any of the pre­vi­ous dips af­ter the Sec­ond World War. QE, in truth, has re­ally amounted to stim­u­lus for as­set prices and has fed very lit­tle into the nuts and bolts of the real econ­omy.

The rea­son the con­di­tions are so dif­fer­ent now to what they were in times past, is that most times of eco­nomic re­cov­ery have been fol­lowed by a nor­mal­i­sa­tion of mon­e­tary pol­icy, mean­ing in­ter­est rates have risen.

But in the years since the past re­ces­sion, what we have had is a ten­ta­tive re­cov­ery, and main­land Europe is very much still in a vul­ner­a­ble state — along with the whole emerg­ing world, it seems. In line with the un­cer­tain re­cov­ery, in­ter­est rates re­mained at record lows.

What the world’s cen­tral bankers haven’t been able to do with this slug­gish eco­nomic re­cov­ery is re­stock ammunition, and the world’s gov­ern­ments haven’t man­aged to rein in their bud­get deficits.

The Fed which, as a cus­to­dian of the re­serve cur­rency, takes the lead on mon­e­tary pol­icy, hasn’t been able to nor­malise rates in the past few years be­cause the global cri­sis was the worst slow­down in the econ­omy since the Sec­ond World War, with the US gross do­mes­tic prod­uct fall­ing 4,2%. Should the US re­cov­ery stall or, worse yet, fall into a re­ces­sion, there is now very lit­tle it can do to soften the im­pact.

Cen­tral bankers won’t be in a po­si­tion to save us, nor will highly in­debted gov­ern­ments, who sim­ply aren’t able to spend the globe out of trou­ble.

That’s the dif­fi­cult ques­tion faced by the Fed’s Janet Yellen as she seeks to get the US back to nor­mal­ity.

The world needs to re­turn to it, but with a re­cov­ery so frag­ile, and a very con­nected global econ­omy, to act too swiftly may take the US econ­omy back to a cold win­ter with­out the tools to en­sure it’s a short one.

…the world’s big­gest econ­omy is closer to the next re­ces­sion than we care to think

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