DON’T BANK ON A CRI­SIS

It may yet be decades be­fore real house prices rise strongly again – but gloomy pre­dic­tions of new fi­nan­cial crash on the hori­zon should not ring true

The Irish Times - Business - - FRONT PAGE - Chris Johns

The year be­gan with a burst of eco­nomic op­ti­mism. That’s mostly be­cause fore­cast­ers had got 2017 wrong: ini­tial pre­dic­tions of sub­dued growth had been con­founded by a ro­bust US econ­omy and sur­pris­ingly buoy­ant Euro­pean ac­tiv­ity. Emerg­ing mar­kets also looked solid at the turn of the year and the long-awaited China cri­sis once again failed to ma­te­ri­alise.

Stock mar­kets had re­flected this be­nign eco­nomic back­ground: healthy dou­ble-digit per­cent­age in­creases were the norm, par­tic­u­larly in emerg­ing mar­kets. While Brexit and Trump dom­i­nated the main head­lines, there hadn’t been much read across to busi­ness or fi­nan­cial mar­kets. In­evitably, most crys­tal-ball gaz­ers as­sumed that much or all of this would con­tinue. Equally in­evitably, it did not.

The first sign of trou­ble came with a wob­ble in those buoy­ant stock mar­kets. A marked in­crease in volatil­ity dur­ing the first quar­ter didn’t ac­tu­ally last that long but, with the ben­e­fit of hind­sight, it was an early warn­ing in­di­ca­tor of much more angst to come, par­tic­u­larly in emerg­ing mar­kets. Much stock-mar­ket anal­y­sis con­sists of smart peo­ple confusing cor­re­la­tion with cau­sa­tion. A cou­ple of things hap­pen and we are tempted to as­sume one causes the other. That’s oc­ca­sion­ally true but more of­ten than not it is pure co­in­ci­dence. One of the many dirty se­crets of fi­nance is that we don’t re­ally know very much. But we are very good at con­coct­ing sto­ries: the typ­i­cal an­a­lyst can say any­thing they like, pro­vided it isn’t “I don’t know”.

Ridicu­lously stretched

So, when mar­kets started to mis­be­have early in the year, ex­pla­na­tions ranged from wor­ries over the global growth out­look to a sud­den and spon­ta­neous re­al­i­sa­tion by in­vestors that tech­nol­ogy stock val­u­a­tions had be­come ridicu­lously stretched. An­other favourite ex­pla­na­tion trot­ted out by com­men­ta­tors fo­cused on debt lev­els: since the fi­nan­cial cri­sis, bor­row­ing, par­tic­u­larly by pri­vate-sec­tor firms, has grown to what many in­vestors think are un­sus­tain­able lev­els.

One of the con­se­quences of the great fi­nan­cial cri­sis is that far too many of us now lie in wait for the next one. That these sorts of cat­a­clysmic events thank­fully hap­pen, at most, once in a gen­er­a­tion, hasn’t stopped a large co­hort of sooth­say­ers in­vent­ing rea­sons why an­other fi­nan­cial calamity is just around the cor­ner. We are all cri­sis spot­ters now.

And the favourite cause of the next big prob­lem is the global level of debt. While there are al­ways rea­sons to keep a close eye on how much is be­ing bor­rowed by whom, no­body re­ally knows how much debt is too much – not, at least, un­til a lot of peo­ple find they can’t pay it back.

And it is, even for this op­ti­mist, some­what sin­is­ter to note that US cor­po­rate debt mar­kets are, as we end 2018, show­ing one or two signs of stress. That said, it is im­por­tant to re­alise that a lot of that in­crease in global bor­row­ing is now in the safe hands of cen­tral banks. If there is a sud­den rush for the exit and in­vestors start dump­ing debt se­cu­ri­ties, that rush will not be joined by sober cen­tral bankers.

“Sober” and “US fis­cal pol­icy” are, how­ever, words that can­not be used in the same sen­tence. Don­ald Trump’s tax cuts for rich peo­ple and cor­po­ra­tions will cause prob­lems – per­haps they al­ready are. US gov­ern­ment bor­row­ing needs are al­most un­prece­dented dur­ing peace­time and at this point in the cy­cle.

Cen­tral banks own debt via years of quan­ti­ta­tive eas­ing (QE). Buy­ing up as­sets as a form of eco­nomic stim­u­lus has never been tried be­fore, at least not on the global scale of the past few years.

One of the many sur­pris­ing as­pects of these poli­cies has been the scale of the de­ter­mi­na­tion of Ja­pan’s gov­ern­ment to buy just about any­thing it can lay its hands on. Un­like other cen­tral banks, Ja­pan has been a big buyer of equities, not just bonds. As­sets now held by the Ja­panese cen­tral bank amount to 100 per cent of GDP. That com­pares with about 20 per cent in the US and 40 per cent in the euro area. For all the jargon sur­round­ing QE, it is best de­scribed as cen­tral banks rolling the money-print­ing presses.

But de­spite all that money cre­ation, there isn’t much sign of in­fla­tion. To the ex­tent that head­line rates of price in­creases ticked up in 2018, they were in part driven by an ear­lier rise in en­ergy costs. Now that oil has once again dipped be­low $50 a bar­rel we can ex­pect in­fla­tion to remain sub­dued in 2019, at least dur­ing the first half. What hap­pens af­ter that de­pends in no small part on the be­hav­iour of wages.

Defin­ing is­sues of the age

In­come and wealth in­equal­ity are the defin­ing is­sues of the age. That was true last year and will remain true for years to come. It’s a big­ger prob­lem in the US than pretty much any­where else. As with stock mar­kets, be­ware ex­perts who make claims about cur­rent lev­els of in­equal­ity: not just in terms of the causes of in­equal­ity but also in de­scrip­tions of just how much there is.

Com­pared to other coun­tries, Ir­ish in­equal­ity is, for ex­am­ple, bang in the mid­dle of the var­i­ous league ta­bles – and a lot bet­ter than in the US. Con­trary to what many lob­by­ists claim, data re­leased at the end of 2018 shows that Ir­ish in­equal­ity hasn’t changed much for years. Even UK in­equal­ity has not changed much since the mid-1980s. We do not live in the dystopian eco­nomic uni­verse de­scribed in too many news­pa­per com­men­taries. As Leo Varad­kar of­ten tweets, things are get­ting bet­ter, al­beit with much still to do.

Two things that can help al­le­vi­ate pop­ulist angst would be higher wages and lower prop­erty prices. I think both are com­ing. From Syd­ney to Van­cou­ver and many other places be­sides, there are signs that the global house price boom is at an end. This is an un­al­loyed good thing. My hope, if not fore­cast, is that we have seen the peak in res­i­den­tial prop­erty prices. Per­haps for this gen­er­a­tion, not just for the cur­rent cy­cle. You read that right: there are rea­sons to think that it will be decades be­fore real house prices once again rise strongly.

This year saw more col­umn inches writ­ten about global trade than in liv­ing mem­ory. Trump fi­nally un­leashed his trade war on the rest of the world and Brexit fo­cused at­ten­tion, but with lit­tle in­sight, on Bri­tain’s fu­ture eco­nomic re­la­tion­ships with the rest of the world.

Global trade slowed down a lot. So did global growth. Mind­ful of my ear­lier re­marks about cor­re­la­tion and cau­sa­tion, I am nev­er­the­less tempted to say that the global slow­down is al­most wholly owned by Trump.

Ar­cane de­tails

If the ar­cane de­tails of trade re­la­tion­ships are be­yond the abil­i­ties of the av­er­age Bri­tish politi­cian to grasp, per­haps the sim­ple fact that the world econ­omy is now threat­ened with an out­right re­ces­sion might fo­cus a few minds. Trade tar­iffs have real eco­nomic im­pact. Take a sim­ple ex­am­ple: av­er­age wash­ing ma­chine prices in the US fell by al­most 25 per cent in the four years to the end of 2017. Thanks en­tirely to Trump’s tar­iffs, they rose 15 per cent in 2018. There are thou­sands of other ex­am­ples. These kinds of price changes have real con­se­quences, most of which Trump will not like.

Nev­er­the­less, Trump will blame the Fed­eral Re­serve. The US cen­tral bank con­tin­ued to raise in­ter­est rates in 2018. The US pres­i­dent reg­u­larly breaks with es­tab­lished pro­to­col to crit­i­cise the Fed and will un­doubt­edly con­tinue to do so. The Fed’s at­tempts to nor­malise in­ter­est rates – and to end QE – are un­der­stand­able. I hate to say this, but Trump does have a point (but only a small one). There is still plenty of ev­i­dence that the US labour mar­ket has plenty of slack (a low un­em­ploy­ment rate notwith­stand­ing) and there is a real con­cern that the Fed is tight­en­ing too much too soon.

We do not live in the dystopian eco­nomic uni­verse de­scribed in too many news­pa­per com­men­taries. As Leo Varad­kar of­ten tweets, things are get­ting bet­ter, al­beit with much still to do. Two things that can help al­le­vi­ate pop­ulist angst would be higher wages and lower prop­erty prices

The world econ­omy doesn’t re­ally fig­ure in the Fed’s man­date but the global slow­down is, in part, down to it. Re­cent sug­ges­tions that 2019 will not see quite so many US rate in­creases as pre­vi­ously ex­pected are to be wel­comed.

‘’The Ir­ish econ­omy, if not its stock mar­ket, proved pleas­antly im­mune to global wob­bles. It is un­usual to be able to write about sen­si­ble eco­nomic poli­cies: quib­bles over whether or not the bud­get should be in sig­nif­i­cant sur­plus should be set in a broader con­text. Un­like in past cy­cles we have not lost the run of our­selves. And the Cen­tral Bank is keep­ing a tight grip on the banks, mak­ing sure that res­i­den­tial prop­erty prices don’t once again set of for the strato­sphere.

Here are my guesses

I don’t do fore­casts – I don’t think any­body can. So here are my guesses – that’s all they are – for 2019.

We won’t have an­other fi­nan­cial cri­sis. The eco­nomic slow­down will per­sist but won’t turn into a global slump. How­ever, we will be as­sailed with com­men­ta­tors wondering about the next re­ces­sion and learned ar­ti­cles about why low growth will per­sist for years to come.

I hope that cen­tral bankers don’t over­re­act to any small rise in wage in­fla­tion: it’s im­por­tant to al­low work­ers to gain a big­ger slice of the eco­nomic pie.

Brexit will prob­a­bly be the big­gest event for the Ir­ish econ­omy in 2019. There, the omens are not good. The prob­a­bil­ity of a hard Brexit is, as I write, higher than ever. For Ire­land, that spells deep trou­ble ahead. I hope the mar­kets and Brus­sels grant us some fis­cal slack: pub­lic spend­ing will have to in­crease, if only for a while. Per­haps by a lot.

PHO­TO­GRAPHS: DREW AN­GERER/GETTY IMAGES, NIALL CAR­SON/PA WIRE

Traders on the floor of the New York ■ Stock Ex­change (NYSE) last week. Be­low: Taoiseach Leo Varad­kar with In­ter­na­tional Mone­tary Fund (IMF) manag­ing di­rec­tor Chris­tine La­garde at Gov­ern­ment Build­ings in June.

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