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 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”.
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.
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.
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.