Sailing dangerous economic waters without a lifeboat
The world economy is disturbingly close to stall speed. The United Nations has cut its global growth forecast for this year to 2.8 per cent, the latest of the multinational bodies to retreat.
We are not yet in the danger zone but this pace is only slightly above the 2.5 per cent rate that used to be regarded as a recession for the international system as a whole.
It leaves a thin safety buffer against any economic shock — most potently if China abandons its crawling dollar peg and resorts to beggar-thyneighbour policies, transmitting a further deflationary shock across the global economy.
The longer this soggy patch drags on, the greater the risk that the sixyear-old global recovery will sputter out. While expansions do not die of old age, they do become more vulnerable to all kinds of pathologies.
A sweep of historic data by Warwick University found compelling evidence that economies are more likely to stall as they age, what is known as “positive duration dependence”. The business cycle becomes stretched. Inventories build up and companies defer spending, tipping over at a certain point into a self-feeding downturn.
Stephen King from HSCB warns that the global authorities have alarmingly few tools to combat the next crunch, given that interest rates are already zero across most of the developed world, debts levels are at or near record highs, and there is little scope for fiscal stimulus.
“The world economy is sailing across the ocean without any lifeboats to use in case of emergency,” he said.
In a grim report — The World Economy’s Titanic Problem — he says the US Federal Reserve has had to cut rates by more than 500 basis points to right the ship in each of the recessions since the early 1970s.
“That kind of traditional stimulus is now completely ruled out. Meanwhile, budget deficits are still uncomfortably large,” he said.
The authorities are normally able to replenish their ammunition as recovery gathers steam. This time they are faced with a chronic lowgrowth malaise — partly thanks to a global savings glut, and increasingly to a slow ageing crisis across most of the Northern Hemisphere. The Fed keeps having to defer its first rate rise as expectations fall short.
Each of the past four US recoveries has been weaker than the last one. The average growth rate has fallen from 4.5 per cent rate in the early 1980s to nearer 2 per cent rate this time. The US fiscal deficit has dropped to 2.8 per cent but is expected to climb again as pension and health care costs bite, even if the economy does well.
The US cannot easily launch a fresh New Deal. Public debt was just 38 per cent of GDP when Franklin Roosevelt took power in 1933, and there were few contingent liabilities hanging over future US finances.
“Fiscal stimulus — a novel idea at the time — may have been controversial, but the chances of it working to boost economic activity were quite high given the healthy starting position. Today, it is much more difficult to make the same argument,” he said.
The great hope — and most likely outcome — is that the recent monetary expansion in the US and the eurozone starts to gain traction later this year. Broad ‘M3’ money data — a one-year advance indicator — has been growing briskly on both sides of the Atlantic. But nobody knows for sure whether the normal monetary mechanisms are working.
JP Morgan estimates that the US economy contracted at an rate of 1.1 per cent rate in the first quarter, far worse than originally supposed.
The instant tracking indicator of the Atlanta Fed — GDPnow — shows little sign that America is shaking off its mystery virus. Growth was just 0.7 per cent rate (annualised) in mid-May. It is becoming harder to argue the relapse is a winter blip or caused by temporary gridlock at California ports. More than 100,000 lay-offs across the oil and gas belt seem to have taken their toll. The Fed thought the windfall gain of cheaper energy for everybody else would weigh more in the balance, but this time Americans have chosen to salt away the money.
Net saving jumped by US$125 billion ($171 billion) to US$728 billion in the first quarter. There was no pickup in April. Retail sales were flat.
It is now more likely than not that the US economy has dropped through the Fed’s stall-speed threshold of two consecutive quarters below 2 per cent rate growth. Exactly how far below is unclear. The Fed uses its own growth measure — gross domestic income (GDI) — and this data has not yet been published.
The stall speed concept is soft science but not to be ignored. “Output tends to transition to a slow-growth phase at the end of expansions,” said a Fed research paper.
Much now depends on China, where the economy is starting to look “Japanese”.
Dario Perkins from Lombard Street Research says the Chinese economy is in a much deeper downturn than admitted so far by the authorities. It probably contracted outright in the first quarter.
Electricity use has turned negative. Rail freight has been falling at near double-digit rates. What began as a deliberate move by Beijing to choke off a credit bubble has taken on a life of its own, evolving into a primordial balance-sheet purge.
It was inevitable that China’s investment bubble would lead to vast inventory of unsold property. The country produced more cement between 2011 and 2013 than the US in the 20th century — Perkins said China is now in a “classic debt deflation spiral”.
Factory gate inflation is now minus 4.6 per cent rate. This in turn is tightening the noose further by pushing up real borrowing costs.
The Chinese authorities have so far resisted the temptation to flood the system with fresh stimulus, fearing that this would store up even greater trouble. This matters enormously. Andrew Roberts from RBS says China accounted for 85 per cent rate of all global growth in 2012, 54 per cent rate in 2013, and 30 per cent rate in 2014. This is likely to fall to 24 per cent rate this year.
“If there is only one statistic that you need to know in the world right now, this is it,” Roberts said.
HSBC’s King says the global authorities face awful choices if the world economy hits the reef in its current condition. The last resort may have to be “helicopter money”, a radically different form of QE that injects money by funding government spending.
It is a Rubicon that no central bank wishes to cross, though the Bank of Japan is already in up to the knees. The imperative is to avoid any premature tightening or policy error that could crystallise the danger.
As King puts it acidly: “Many, including the owner of the Titanic, thought it was unsinkable. Its designer, however, was quick to point out that, ‘She is made of iron, sir, I assure you she can’.”
It was inevitable that
China’s investment bubble would lead to vast inventory of unsold
property. The country produced more cement between 2011 and 2013 than the US in the 20th
century.