What’s happening with the global economy? The global economy can be described by comparing it to a plane that will either have a soft or hard landing.
It may be more appropriate to say to fasten your seatbelts, and brace yourself to face turbulence. Pilots often seem to have no idea how to fly or what direction they’re heading.
Concerns about growth are at the forefront. The recent market behaviour shows this, with bond yields rising and equity markets falling.
The minutes of the US Federal Reserve released last week showed the same thing. The minutes showed that a number policymakers were afraid of tightening the monetary policy. These concerns are greater in this country.
A recession in Western economies had been widely anticipated at the beginning of the year. However, this has not happened. The UK is one of the most resilient. Lower inflation will increase spending power. However, where bond yields and interest rates settle will determine the growth rate.
A credit crunch, tight lending conditions, and a risk-averse capital market environment could make it more difficult and expensive for businesses to raise money. This is already happening.
The International Monetary Fund’s economic forecasts are a good indicator of the consensus view. They predicted in late July that the global economy would slow down from 3.5pc to 3pc for this year and next. This is an incredibly low number.
is a bit worried about the recent bad economic news coming out of China.
There is concern over deflation now that some prices are falling. However, low inflation is likely. It is better to consider a deflationary climate if both output and prices are declining. China is not at that point.
China has shifted to a dual-circulation economy in recent years. China has been trying to achieve self-sufficiency after the trade war it had with the US, under President Trump. This included food, fuel, and technology. The US-led trade sanctions and those that followed do not help.
This structural change was difficult at best, but coincided with more prudent policies, both in China to control inflation (which they have done well) and to limit the debt overhang.
When you add in the future shrinking of the population, the result will be that China’s growth rate in the future will be slower and more irregular than it was in the past. This is not the time to panic but rather to acknowledge such a shift in structural factors. There are also signs that the private sector is doing well in other parts of Asia, and a recovery is taking place in Japan, which is the third largest economy on earth.
I am optimistic about the long-term prospects for global growth. Near-term growth concerns must be taken very seriously, especially as the full effect of normalising monetary policy has not yet been felt in Western economies.
Western economies experienced a period of cheap money for a dozen consecutive years. Central banks’ balance sheets soared. Money was not only cheap but also widely available. Global liquidity was abundant.
Cheap money caused asset price inflation. It allowed the markets to misprice risk. This led to capital misallocation, including the survival zombie firms.
The countries who have adopted a cautious approach to monetary policies are better placed to act today. They were mostly in so-called emerging countries. Chile and Brazil, for example, have both been able in recent weeks to reduce interest rates. The policy was tightened before the recent spike in inflation, and now they can ease it to prevent economic weakness.
China also cut interest rates in response to the slowing economy. However, it was able to do so because of its prior prudence.
There is valid concern that the policy rates in the US and UK, as well as in euro zone are rising too fast. Even when interest rates reach their peak, central bankers will continue to tighten policy by shrinking the balance sheets of their banks through quantitative tightening. This is not good for the economy.
I would not tighten any further but there is a need to prevent a return of cheap money. In the future, policy rates could have to be set at a higher level.
It is not clear how the markets will react to this. This has already raised the question: What is a risk-free investment? This was the perception of government bonds. During the pandemic a third global government bonds traded at negative yields. This meant that investors viewed these as safe. In effect, borrowing was rewarded by the government.
Government bonds are now experiencing negative returns due to inflation, policy rate increases and tighter liquidity globally. You would have lost your money if you bought this safe-haven.
Shadow banking has grown in popularity since the global financial crisis of 2008. According to the latest Financial Stability Board report, the total value of financial assets will reach $485 trillion by the year 2021. Yes, trillion. The amount of money provided by nonbank financial institutions has reached $239 trillion, almost half.
This system is based on collateral, which can be in the form or government bonds or other high-quality debt. This suggests greater financial instability, but also greater risk-aversion. Global liquidity conditions are therefore likely to tighten. It may be vital to stabilise policy rates and yields.
The focus has shifted from inflation to economic growth. Next, I anticipate that the financial markets will turn their attention to debt. Globally, public and private debt is high. This limits policy options and leaves many people and companies exposed to high interest rates for a prolonged period. Seatbelts should be tightened.