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Page added on February 7, 2016
The world economy is shaky and ‘funny money’ won’t fix it
So that was “jarring January”. Since the start of the year, over £4 trillion has been wiped off the value of global equities – that’s four, followed by 12 zeroes.
US stocks endured a steeper first-week decline in 2016 than in any year since before the First World War.
Market volatility drove the MSCI World Index of leading shares down 8pc in January – a degree of decline usually seen during systemic crises, such as the 2008 Lehman Brothers collapse or the 2001 dot.com bust.
While policymakers maintain that “the fundamentals are sound”, many large investors now think otherwise. We’re getting caught in the dreaded “negative feedback loop” – when market turbulence brings about the very economic slowdown it fears, with investor anxiety itself becoming the catalyst for a renewed slump.
The world economy is “still expanding” but growth is “weak and uneven” admitted Maurice Obstfeld, the International Monetary Fund’s chief economist, last week.
“This coming year will be one of great challenges and policymakers should be thinking about short-term resilience,” he said.
Having downgraded its global growth forecast for 2016 by another 0.2pc, to 3.4pc, the IMF is acknowledging the world economy is shaky.
US banking giant Morgan Stanley goes further, pointing to a one-in-five chance the world economy will re-enter recession this year – defined as growth below the 2.5pc rate needed to match world-wide population gains. This last happened in the immediate aftermath of the Lehman Brothers collapse.
The reasons behind recent stomach-churning falls on global markets are many and varied. The most significant, in my view, was brought into focus by the quarter point rise in US interest rates in December, the first in almost a decade.
Since late-2008, Western stock markets have been pumped up by quantitative easing (QE), with the Federal Reserve increasing its balance sheet more than three-fold since 2009 – ably assisted in such bubble-blowing by the Bank of England and the Bank of Japan.
Yes – some extra liquidity was needed in the darkest days of the credit crunch. But QE has gone way beyond that.
Necessary emergency measures have been transformed, at the behest of powerful financiers and myopic politicians, into a stock-boosting lifestyle choice, the financial equivalent of crack cocaine.
With US money-printing now on hold and rates seemingly on the up, many financial assets – from equities to bonds – look overvalued, not just in America but across the world. That’s the single most important reason global markets are so jumpy – because investors know, in their bones, that the strong gains of recent years have been built on debt and QE.
Despite massive monetary and fiscal stimulus, the US economy has not only been unable to stage a sustained recovery, but is now showing worrying signs of reversal.
The biggest economy on earth is failing to fire on all cylinders and produce anything like the growth that could justify current stock prices.
America’s all-important consumers are now reining in their spending, with retail sales falling 0.1pc in December, marking the end of the weakest consumer year since 2009. Industrial production was 0.4pc down, having dropped 0.9pc the month before, with the US manufacturing sector now officially in recession.
Survey data released last week points to an alarming slowdown in America’s service sector, which accounts for two-thirds of the economy. The influential purchasing managers’ index dropped to 53.2 in January – a 27-month low.
While still expanding, growth in US services is now slowing, with financial volatility taking its toll on deal-making and spending across a range of sectors, as the feed-back loop tightens.
Rather than a “normalisation” of policy-making, then, this US rate rise, and the spasmodic response of financial markets and the broader economy to it, indicates the Fed’s weakness.
Having boldly pointed to four rate rises during 2016, US policymakers have changed their tune – with futures markets now pricing in no US rates hikes until next year at the earliest.
I maintain that financial volatility will prove so destabilising, and cause such damage to America’s economy that we’ll see yet more US QE – and perhaps even a reversal of December’s rate increase. Rather than placating the markets, that could do more harm than good.
This over-reliance on monetary and fiscal stimulus obviously extends way beyond the US.
The Eurozone and Japan have now grabbed the money-printing baton, of course, as they too try to keep their moribund banks alive with “funny money” and their central banks prop up their respective “markets” for government debt.
The 25pc drop in oil prices so far during 2016, the latest leg in a 70pc collapse since mid-2014, also has everyone spooked.
Ordinarily, it’s high oil prices that point to economic danger. Every global recession since 1970 has been preceded by a big rise in oil prices. Significant drops in the price of crude have, over the years, sparked faster growth. But the world has now changed.
Ultra-cheap oil has piled pressure on commodity exporters; from Russia to South Africa; from Brazil to the Gulf. These countries are now themselves of global economic significance – and their oil-price pain has slowed overall global demand.
Rather than responding to cheaper fuel and heating costs by spending more, as they have in the past, debt-soaked Western consumers are now retrenching, using the windfalls that haven’t been grabbed by the petrol and utility monoliths to reduce their debts.
Cheap oil is also raising major questions about the health of the US corporate debt market. This is particularly true of the huge “junk bond” sector, dominated as it is by struggling energy companies, not least those trying to survive as Saudi Arabia floods global markets with oil.
A key US “junk-bond” stress index hit a six-year high in January, Moody’s announced last week. The ratings agency indicated liquidity is drying up in sectors going beyond energy, suggesting cheap oil could yet spark a bond crisis similar to previous “sub-prime” woes.
Low oil prices have also generated a renewed danger of sovereign debt risk, with Venezuela, one of the world’s top-10 oil exporters, now seen as a likely default candidate. Venezuelan government bonds are yielding over 40pc, up from 10pc just 18 months ago. Given that a Thai default was enough to spark a global crisis in the late-1990s, the seemingly obscure Venezuelan sovereign debt market cannot be ignored.
Since the Lehman collapse, the world’s major economies have engaged in “currency wars”, attempting to bring about foreign exchange depreciations to grab competitive advantage. These must now end.
Despite all the geopolitical tensions, and bad-tempered exchanges between the Western world and the emerging markets in recent years, serious international policy coordination is needed.
Back in 1985, the world’s leading powers came together in a New York hotel and negotiated the Plaza Accord. This saw central banks join together to steadily depreciate an over-valued dollar, which threatened to cause an outbreak of protectionism in the US. We need something similar, but different, today.
The yuan has weakened significantly over the last six months, as the Chinese economy has slowed and capital has shifted back to the West. As China’s central bank has sacrificed over $500bn of reserves, fears have mounted Beijing could act aggressively, imposing a sudden, one-off devaluation that would spread global panic.
China is chairing the G20 group of world economic powers during 2016. Finance Ministers meet in Shanghai next month.
What we need is “Plaza 2”, to support the Chinese yuan and prevent the dollar from strengthening more. That won’t defuse QE or prevent further falls in global stocks. But it would be a start.
11 Comments on "The world economy is shaky and ‘funny money’ won’t fix it"
twocats on Sun, 7th Feb 2016 10:15 am
Oof! Deutsche Bank recently called for ending Central Bank easing, and now a major newspaper in another qe-country. Things could get messy. I wonder if they realize that without QE we’d be well down the backside of peak.
onlooker on Sun, 7th Feb 2016 12:01 pm
Funny money won’t fix it, boy that is an understatement. Funny money is setting up for the biggest price correction/discovery the world has even seen. bye bye asset prices hello deflation. Funny money is just another bubble in the end.
makati1 on Sun, 7th Feb 2016 7:09 pm
Lots of Western guessing about what China will do but only China knows it’s plans. I doubt they will match the scenario proposed/desired by the Western Sinophobes. The West is sinking fast and the rest of the world is rushing to decouple from the soon-to-be valueless US Dollar.
joe on Sun, 7th Feb 2016 11:00 pm
Not sure why the media is so confused as to why oil price cuts are not delivering a consumer led boom. The biggest sector of the economy, pays the lowest wage increases. If this was the pre-globalised world where workers had good jobs in factories that paid well, then people could afford spending. But this is the wal-mart society of post-industrial decay. Extra profits from oil price cuts goes to Big Food, Big Airline, Big Supermarket. People are debt shy after the pozi-scheme econony of the 00’s, where is the incentive to spend?
GregT on Sun, 7th Feb 2016 11:12 pm
“where is the incentive to spend?”
Patience joe, they’re working on it. NIRP just might be that incentive. Desperate times call for desperate measures.
Davy on Mon, 8th Feb 2016 5:35 am
Credit Bubble Bulletin
Weekly Commentary: The Adjustment Cycle
http://creditbubblebulletin.blogspot.com/2016/02/weekly-commentary-adjustment-cycle.html
“My view that crisis has reemerged is based on the analysis that de-risking/de-leveraging dynamics have reached a point of self-reinforcing momentum beyond the control of central bank policies. In short, The Adjustment Cycle has commenced and there’s little left at this point to hold it back.”
“Bubbles inflate both perceived wealth and future expectations. Meanwhile, in the real economy sphere, myriad Bubble facets work to destroy wealth. Mal-investment, over-investment and associated wealth destruction remain largely concealed so long as financial asset inflation persists. This is true as well for wealth redistribution. The unfolding adjustment process will deflate asset prices so as to converge more closely with deteriorating underlying economic fundamentals.”
“Marking down Chinese debt to a more reasonable level will leave a gaping hole – in bank capital, in government finances and in household savings…..Mark down European debt and asset prices to sensible levels and the banking system is insolvent and Europe’s economy is right back in the ICU…..I would argue that the U.S. has among the widest divergences between inflated financial wealth and deflating real economy prospects.”
“A disorderly unwind of leveraged positions concurrent with selling from derivative-related “dynamic” hedging programs would ensure market illiquidity and dislocation. And such a scenario could easily unfold concurrently on a global basis.”
“In a world of de-leveraging, there’s a strong case to be made that negative rates are worse than doing nothing. I’m assuming more QE will be forthcoming – from all major central banks. That’s certainly what the Treasury, JGB and bund markets are telegraphing.”
“It’s reminiscent of the buildup to the 2008 market crash. It wasn’t entirely clear how things would unfold back then, but I knew tens of millions would be badly hurt. Nowadays I fear for hundreds of millions, and the associated geopolitical… So far, the public hasn’t panicked. Why would anyone sell now when stocks always recover? The Adjustment Cycle is just getting underway.”
joe on Mon, 8th Feb 2016 8:08 am
The 1929 crash caused currency wars and protectionism, they gave room for defeated and marginal politically dissaffected people to pose as the defenders of civilisation against the righteous anger of impoverished revolutionary people who ‘had a dream’. A man like Stalin could easily pose as al Baghdadi, that is the threat we really face, not that they are strong, but their message could be. Economics is all well and good but the real world outside of incentives and unimaginable debt figures is more fragile than people think. People spend what they believe that they can afford. Or what they need or have to spend on. One round of a quarter of a basis point of FED rate hike has upset the computer systems which run our economy so much that a person wont trust it when it goes haywire. Stock markets are returning to the price point it should have been before QE lost its mind. The markets are reflecting the reality that ‘normal’ conditions dont exist post 07/08 and that without funny muny and 0% rates, the world is fragile. Even cheap oil is not helping.
Apneaman on Mon, 8th Feb 2016 2:52 pm
The Obama Administration Has Just Recklessly Escalated Its Military Confrontation With Russia
The Pentagon’s announcement that it will quadruple US-NATO military forces in countries on or near Russia’s borders pushes the new Cold War toward actual war, possibly even a nuclear one.
“This installment focuses on the Pentagon’s announcement that it will quickly quadruple the positioning of US-NATO heavy military weapons and troops near Russia’s eastern borders. The result, Cohen argues, will further militarize the new Cold War, making it more confrontational and likely to lead to actual war with Russia. The move is unprecedented in modern times. Except during Nazi Germany’s invasion of the Soviet Union, Western military power has never been positioned so close to Russia, making the new Cold War even more dangerous than was the preceding one. Russia will certainly react, probably by moving more of its own heavy weapons, including new missiles, to its Western borders, possibly along with a large number of its tactical nuclear weapons. The latter reminds us, Cohen points out, that a new and more dangerous US-Russian nuclear arms race has been under way for several years, which the Obama Administration’s decision can only intensify. The decision will also have other woeful consequences, undermining ongoing negotiations by Secretary of State Kerry and Russian Foreign Minister Lavrov for cooperation on the Ukrainian and Syrian crises and further dividing Europe itself, which is far from united on Washington’s increasingly hawkish approach to Moscow.”
http://www.thenation.com/article/the-obama-administration-has-just-recklessly-escalated-its-military-confrontation-with-russia/
Russia only has 7700 nuclear weapons. Better hug your kids just in case the ape species ending war goes down.
Nuclear Weapons: Who Has What at a Glance
https://www.armscontrol.org/factsheets/Nuclearweaponswhohaswhat
Boat on Mon, 8th Feb 2016 3:32 pm
Since Obama is weak and so easily outfoxed by Putin there should be no fear in Russia. I am sure Trump will move the troops out and apologize for the sanctions.
Apneaman on Mon, 8th Feb 2016 3:59 pm
Boat, I can guarantee you there is at least 1 Russian ICBM with “Houston” written on it. It only tooK 1 generation to completely forget the concept of MAD. Dumbed Down indeed.
makati1 on Mon, 8th Feb 2016 6:44 pm
Ap, Perhaps Boat doesn’t realize that the new Russian ICBMs can get to Houston in 27 minutes from Moscow. And 3 minutes, or less, from A Russian sub in the Gulf of Mexico. The oceans no longer protect the ‘indispensable ‘country. And one ICBM carries 10 nukes, not one.
Americans didn’t really feel all of the wars they have been in since 1914. Had say New York City been bombed into ruin and hundreds of thousands of women and children been killed like many European cities of WW1 & WW2 or the ME cities today, they would not support their ‘team’ with so much vigor, if at all. War would put real fear into their minds, not the MSM bullshit of today.
If they keep pushing Russia, it’s gonna happen. What if Russia was doing in Canada and Mexico what the US is doing in Poland and Ukraine? The Cuban missile crisis in reverse or WW3?