A dark age of monetary confusion

In the absence of building blocks for sustainable recovery, Brexit could be the final straw that breaks the camel’s back for global economic well-being

PUBLISHED : Monday, 25 July, 2016, 4:32pm
UPDATED : Monday, 25 July, 2016, 10:38pm

The global economy appears to be losing its ability to weather storms and withstand crises. Particularly when confidence is at such a low ebb, it seems to take very little to upset what appears to be a mounting vulnerability to systemic shocks.

Brexit could be the final straw that breaks the camel’s back for global economic well-being in the coming months.

In Britain, recent purchasing managers’ surveys for the economy already hint that the country could be heading into an economic deep freeze fairly soon, with the risk of UK recession back on the cards later this year.

Brexit’s ripple effects are already spreading into Europe, with the recent plunge in German business confidence laying the blame squarely on the Brexit vote. If Britain’s exit sets a precedent for future European disintegration, the world could be in deep trouble.

With some commentators calling Britain’s decision to quit Europe as one of the biggest threats facing the global economy right now, it should be a wake-up to policymakers to get a move on mitigating the risks.

The global economy is a fragile house of cards that could come crashing down with a vengeance at any time

The International Monetary Fund might have acknowledged the Brexit threat last week, but its subsequent miniscule 0.1 per cent downward revision to 3.4 per cent for global GDP growth next year inspires no confidence that the IMF is on top of the situation.

The global economy is a fragile house of cards that could come crashing down with a vengeance at any time. The key building blocks for sustainable recovery are simply not there. If world GDP growth is supposed to be the summation of global consumption, investment, government spending, net trade (exports less imports) and stock changes, then the most basic economics formula is flagging that world growth is compromised right now.

For the global economy to thrive, confidence needs to be strong and free of the debilitating uncertainty currently facing consumers, businesses, governments and investors.

Fears about recession, deflation, unemployment and rising political risks are casting dark shadows over spending, production and investment intentions and making it easier to postpone new commitments to a later date.

At some point the global economy will eventually lose faith and roll over into recession.

In the meantime all that policymakers can do is to keep on applying the same medicine that they has used over the last eight years, force-feeding the economy with more of the same monetary super-stimulus.

Unfortunately it is also opening up the global economy to a new dimension of systemic risk – the growing reliance on cheap and easy money from the central banks, which is feeding the market’s addiction to liquidity-fuelled rallies in the bond and equity markets.

The worry for policymakers and regulators is managing the widening expectations gap between the market’s investment euphoria and the deteriorating underlying economic fundamentals.

Rallying equity and credit markets become a bigger risk the more they become detached from global economic reality. It sets the markets up for a harder fall when the ‘animal spirits’ finally run out and investor enthusiasm crashes back down to earth.

This global glut of cheap money is causing other worrying distortions.

Higher risk and return strategies may favour the brave, but cautious investors and savers are losing out holding safe haven investments.

The crash in global interest rates and government bond yields towards zero and below in some countries has been a disaster for savers and pensioners looking for a decent return on their long term savings

The crash in global interest rates and government bond yields towards zero and below in some countries has been a disaster for savers and pensioners looking for a decent return on their long term savings. It is stacking up problems as reduced disposable incomes pose a heavy drag on future economic growth.

If Japan is the role model for how long QE and low interest rates can become embedded into the national economic psyche, it hardly looks hopeful for those countries that have already committed to similar policy programmes.

Japan has been trapped in a zombie land of chronic recession, deflation and low interest rates for the last two decades with no obvious way out.

Growing global gloom and the fall-out from Brexit suggest that the UK economy will not be in shape for higher rates much before 2020. While in Europe, it could even be longer before the euro zone is in a fit state for a tightening of monetary policy. Interest rates and bond yields could be marooned in near or negative territory for a very long while.

The prospect of perpetual cheap money may be good news for some but it brings with it attendant risks. The global economy has entered a dark age of monetary confusion.

David Brown is chief executive of New View Economics