When the next recession hits, central banks in the US, Japan and Europe simply won’t have the tools to fight it
Nicholas Spiro says the global economy is looking shaky amid escalating trade tensions, but the worse news is that the monetary policies already in place to stimulate demand and the explosion in public indebtedness will severely limit policy actions to fight a downturn
It was only in January that the International Monetary Fund was trumpeting “the broadest synchronised global growth upsurge since 2010”, accentuating the “upside surprises in Europe”.
Fast forward six months, and the message from Christine Lagarde, the IMF’s managing director, is a much less rosy one. Speaking in Berlin last week, she warned that “the clouds on the horizon … are getting darker by the day”.
To be sure, the global economy is still chugging along at a solid pace. In its latest outlook published at the end of last month, the Organisation for Economic Cooperation and Development forecast that growth would reach nearly 4 per cent this year and next, with America’s economy growing nearly 3 per cent. Yet while the OECD’s gross domestic product forecasts may be upbeat, it tellingly titled its outlook “Stronger growth, but risks loom large”.
One of these vulnerabilities is the sudden end to the period of synchronised growth. The “upside surprise” in the euro zone has been supplanted by a marked slowdown in the past several months. IHS Markit, a data provider that produces monthly purchasing managers’ index surveys, notes that Europe’s single currency area is likely to have just suffered its worst quarter since 2016, with the deceleration proving broad-based.
Other cracks in the global growth story are starting to show. The dramatic escalation in tensions over international trade is contributing to weakness in Germany’s export-led economy, where investor confidence has sunk to its lowest level since 2012, and threatens to exacerbate the recent slowdown in China where industrial output, retail sales and investment all rose less than expected in May.
In a report published earlier this month, JPMorgan noted that the threat of a full-blown trade war “is happening during the most critical period of China’s deleveraging efforts”, adding to the uncertainty.
While it is too early to fret about another global recession, international investors should be concerned about how ill-equipped the world’s leading central banks and governments are to counter the next downturn when it comes.
Policymakers in advanced economies had plenty of weapons in their armouries to help revive growth in the wake of the 2008 financial crisis. Since then, however, they have been running out of ammunition due to the quantity and variety of non-conventional monetary policies introduced to stimulate demand and – just as importantly – the explosion in public indebtedness which, according to the IMF, has surged to its highest level since the second world war.
On the monetary front, leading central banks are caught between a rock and a hard place. On the one hand, years of aggressive quantitative easing have severely distorted asset prices and led to overstretched valuations in bond and equity markets, adding impetus to recent measures to start unwinding quantitative easing.
On the other hand, inflation rates are still sufficiently low and growth fragile enough (particularly in Europe and Japan) to keep interest rates at historically low levels, reducing the scope for recession-fighting cuts in borrowing costs.
There is even less firepower on the fiscal side, particularly in the United States, which has recklessly implemented a huge budgetary stimulus at a time when the economy is already at full employment and America is driving the global expansion.
In Germany, meanwhile, the only leading economy in Europe with the fiscal ammunition to help counteract the next recession, a deep-rooted obsession with austerity continues to hamper the euro-zone’s ability to integrate more closely and boost growth.
Much will hinge on what happens in the world’s two largest economies, which are hurtling towards an all-out trade war.
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With global growth now relying heavily on America, any sign that protectionist actions are undermining confidence in the US economy will place the Federal Reserve under intense scrutiny. Bond investors, who are already concerned about the risk of a hawkish policy mistake, would start to question the credibility of the world’s most influential central bank.
Renewed fears about China’s economy, an anchor for emerging markets and the broader economy, could have an equally damaging effect on market sentiment. The greater the strains on China’s economy, the greater the tensions between deleveraging and growth, fuelling concerns that China’s vulnerabilities will exacerbate the next downturn.
At a conference in Portugal this week organised by the European Central Bank, the heads of the big three central banks warned of the dangers posed by a trade war. What should really concern them, however, is how many bullets they have left to fight the next recession.
Nicholas Spiro is a partner at Lauressa Advisory