By Felicity DuncanÂ
Let’s imagine that the global economy is the weather. Say we were all on holiday at the beach. Right now, we’d be standing in the warm sunshine. But we’d also be looking at the sky, trying to decide if the gathering clouds on the horizon mean that its time to retreat to our hotel rooms ahead of a storm.
Around the world, stock markets are ending the year in the red. European stocks are down around 10% on the year. In the UK, the FTSE 100 is down close to 10% on the year. And emerging markets have been heavily sold off – the MSCI Emerging Markets Index is down more than 12% year-to-date.
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The relationship between the stock market and the real economy is always a little uncertain. Markets can be frothy even when households are struggling, and bear markets can start long before any economic distress.
However, this year, slumping stock markets have been matched with bad news about economic growth. The IMF has warned that global growth has become uneven and fragile and the organization has recently downgraded its global growth forecasts. Growth in Europe has slumped, as has China. And, of course, South Africa.
The one global bright spot, in both economic growth and stock market terms, has been the US. The S&P 500 is still in the green – although just barely – and the US economy has clocked a couple of quarters of strong growth.
But even there, problems are brewing. The US housing market has been weakening thanks to higher mortgage rates, and corporate bond markets have been sold off recently as investors have grown more anxious about credit quality. Unusually low unemployment is also raising concerns about potential inflationary pressure.
So, is a storm coming? Or will this bad weather blow over? A lot depends on the outcomes of a few key issues.
US/China trade war
The biggest threat to the global economy is the trade cold war between the US and China. Every day features headlines that indicate a sea change one way or the other – Peace in our time! War escalates! – but the basic, underlying situation has not changed at all.
US president Donald Trump places great weight on America’s goods trade deficit (the US has a services trade surplus, which Trump has not discussed much). He believes that the trade deficit is caused, in large part, by unfair Chinese trade practices and that this is why manufacturing jobs have disappeared. Opinion on these issues varies.
Nevertheless, his beliefs mean that Trump is committed to changing the trading relationship between the US and China. Specifically, he is committed to importing less from China and exporting more to it. Unfortunately, making this dream a reality is likely to be extremely complicated due to, among other things, the nature of global supply chains, the role of the US dollar in the world, the relationship between the dollar and the Chinese renminbi, and a host of other factors.
This is going to be a tough circle to square. Hopefully, the two nations can patch together some kind of trade deal in the next 90 days. But the underlying reality – Trump is hostile to trade and wants the US to import less – will not change. And his attempts to achieve this goal are likely to have widespread and negative impacts on the global economy. In other words, watch this space.
Global credit tightening
US interest rates have been slowly rising. This is having a broad impact on global liquidity. Specifically, rising rates mean that a lot of capital is now flowing into US assets, which means that when other countries want to raise money, they are being forced to offer higher interest rates to attract investors.
At the same time, a lot of countries – especially emerging markets – that borrowed heavily during the boom times of low US rates are now facing collapsing confidence in their ability to pay what they owe. This is particularly true for those that borrowed in US dollars. The dollar has been fairly strong this year, so countries (and companies) that have dollar-denominated debt are struggling with higher repayments (in domestic currency terms).
Most recessions are associated with liquidity problems – a shortage of cash, a collapse in confidence in a particular sector of the debt market (think mortgage-backed securities in 2007, Asian debt in the late 1990s), a currency crisis and so on. With global liquidity on the retreat, we’re facing the real possibility of some type of credit crisis.
The global economic expansion is getting long in the tooth, and the downside risks are mounting. Those clouds above the water may blow away. But it’s also possible that we are heading into stormy weather.
