That, in one word, is the state of the world economy: slowing. It wasn’t going very fast hitherto, but it is going to go slower henceforth. That was the word from no less august an institution than the International monetary Fund (IMF) yesterday, in its latest forecast for the world, and key regional and national economies. If we skip the detailed numbers, the summary is very simple: Europe — down, China — the same (as the previous forecast), US — up, the world as a whole, including Japan, Russia and the emerging economies — down. Last but not least, global trade — down.
Just to clarify, that’s not saying that the economies will be ‘down’ in the sense of negative growth, only that the rate of growth previously forecast has been cut. In fact, even the new forecast — 3.8% versus 4% in the July forecast for global growth — is still higher than the 3.3% the IMF expects the world to manage this year.
So at least in that sense, this could be construed as good news. However, it’s not really news and it’s certainly not really good. It’s not news because it’s a forecast, or an update of a forecast. By dint of its position as the premier ‘international economic institution’, the IMF is an important player in the game of economic forecasting, but its record in this area is undistinguished — to be charitable. That may be because, for political reasons, it feels obliged to act as a cheerleader rather than a professional player, but the fact is that it has consistently forecast higher rates of growth than were subsequently achieved in practice. The pattern in recent years has been that the IMF’s forecast for a specific year has been steadily reduced as the forecast period shortened and that year approached. This pattern is now being repeated with respect to 2015 — and that’s why there is no reason to think or hope that we will actually see 3.8%, but rather a lower number, possibly much lower.
The extent to which the IMF is a cheerleader may be judged from the sad fact that, even after yesterday’s downgrade, the IMF forecast for the global economy in 2015 is still some 30% higher than the consensus forecast of private-sector economists. In other words, the IMF is trailing behind reality — as usual, but probably even more severely than usual.
The reasons to be pessimistic about the forecast’s outcome are contained in the IMF’s own analysis. First and foremost, it admits that ‘geo-political risk’ has risen. Given Ukraine-Russia, Iraq-Syria-ISIS, and the rest of the growing list of trouble-spots around the globe, you can’t argue with that. You can hope that the list will shrink and that its component items will stabilize — but hope is not a policy and there is no strong rationale on which to base that hope.
There are plenty of other problems that are growing and that have significant disruptive potential, with the Ebola epidemic an obvious candidate — many African countries were among the fastest-growing in the world in recent years — but there is also the need to face the bitter truth that government policies in key countries are making things worse, rather than better. Japan is the leading and most important example; only yesterday, the Japanese government admitted that the economy is heading into recession — and may already be there.
But at least the IMF is now openly warning that the prolonged use of zero-interest monetary policies and the massive injections of liquidity they have required, have wrought huge damage to financial markets and made them very dangerous.
“Downside risks related to an equity price correction in 2014 have also risen, consistent with the notion that some valuations could be frothy,” were the actual words used and, not surprisingly, they were sufficient to trigger sharp falls in financial markets. The publication of poor data on German industrial production ensured that the German stock market led the way down, but almost every European market registered a sharp drop, continuing the generally weak tone of the last few days and weeks.
This column has flagged previous warnings from, inter alia, Fed chair Janet Yellen and the much less-well-known Bank for International Settlements, with regard to the over-heated state of the financial markets. In this context, the stock markets are far more prominent and closely-followed, but the extent of the over-valuation and the degree of risk is actually greater in the corporate bond markets.
Hitherto, the warnings have been largely ignored, in that the leading equity indices, at least in the US, made new record highs as recently as last month. The European and markets have been unable to emulate that, despite the fact that the European Central Bank is now conducting a looser monetary policy than the Fed — and that it is expected to loosen further, whereas the Fed is expected to tighten.
The canary in the financial markets’ coalmine, however, is the US dollar. Its strength in recent months is, on the one hand, a reaction to the divergent monetary policies just noted — but, on the other, a signal that liquidity is drying up everywhere. If central banks are unwilling and/or unable to take even more aggressive steps — and there is increasing evidence of such reluctance — then the ‘froth’ on the markets will rapidly disappear.