September 2015 September brought more evidence that QE / monetary policy’s capacity to spur economic growth is exhausted. Yet, the distortions it creates in terms of misallocation of capital and rising inequalities are still mounting. This year, global GDP growth will stand at just under 2.5%, a full percentage point below the long-term pre- crisis average of 3.5%. In the foreseeable future, the contours of the economic landscape will be shaped by low nominal growth and low real interest rates - an “ice age” that will engulf both emerging markets (EM) and high-income countries. The crisis in EM is one of the main culprits responsible for the fall in potential global output. EM now account for 38% of global GDP (in nominal terms) - more than half when calculated in purchasing power parity terms. Thus, EM weakness inevitably has a contagious effect on the rest of the world. This year, EM growth won’t exceed 3.5% at best, constrained by excessive leverage, the collapse of export-driven growth and the exhaustion of the credit-fuelled consumer boom. Japan offers a dramatic example of how hard it is for a country to extricate itself from the deflationary morass. Despite the BoJ’s unprecedented monetary stimulus, last month Japan fell back into deflation, with CPI falling by 0.1% (Y-o-Y). In 2015, economic growth won’t exceed 0.4%, partly because Japan’s ageing population and shrinking potential workforce exerts a formidable structural headwind on GDP. This is proof that, as the saying goes, demographics explain two thirds of everything! The plunging rate of growth in the global working-age population (now amounting to about 1% per year, versus 2% until 20 years ago) is weakening or is about to weaken economic growth around the world. As trend economic growth equals growth in the labour force + growth in productivity, only technological innovation can offset the unfavourable demographics. In simple arithmetic terms, this means that if a country has an annual growth in its working population of 1% per year (like India in the next decade, down from 2.2% last decade), it will need to increase trend productivity growth to about 4% to achieve a GDP target of 5%. This is a tall order. We’ve written extensively about the raging debate between techno-optimists and techno- pessimists. Uncertainty prevails as to whether innovation and the digital disruption will unleash a productivity boom or not, and if so when. Immigration offers a solution to compensate for a country’s shrinking workforce. Consider Germany. Between now and 2050, its working population will drop from 54m to 40m. It therefore needs an inflow of 380,000 migrants per year to close the gap. Setting aside the moral argument, Chancellor Merkel’s policy of welcoming refugees makes sound economic sense. Those who claim otherwise are victims of the “lump of labour fallacy”: the false notion that there is a fixed amount of work to be done in the world, so that any increase in the amount a migrant worker can produce reduces the number of available jobs. Europe bashing is back in vogue. Yes: the continent is in the midst of several conflating crises - (1) the refugee crisis, which brings to the fore the issue of open borders and free movement of labour, (2) the geopolitical crisis with Russia (3) the economic crisis in the Eurozone, with a possible “Grexit”. Contrary to what the media and most analysts suggest, (1) and (2) can and will be dealt with. It’s the economic outlook that is more worrisome. With a current account surplus of 3.5% of GDP, the Eurozone recovery depends largely on net exports to the rest of the world. The US is outperforming most other economies around the world, but it won’t grow this year as much as the consensus’ estimate of 2.5%. The main reason: a “vicious” feedback loop - as the strength of the US economy becomes more apparent, it leads to an appreciation of the $ that negatively affects net trade and becomes a drag on growth by choking off the manufacturing recovery. The idea of “punishing”, and possibly even abolishing, cash is gaining traction. Influential central bankers and economists argue that paper money is not the best fit for a modern economy, and wonder whether central banks could issue a digital currency. Andrew Haldane in particular (the BoE’s chief economist) says that a stamp tax on cash or the widespread use of a digital currency such as the bitcoin would break the “zero lower bound” (the impossibility to reduce rates below 0 when people hold cash) when the next recession hits. The anonymity that cash affords would be the direct casualty of such a move, but the day when carrying cash arouses suspicion will arrive much sooner than most imagine. Volkswagen’s massive manipulation of emission tests, Pope Francis’s condemnation of “extreme consumerism”, Akerlof and Shiller’s (two Nobel laureates in economics) warning that “competitive markets by their very nature spawn deception and trickery”, the end-tail of the LIBOR scandal - all these form a disparate, yet common thread that points to the following: (1) in our digital world in which every product embeds a computer, the potential for manipulations rises dramatically; (2) the sacredness of the “free markets” in being increasingly questioned from many different corners. Policy-makers will react with a regulatory backlash, which, by its very nature, can only be behind the curve. The whole picture is one of growing disenchantment, disillusion and dissatisfaction in democratic societies. 2015 will be remembered as the year when loads of data was stolen through cyber-attacks. 2016 will be the year when data is not only stolen, but also manipulated, making it impossible to tell whether the information upon which we make decisions is accurate and reliable or not. Financial markets will be particularly vulnerable to this risk. In the coming weeks, “must-watch” issues include: (1) China – the current epicentre of concern, and whether (1.1) the devaluation, (1.2) capital outflows, (1.3) equity-market correction and (1.4) imports will worsen; (2) signs that deflationary trends are not transient (with a focus on PPI and inflation expectations); (3) the continuous fall of EM currencies against the $ and their feedback loop on EM economies; (4) the impact of the fall in oil prices on commodity exporters (including second-round effects such as Saudi Arabia’s decision to withdraw $70bn from global asset managers); (5) the vast array of global geopolitical and societal risks with a focus on developments in Syria and the broader MENA region. For real-time or in-depth analysis on any of these, and if you are interested in prediction markets to better forecast some of the risks, please contact us.
Barometer September 2015
Jan 31, 2016
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September 2015
n September brought more evidence that QE / monetary policy’s capacity to spur economic growth is exhausted. Yet, the distortions it creates in terms of misallocation of capital and rising inequalities are still mounting.
n This year, global GDP growth will stand at just under 2.5%, a full percentage point below the long-term pre-crisis average of 3.5%. In the foreseeable future, the contours of the economic landscape will be shaped by low nominal growth and low real interest rates - an “ice age” that will engulf both emerging markets (EM) and high-income countries.
n The crisis in EM is one of the main culprits responsible for the fall in potential global output. EM now account for 38% of global GDP (in nominal terms) - more than half when calculated in purchasing power parity terms. Thus, EM weakness inevitably has a contagious effect on the rest of the world. This year, EM growth won’t exceed 3.5% at best, constrained by excessive leverage, the collapse of export-driven growth and the exhaustion of the credit-fuelled consumer boom.
n Japan offers a dramatic example of how hard it is for a country to extricate itself from the deflationary morass. Despite the BoJ’s unprecedented monetary stimulus, last month Japan fell back into deflation, with CPI falling by 0.1% (Y-o-Y). In 2015, economic growth won’t exceed 0.4%, partly because Japan’s ageing population and shrinking potential workforce exerts a formidable structural headwind on GDP.
n This is proof that, as the saying goes, demographics explain two thirds of everything! The plunging rate of growth in the global working-age population (now amounting to about 1% per year, versus 2% until 20 years ago) is weakening or is about to weaken economic growth around the world.
n As trend economic growth equals growth in the labour force + growth in productivity, only technological innovation can offset the unfavourable demographics. In simple arithmetic terms, this means that if a country has an annual growth in its working population of 1% per year (like India in the next decade, down from 2.2% last decade), it will need to increase trend productivity growth to about 4% to achieve a GDP target of 5%. This is a tall order. We’ve written extensively about the raging debate between techno-optimists and techno-pessimists. Uncertainty prevails as to whether innovation and the digital disruption will unleash a productivity boom or not, and if so when.
n Immigration offers a solution to compensate for a country’s shrinking workforce. Consider Germany. Between now and 2050, its working population will drop from 54m to 40m. It therefore needs an inflow of 380,000 migrants per year to close the gap. Setting aside the moral argument, Chancellor Merkel’s policy of welcoming refugees makes sound economic sense. Those who claim otherwise are victims of the “lump of labour fallacy”: the false notion that there is a fixed amount of work to be done in the world, so that any increase in the amount a migrant worker can produce reduces the number of available jobs.
n Europe bashing is back in vogue. Yes: the continent is in the midst of several conflating crises - (1) the refugee crisis, which brings to the fore the issue of open borders and free movement of labour, (2) the geopolitical crisis with Russia (3) the economic crisis in the Eurozone, with a possible “Grexit”. Contrary to what
the media and most analysts suggest, (1) and (2) can and will be dealt with. It’s the economic outlook that is more worrisome. With a current account surplus of 3.5% of GDP, the Eurozone recovery depends largely on net exports to the rest of the world.
n The US is outperforming most other economies around the world, but it won’t grow this year as much as the consensus’ estimate of 2.5%. The main reason: a “vicious” feedback loop - as the strength of the US economy becomes more apparent, it leads to an appreciation of the $ that negatively affects net trade and becomes a drag on growth by choking off the manufacturing recovery.
n The idea of “punishing”, and possibly even abolishing, cash is gaining traction. Influential central bankers and economists argue that paper money is not the best fit for a modern economy, and wonder whether central banks could issue a digital currency. Andrew Haldane in particular (the BoE’s chief economist) says that a stamp tax on cash or the widespread use of a digital currency such as the bitcoin would break the “zero lower bound” (the impossibility to reduce rates below 0 when people hold cash) when the next recession hits. The anonymity that cash affords would be the direct casualty of such a move, but the day when carrying cash arouses suspicion will arrive much sooner than most imagine.
n Volkswagen’s massive manipulation of emission tests, Pope Francis’s condemnation of “extreme consumerism”, Akerlof and Shiller’s (two Nobel laureates in economics) warning that “competitive markets by their very nature spawn deception and trickery”, the end-tail of the LIBOR scandal - all these form a disparate, yet common thread that points to the following: (1) in our digital world in which every product embeds a computer, the potential for manipulations rises dramatically; (2) the sacredness of the “free markets” in being increasingly questioned from many different corners. Policy-makers will react with a regulatory backlash, which, by its very nature, can only be behind the curve. The whole picture is one of growing disenchantment, disillusion and dissatisfaction in democratic societies.
n 2015 will be remembered as the year when loads of data was stolen through cyber-attacks. 2016 will be the year when data is not only stolen, but also manipulated, making it impossible to tell whether the information upon which we make decisions is accurate and reliable or not. Financial markets will be particularly vulnerable to this risk.
n In the coming weeks, “must-watch” issues include: (1) China – the current epicentre of concern, and whether (1.1) the devaluation, (1.2) capital outflows, (1.3) equity-market correction and (1.4) imports will worsen; (2) signs that deflationary trends are not transient (with a focus on PPI and inflation expectations); (3) the continuous fall of EM currencies against the $ and their feedback loop on EM economies; (4) the impact of the fall in oil prices on commodity exporters (including second-round effects such as Saudi Arabia’s decision to withdraw $70bn from global asset managers); (5) the vast array of global geopolitical and societal risks with a focus on developments in Syria and the broader MENA region. For real-time or in-depth analysis on any of these, and if you are interested in prediction markets to better forecast some of the risks, please contact us.
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