America is the Key to Global Recovery, but We Must be Willing to Play Our Part

The world economy is slowing, but how weak is it and what does it mean for us?

Twice in recent years, financial markets have been caught unawares. The first time, during 2016, was when markets failed to anticipate the pick-up in global growth. This strong pace continued through 2017 and into 2018. The second was last year, when markets failed to see the imminent slowdown.

Then growth weakened for a combination of reasons. Three stood out: the US-China trade dispute; tighter monetary policy; and a slowdown in China. Now interest rates look more likely to fall than to rise. Equity markets assume that this will allow global growth to stabilise or even rebound. In contrast, bond markets suggest that recession is nearby. Both cannot be right.

The trade dispute is hard to predict. President Trump and President Xi will meet on the side-lines of next week’s G20 in Japan. If they want to, these leaders could find a way to resolve their dispute. This would be the most welcome boost for the world economy, removing the biggest risk. Although not guaranteed, a resolution makes sense, but it may take a while to work out the detail.

In the meantime, monetary policy is again acting as the global economy’s shock absorber. Thus, there has been a U-turn in many countries. Across Asia, rates are falling.

The key, though, will be the United States, where the economic cycle will become the equal longest on record this summer. That, plus Mr Trump’s fiscal boost having already had its biggest impact, adds to expectations of a slowdown.

The Federal Reserve decided this week to keep interest rates on hold, but its doveish stance suggests a rate cut at the next meeting. The market expects three quarter-point cuts this year. If this happens, the US economy should stabilise, not slow, in the second half of the year.

The European Central Bank, meanwhile, has adopted a more doveish tone, too. It is just as well. Given the balance of risks facing the global economy, with growth slowing and inflation low, this is justified.

Bond yields are in negative territory in Germany and France and the poor performance of European bank shares signals tough economic times ahead. Expect European rates to stay low.

What about China, the world’s second largest economy and a key factor leading to the global slowdown? Last year the best way to think of policy in China was the three Ps: pollution control, poverty reduction and prevention of risks. It was the latter, in particular, that hit hard. Worried about a build up of leverage and debt, China tightened policy. By itself that would have slowed the economy, but in addition the trade dispute had an impact.

This year, in response, China has announced a significant fiscal stimulus. This should help the economy. The latest economic signals are mixed: in all likelihood the official forecast of 6 per cent to 6.5 per cent growth for 2019 will be met. To put this in perspective, at 6.5 per cent China would grow in one year by the equivalent of the Dutch economy, the 17th largest in the world. At 6 per cent it would add the equivalent of Saudi Arabia, the 19th largest economy.

In the past the saying was that if America sneezed the rest of the world caught a cold. That is still true but now applies to China, as well. In fact, a significant feature this year is renewed competition from emerging economies, suppressing global inflation.

Of course, there is the perennial question about data accuracy. In recent days, for instance, Guanghan in Sichuan province has been the latest area that the Chinese National Bureau of Statistics has found to have falsified data. This bureau has been reporting irregularities since the end of last year and was identified as part of a welcome national campaign.

This is also a problem in India. Over the past week Arvind Subramanian, India’s former chief economic adviser, has cast doubt on its GDP data and whether it overstates growth. Others dispute this and since its recent election India is expected to grow more strongly.

The reality is that the pace and scale of change overseas is phenomenal. Unfortunately, however, one measure that appears to be accurate is the amount of debt globally. This has risen substantially over the past decade to about three and a quarter times the size of the world economy. Low rates help debt servicing, but also encourage more borrowing.

Despite this, a debate continues about how much room there is for fiscal manoeuvre. This varies by country. Take the UK: the government’s debt dynamics are improving, creating more fiscal headroom. Since the 2016 EU referendum, the economy has demonstrated how flexible and adaptable it is, adding a million jobs — over the past year all full-time. If the world economy slows, however, jobs growth here will slow, too.

Wage growth is rising slowly and with low inflation should underpin consumption, but we have too many low-paid jobs. The Living Wage Foundation is right to keep pushing more larger firms to boost wages.

After 0.5 per cent growth in the first quarter, the UK looks likely to have stagnated between April and June. Uncertainty most likely will boost stockbuilding and depress investment before the October 31 Brexit deadline.

Yet while Brexit uncertainty persists, it should not divert attention from the longer-term trends driving global growth: climate change, demographics and the fourth industrial revolution. While disruptive, they will deliver innovation and investment.

In climate change, the UK is taking a lead. The Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Imperial College is at the forefront of the global debate. The government has committed itself to zero net emissions. We are not immune to the global slowdown and should join in the policy action to stabilise growth. Likewise, we must recognise the new economy under way globally and be at the forefront of the investment, infrastructure and innovation needed.

This article, written by Gerard Lyons, appeared in The Times on Saturday 22nd June, 2019.

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