The global economy—let’s make hay while the sun shines

This week, the Economist’s cover line was “On the up,” referring to coverage of a synchronised upturn in global growth. The main story here—which has been echoed by commentators around the world—is quite important. For the first time since the synchronised economic bounce-back after the 2008-09 recession, the global economy is firing on most, if not all cylinders.

So does this mean that everything’s fine? Not quite. But let’s start with the good news, which is indeed something to cheer about.

The global purchasing manager’s index, which aggregates survey data in manufacturing and services for the most important economies in the world, started turning up gently in the middle of last year, and by February 2017 it was at its highest level for over two years. The manufacturing survey was at its highest since 2011. This marks a material change from the two and a half years to mid-2016 in which these indicators declined consistently, indicating the world economy was in a sour state.

In the Euro Area, the improvement has been as marked as anywhere. The composite manufacturing and services survey reading was stronger than at any time since April 2011, just before the euro crisis began in earnest. There is no question that problems remain with Greek debt and Italian banks, but the overall dynamic is different compared to the last few years: moderate growth is coming back and unemployment has fallen from over 12 per cent in 2013 to just over 9.5 per cent.

China has also turned its fortunes around, at least for the time being. Back in 2015 and 2016, financial markets and economic observers were fearful that China was succumbing to not just an economic stall but also a meltdown in its stock and currency markets. But a combination of up to $500bn of financial market support measures, the abandonment of verbal commitments to the use of market mechanisms for a more regulated and controlling policy approach, and a sharp acceleration in infrastructure and quasi-fiscal spending can do wonders to stabilise an economy temporarily. That is precisely what has happened. China can look to its crucial 19th Party Congress later this year in the knowledge that stability should prevail.

Japan managed to turn in its first positive reading on underlying inflation in February for the first time in two years and only the second time in nine years, and economists have been revising up estimates of capital spending and economic growth for the country in 2017. Significant improvements in economic activity indicators have also been registered in a number of emerging markets that had tumbled into sharp economic downturns over the last 2-3 years, as world trade drooped and as the commodity boom turned into a slump. Commodity-exporting emerging and developing economies barely grew at all in 2015 and 2016, and some notables such as Brazil, Russia and Nigeria lapsed into recession. In Brazil’s case, it was the most serious recession since records began in 1900, albeit abetted by a political crisis too. This year and in 2018, it looks like major emerging markets—including oil producers—have a slightly better outlook.

The US, though, is the single most important part of the world’s economic jigsaw. As I commented here recently, the Federal Reserve’s decision two weeks ago to raise interest rates for the third time since the financial crisis is being taken as a sign of confidence. After an extraordinarily long inventory rundown, lasting five quarters, the US economy is perkier, growing by 3.5 per cent and 1.9 per cent, respectively, in the last two quarters of 2016. The early indications for the start of 2017 are mixed, but employment growth has been firm, there has been some gentle rise in wages and labour force participation, and we have yet to see any impact from the Trump Administration’s spending and tax policies. Even if financial markets are exaggerating the growth boost from his tax and infrastructure policies, there should be some positive impact on growth in 2017, and a slightly bigger one in 2018.

What could go wrong? Unfortunately, quite a lot. Political risk looms large over the current expansion. The Dutch may have dodged a bullet in last week’s elections, but there are more battles to fight against resurgent populism and the restrictive, protectionist economic policies that populists embrace. Politics aside, though, economic expansions can’t be milked forever. Imbalances emerge over time, and someone’s balance sheet—whether it belongs to the government, companies, banks or households, deteriorates to the point where it threatens and then undermines the business cycle.

The US expansion is already getting on in years. It has been running for 93 months, compared to a US average of 58 months since 1945, and 95 months since 1990. It could continue into 2018, or even 2019, but equally there’s a high chance of another recession by then, given that monetary policy will likely be tightened and inflation will rise. If the US attempts to force-feed growth at this stage and ends up with higher fiscal deficits, a stronger US dollar and restraints over trade, the problems will be particularly pronounced.

Here in the UK, the expansion has also been growing old. It is about as mature as the US’ expansion, which makes it quite old when set against the average three year expansion from 1952-92, but still quite spritely compared to the unusually long 16 year expansion from 1992-2008. It certainly looks as though growth is now coming off the boil, as far as momentum goes, and the challenges ahead for the government in managing the process and consequences of Brexit will expose the UK to downside economic risks as well as to any untoward global developments.

Emerging markets may soon confront a shortage of US dollar liquidity as US interest rates and the dollar rise, and have to raise interest rates themselves at a time when the deadweight of accumulated corporate debt has to be refinanced or repaid. While China’s prospects look better now, the country will be hard-pushed to avoid credit stress and renewed capital outflows over the medium-term, and perhaps in the wake of the Party Congress at the end of this year.

The world economy looks good right now, relative to where it has been, but the “making hay” analogy is never more apt than when it does.