The biggest risks come more from politics than economicsby Duncan Weldon / December 13, 2018 / Leave a comment
Global economic momentum at the start of 2018 was good—at the end, less so. 2017 saw the strongest global growth in a decade and a simultaneous expansion in all the world’s major regions. At the beginning of 2018, that pattern looked set to continue.
In recent months, however, European growth has come off the boil, and an escalating trade war and outbursts of instability in Turkey and Argentina, combined with rising US interest rates, have spooked markets. Global growth has begun to slow. The fight between the new populist Italian government and the eurozone authorities over the budget is bringing back memories of the last eurocrisis, while the agonising grind of Brexit continues. The IMF has revised down its forecasts for 2019 and 2020 and ever more voices are arguing that global expansion is in its final phases.
But this immediate pessimism is overstated. The weakness of the last few months is partially driven by temporary factors in a couple of major economies: tighter emissions regulations that hit German car production; and flooding in Japan that hit manufacturing. Argentina and Turkey have had a tough year, but their respective crises owe more to idiosyncratic national factors than any general problem in the emerging economies. US growth remains robust, with a tightening labour market, evidence of (finally) growing wages and above-trend growth, helped by tax cuts.
While the global economy is not about to fall off a cliff, there are growing fragilities and risks. One counter-intuitive source of risk is that the US economy is doing too well when compared to its major peers. The divergence between US and European growth has led to rapidly diverging monetary policies. Since late-2015, the US has been hiking interest rates—by contrast, the European Central Bank is only just in the process of ending its own programme of quantitative easing and rate hikes are a long way off.
If US rates continue to rise faster than their European equivalents, then the relative attractiveness of the returns available on dollar-based assets will continue to pull money towards the US. A rising dollar tends to signal problems for the emerging economies, as money flows back away from the periphery of the global economy towards its centre.
A stronger dollar—which raises the cost of US exports, and cuts the price of its imports—won’t help with President Trump’s obsession: the US trade deficit. While he has turned to tariffs in a futile attempt to cool imports, the stronger dollar is pushing against this. Trump’s “trade war” so far has generated a lot of noise, but less concrete action. Instead, the new US-Mexico-Canada trade agreement looks suspiciously like the North American Free Trade Agreement it is “replacing,” while the US-EU trade fight is more skirmish than war. The potential is there for escalation—especially if Trump puts tariffs on European cars, which would draw a strong response from Brussels—and for more confrontation with China.
But the Republican loss of control in the House of Representatives raises the risks. First because, with the possibility of domestic legislative changes closed to the White House, Trump will double down on what he can do without Congress (which includes most trade policy). Second, the president may now feel the need to throw more red meat to his “America First” base.
Away from the US, there are two big, familiar concerns—Chinese debt and European politics.
Much of China’s debt is concentrated in local governments and state-owned entities which are both opaque and troubling. But in recent months, more than 80bn RMB-worth of corporate bonds have gone into default, up from 50bn in 2017. There are signs that the long-feared consequences of the credit boom may finally be emerging.
In Europe, much of the angst has focused on Italy and the clash between its government and Brussels over its budget. That fear can be overdone: Italy is extremely unlikely to leave the euro or default on its obligations.
The global economy enters 2019 in a state of relative health. The fundamentals still look decent. But in short, the biggest risks come more from politics than economics.