Notes on the global economy as of early April 2016
A Note on the Likelihood of Recession: With global inflation currently more than quiescent, there is no chance that global recovery will be—as Rudi Dornbusch used to say—assassinated by inflation-fighting central banks raising interest rates.
As for recovery being assassinated by financial chaos, we face a paradox here: Financial risks that policymakers and economists can see are those that bankers can see and hedge against as well. It is only the financial risks that policymakers and economists do not see that are truly dangerous. Many back in 2005 saw the global imbalance of China’s export surplus and feared disaster from a fall in the dollar coupled with the discovery of money-center institutions having sold massive amounts of unhedged dollar puts. Very few, if any–even among those who believed US housing was a massive bubble likely to pop—feared that any problems created thereby would not be rapidly handled and neutralized by the Federal Reserve.
The most likely danger of recession is thus absent, and the second most likely danger is unknowable.
That leaves the third: a global economy that drifts into a downturn because both fiscal and monetary policymakers sit on their hands and refuse to use the stimulative demand management tools they have.
Here there is, I think, some reason to fear. A passage from a recent speech by the nearly-godlike Stan Fischer was flagged to me by Tim Duy:
If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years–including in the second half of 2011–that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016. As Chair Yellen said in her testimony to the Congress two weeks ago, while “global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy”…
And Tim commented:
This… again misses the Fed’s response to financial turmoil…. I really do not understand how Fed officials can continue to dismiss market turmoil using comparisons to past episodes when those episodes triggered a monetary policy response. They don’t quite seem to understand the endogeneity in the system…
However, anything that could be called a “global recession” in the near term still looks like a less than 20% chance to me. But that is up from a 5% chance nine months ago.
A Note on China: I do not understand China. And I know I do not understand China. Perhaps that gives me an advantage in analyzing China, perhaps not. The relevant long-run fundamentals of China seem to me to be two:
- Your typical wealthy Chinese plutocrat-political clan seeks in the long run to have perhaps 1/3 of its wealth outside of China as insurance against political risks, and thus seeks an opportunity to export capital from China.
- Your typical North Atlantic business or investment group sees returns from further massive investments in China as uncertain and sees political risks as large but as capable of resolution over the next decade, and so will delay investing in China.
That means renminbi weakness as a background trend behind shorter-term financial- and political-business cycles. And that has to shape what the real risks are (large) and opportunities (smaller).
A Note on the Non-Need for a New Plaza Accord: I would say that international monetary affairs in the Global North high now need not an accord but, rather, the right kind of discord.
At my Berkeley office I dwell in the zone of influence of the truly formidable Barry Eichengreen. His strongly, and I believe correctly, argued view is essentially that he set out in Eichengreen and Sachs (1986): that what we need is not an accord but a currency war. Global North blocs—the U.S., Britain, the Eurozone, Japan—leapfrogging each other with aggressive competitive devaluations every four months or so are likely to produce positive monetary spillovers as large as anything that monetary policy could now produce.
But what could monetary policy now produce?
My career analytical nadir was my memo to my Treasury bosses in 1993 that NAFTA was likely to put upward pressure on the peso. My second-worst was my confident prediction at the end of 2008 that within three years North Atlantic nominal demand would be back to its pre-2008 trend. My third has been my prediction that Abenomics would be an obvious and substantial success. That third prediction was based on my reading of the 1930s, in which four aggressive reflationary régime changes—that of Neville Chamberlain as Chancellor of the Exchequer in 1931, that of Takahashi Korekiyo as Finance Minister in 1932, that of Hjalmar Horace Greeley Schacht as Reichsbank President in 1933, and that of Franklin Delano Roosevelt as President in 1933—had been substantial successes. The mixed success of Abenomics thus tells me that my views of what monetary policy tools would work and how well they would work are almost surely wrong, and that I need to rethink.
Thus as far as monetary policy is concerned I am at sea.
With respect to fiscal policy, however, I am much more confident: Blanchard and Leigh (2013) is convincing. DeLong and Summers (2012) is correct. Coordinated North Atlantic fiscal expansion—unless the money is spent in a truly perverse fashion—is highly likely to boost production with North Atlantic-wide multipliers of around 3 and to reduce debt-to-GDP ratios. Whether it will generate enough inflation to be unwelcome hinges on the state of aggregate supply in the North Atlantic. And there we are so far outside the bounds of previous experience that I do not think anyone can or should speak with confidence.
A Note on Negative Interest Rates: Cash should be a very attractive asset vis-a-vis Treasury bonds at any negative or, indeed, slightly positive interest rate. Containers full of durable, storable commodities should be a very attractive asset vis-a-vis cash—and more so vis-a-vis Treasury bonds and even cash at a wider range of interest rates up to nearly the long-term expected rate of inflation. The only way I can understand current strong demand for the interest-bearing securities and, indeed, the cash of reserve currency-issuing sovereigns possessing exorbitant privilege is that 2008-9 and the political reaction thereto has cast the existence of the Bagehot lender-of-last-resort into grave doubt. Thus we not only have East Asian and other sovereigns desperate for reserves to avoid another 1998, we have every major financial institution desperate to avoid another fall of 2008. These economic agents seem to me to be no longer pursuing sensible risk-return optimization strategies. Instead, they seem to seek enough reserves to surmount any possible future crisis so that they can stay in the game and then earn profits whenever normalization and the future come.
As to dysfunctionalities—so far I see no signs of massive malinvestments in physical or organizational capital that will pay large negative societal returns, and I see no taking of extraordinarily risky large positions by too-big-to-fail entities. I feel that dysfunctional asset prices that produce dysfunctional investments and dysfunctional portfolios. But I cannot see what they are…