Photo: Reuters
Photo: Reuters

Opinion: Global economic events predict pathos in the coming year

Emerging economies have to contend with economic and political turbulence in China

It is that time of the year when we peer ahead into the New Year in a vain (pun intended) attempt to see what it holds for us.

A meeting of the Federal Open Market Committee concluded last week. The Federal Open Market Committee raised the federal funds rate to 2.25% and 2.5%. Apparently, in the wake of the rate action by the Federal Open Market Committee, US President Donald Trump had contemplated dismissing Jerome Powell, chairman of the Federal Reserve Board. If he
did that—very few think that he
has the powers to do so—he would unleash the very crash in asset prices that he thinks that the rate hikes are precipitating.

Rate hikes are, at best, only peripheral to the decline in asset prices. Cycles are inevitable and contrary to what Powell’s predecessors told us, business cycles have neither been moderated nor eliminated.

The economy is in its 10th year of expansion. It will slow down because, inevitably, excesses build up over a long expansion. They have to be eliminated. A recession in 2019 in the US will neither be surprising nor undesirable. One can, therefore, say that the 10-year bond yield bear market is yet to begin and that the
yield will stay to the south of 3% for the most of the year.

That will not necessarily mean that the dollar will collapse. On the contrary, the dollar is a countercyclical currency. As the US economy slows, its imports decline and the trade deficit declines slightly. Global dollar liquidity declines at the margin.

Therefore, it will be premature to write off the dollar strength in 2019. That should be the base case, unless political developments raise fundamental questions on the global role of the dollar.

Somehow, many are comfortable predicting a smoother year for emerging economies and assets next year after a rough ride in 2018. I am not one of them. If the US economy enters a recession and if stock prices in America decline while the dollar rules firm, it is difficult for emerging market assets to perform well, in absolute terms. They may or may not perform better in relative terms. That is small consolation for investors.

In addition, emerging economies have to contend with economic and political turbulence in China. Xi Jinping’s speech on the 40th year of the China economic reforms did not rekindle the spirit of economic openness and liberalisation. Not that China ever embraced it openly even as its fans in the West swallowed the propaganda and spread the myth around. The rest of us are better off reading Michael Pillsbury’s The Hundred-Year Marathon: China’s Secret Strategy To Replace America As The Global Superpower. China wrongly believes that the decline of the West has begun and that the time has come for it to declare its arrival on the world stage as the true Middle Kingdom. However, such celebrations are premature.

China’s economy is hurting from the trade actions that the US has taken. For the first time in nearly four decades, a bipartisan consensus has emerged that China poses a threat to American hegemony and technological dominance.

Recently, America and Britain have charged China with industrial espionage. Many countries have shut their doors to Huawei, with the curious exception of India. Retail sales, industrial production and foreign direct investment into China have declined. A lot of economic data has been withheld from publication and there is a gag order on reporting bad news. Recently, Moody’s Investors Service came up with several reports that tell the story of China’s painful dilemmas— between deleveraging and economic stimulus to preventing the recent slowdown from becoming deeper and prolonged—and reluctance to face up to its debt problem, especially in local governments.

It is not even clear that opening the credit taps would help as much as it did in the past as incremental debt, on top of the debt pile already accumulated, would be less effective in stimulating economic growth.

China will also cast a long shadow on the commodities markets—industrial metals especially—and on Asian economies and stock markets.

Europe never really came out of the 2008 recession. Notwithstanding the bombast by the president of the European Central Bank (ECB) Mario Draghi that he would do what it takes to keep the eurozone together, the political cost of ECB’s monetary policies and eurozone’s structural weaknesses has been substantial.

European “liberal" elites refuse to acknowledge the anger and alienation that their policies cause while economic policies favour asset markets and corporate malfeasance more than they stimulate the real economy. Disaffection is widespread across Europe. That is what recent local elections in Spain and the strife in France indicate.

Therefore, the strength of the euro is to be sold and not bought.

In short, the last few months of 2018 will turn out to have been the curtain-raiser for the pathos that 2019 will be.

V. Anantha Nageswaran is the dean of IFMR Graduate School of Business (KREA University).

These are his personal views.

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