Opinion
Why global economy is headed for a perfect storm
Summary
- A range of global threats loom that should make us brace for worse economic conditions.
Liability-driven investing may prove to be one of those clunky bits of financial jargon, like ‘sub-prime mortgages’ during the Global Financial Crisis, that we are all going to become familiar with. These derivative contracts have been used by UK pension funds to ‘protect’ their investments in bond markets and hedge against swings in interest rates. Unfortunately, the wild rise in UK government bond yields and fall in bond prices after the Liz Truss government unveiled a ‘mini budget’ in late September was so extreme that the pension funds had to raise cash positions, leading to a further drop in bond prices. Disaster loomed for many defined-benefit pension plans that have 10 million members and £1.5 trillion in assets under management; the UK’s central bank was forced to step in. On Wednesday, Bank of England (BoE) officials reiterated that its emergency £65 billion bond-buying programme will end Friday, sending the yield on the 30-year UK bond higher to 5%.
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Everywhere one looks more than a decade of easy money has led to excesses, from the UK’s until-now boring pension fund industry and property markets across much of the developed world to overvalued startups in India and elsewhere. Now, the effects of higher interest rates (still not positive after adjusting for inflation) and high inflation are made worse by epic miscalculations by politicians and central banks. The Bank of Japan is alone in the developed world in keeping interest rates low: the yen has fallen to an almost quarter-century low in response.
Like extreme weather events, the storms keep coming and in higher frequency. Just as oil prices were headed down because of markedly slower growth in China, the Organization of the Petroleum Exporting Countries (OPEC) decision last week to cut production sent them up again. Only yesterday it seemed supply chains worldwide were rocked by chip shortages. Last Friday, Samsung Electronics, the world’s largest memory chip-maker, said its operating profit for the quarter ended in September fell by almost a third. Analysts warned that demand for smartphones, TVs and computers was falling “very fast", and chip orders being slashed faster still due to high inventories.
On Tuesday, the International Monetary Fund (IMF), while cutting its global gross domestic product (GDP) growth forecast to an overly optimistic 2.7% in 2023, warned there is a 25% chance that growth would fall below 2% next year and a 15% chance it might fall below 1%. The trouble is, as with climate change, this bunching of bad news, ranging from geopolitical crises and the effects of a strong dollar on emerging markets to a quake in UK pensions, makes economic forecasting more problematic than, say, forecasting the progress of this year’s unending Indian monsoon.
Unpredictable politicians make it harder still. The OPEC+ decision last week to cut production by 2 million barrels per day—or 2% of global production—was justified by Saudi Arabia as a response to rising interest rates and weaker global growth. Still, its timing suggested to many observers a bizarre settling of political scores by Saudi Prime Minister Mohammed bin Salman al Saud directed at the Joe Biden administration. The Saudi administration is seen as partial to former president Donald Trump and his family. Higher oil prices could prove crucial to damaging the prospects for US Democrats and tilting the balance in the US Congress after mid-term elections due in a couple of weeks. President Biden may well come to regret having said during his election campaign that there was “very little redeeming social value in the present government in Saudi Arabia." There is much truth to that, but unless the world can rapidly shift to non-fossil fuels, realpolitik demands discretion. Then again, a period of sustained higher oil prices may be what the world needs to reduce its dependence on oil, but the timing is not ideal. Currencies in emerging markets are under pressure from Indonesia to India as current account deficits widen dramatically (in the Philippines to 7% of GDP by the end of this year).
None of this seems to weaken the resolve of the world’s grim gang of autocrats and populists who appear to take pride in laughing in the face of economic realities. Russian President Vladimir Putin’s bombing of civilian targets and handing control of the war effort to a general with a reputation for brutality in Syria suggests Russia’s invasion of Ukraine is turning uglier. In China, President Xi Jinping seems bafflingly intent on pursuing a covid elimination strategy despite relatively low rates of vaccination, inferior China-made vaccines and higher transmissibility of Omicron variants. China’s prolonged property market slump and sharp slowdown in GDP growth is hurting Asian economies and global demand. If the upcoming US midterms swing control of Congress to the Republicans, Trump’s hold on the party will get stronger. The dysfunctional gridlock in American politics will only intensify.
This week, IMF chief economic adviser Pierre Olivier Gourinchas highlighted the new UK government’s peculiar dislike of economic orthodoxy and embrace of expansionary fiscal policy via lowering taxes and higher spending a fortnight ago just as the BoE was tightening. He said it was akin to two drivers having separate steering wheels in the same car. The trouble for the global economy is that many of the world’s political leaders seem to be driving drunk, even as multiple hairpin bends of financial stress loom ahead. Forget the Bollywoodesque fantasy that India can decouple. Fasten your seat belts, as the old line goes, it’s going to be bumpy.
Rahul Jacob is a Mint columnist and a former Financial Times foreign correspondent.
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