Why the world economy feels so fragile

Political instability will make it harder to ride out a slowdown

Martin Wolf

Should we be concerned about the state of the world economy? Yes: it always makes sense to be concerned. That does not mean something is sure to go badly wrong in the near future. On the contrary, the world economy seems to be heading into just a mild cyclical slowdown. Far more important is the adverse longer-term structural and cyclical context because it makes any short-term swing far more perilous.

According to Goldman Sachs, the momentum of global economic growth slowed markedly in 2018. The most globally significant slowdown has been in the Chinese economy— the main engine of global growth since the financial crisis of 2007-08. But Germany and Japan also recorded economic contractions in the third quarter of last year. Stock markets have also been in turmoil. In part, that presumably reflects worsening perceptions of prospects. These falling markets should also weaken consumption and investment.

All this suggests a cyclical slowdown is on the way. Yet conventional forecasters are hardly unduly worried. The OECD stated last November that the “global expansion has peaked” and that global gross domestic product growth is “projected to ease gradually from 3.7 per cent in 2018 to around 3.5 per cent in 2019 and 2020, broadly in line with underlying global potential output growth”. This would be an ultra-soft landing. Consensus forecasts support this: the December consensus forecasts for growth in 2019 are little different from those made a year ago. Growth prospects for the US are even slightly upgraded. (See charts.)

A mild economic slowdown should hardly be problematic. On the contrary, it is to be expected. In the high-income economies, which still generate three-fifths of world output (at market prices), the cyclical upswing is elderly and excess capacity has fallen sharply. Where the expansion is most advanced and excess capacity has disappeared, monetary policy has been duly tightened, quite appropriately, pace Donald Trump. Happily, inflation is still subdued and nominal and real interest rates are low. While equity markets have indeed corrected, US stocks have rarely been as highly valued as today.

Nothing here suggests a severe global recession is on the way. Indeed, it bears remembering that while capitalist economies have always been cyclical, severe recessions, especially global ones, are rare. It would appear wise, in sum, for everybody “to keep calm and carry on”.

Yet there is a catch — a big one. As Ray Dalio of Bridgewater argues in a note on what is going on, the short-term cycle is the least of our challenges. There are also structural changes, which he summarises in terms of differential productivity trends, and the long-term debt cycle.

Crucially, these developments have made the world economy fragile.

“Productivity” should be viewed as a shorthand way of summarising the shifts in global economic power, widening inequality, collapse in employment in manufacturing, rise of the digital economy and the “savings gluts” of past decades. The long-term debt cycle, which accelerated from the 1980s, was, among other things, a way to manage the social and economic consequences of those structural shifts.

These structural shifts have had big political effects: a surge in nationalism and populism, Brexit, the election of Mr Trump, a trade war between the world’s two most important economies and an erosion of the liberal global economic order. The long-term credit cycle reached its denouement in the disastrous financial crisis of 2007-08. Today, China, whose long-term debt cycle accelerated after the crisis, is reaching the limits of debt accumulations, too.

These long-term conditions significantly constrain any optimism one feels over a short-term cyclical slowdown.

A powerful implication is that room for a response to a recession would be limited by historical standards, especially in monetary policy. If the US Federal Reserve had to make a standard response to a significant recession, its short-term rates might need to be minus 2.5 per cent. The European Central Bank and Bank of Japan would have to go further still. If the worst came to the worst, the Fed and the ECB might be forced to follow the BoJ into even more deeply unconventional policies. While the People’s Bank of China has more room for manoeuvre, reigniting China’s credit boom carries longer-term risks.

The transformation of the global environment brings further dangers, both negative and positive. The biggest negative risk is that it would be impossible to mount a co-ordinated and effective response to a severe global economic slowdown. One obvious positive danger comes from the possible unmanageability of the past accumulations of private and public debt. Another danger is that a breakdown in the global political order creates severe economic disruption on its own, perhaps through a collapse in trade, perhaps as a result of another geopolitical event.

The issue to worry about then is not the state of the short-term cycle. It is perfectly likely that there will be a modest and manageable slowdown, with nothing much damaged as a result. The worry must rather be over the context in which such a slowdown might occur. It is the political and policy instability, combined with the exhaustion of safe options for credit expansion, that would make handling even a limited and natural short-term slowdown potentially so tricky.

Unfortunately, no simple mechanisms for reducing these sources of fragility now exist. These are deeply ingrained and, given recent political developments, are more likely to get worse than better. If you do want to worry, you should worry about that.

Chinese Overcapacity Returns to Haunt Global Industry

Beijing’s ‘supply-side reforms’ helped reduce global overcapacity—for a while

By Nathaniel Taplin

Chinese overcapacity is back. That’s bad news for manufacturers world-wide—and for China’s mounting debt problem.

China’s producer prices rose just 0.9% in December, slumping from 2.7% in November as global oil prices fell sharply late last year. Most concerning is what lies behind the headline figures. Iron and steel sector producer prices fell for the first time since 2016. The decline in the auto sector PPI deepened. And the nonferrous metals PPI logged its fourth straight month in negative territory.

Just a few months ago, many analysts were convinced China had conquered its industrial-deflation problem, thanks to an aggressive campaign to shut factory capacity—mostly private-sector owned—in 2016 and 2017. That helped push global material prices back higher in 2017, as well as profits at iconic American companies such as U.S. Steel.

But that campaign coincided with big stimulus, which stoked demand for China’s property, infrastructure and automobile sectors, muddying its impact. The verdict is now in: Beijing’s “supply-side reforms” helped reduce global overcapacity for a while, particularly in the steel industry. But they probably weren’t deep enough to stave off a significant decline in global material prices, now that China’s economy is weakening and the benefits of previous stimulus efforts have mostly worn off.

A worker walking past rolls of aluminum at a factory in China. The nonferrous metals producer-price index remains in negative territory.
A worker walking past rolls of aluminum at a factory in China. The nonferrous metals producer-price index remains in negative territory. Photo: -/Agence France-Presse/Getty Images

In fact, the ugly PPI data confirms what has been evident for several months. Profits in the Chinese auto and nonferrous-metal sectors were down 6% and 17%, respectively, in the first 11 months of 2018. And new orders for manufacturers overall are once again growing much slower than production—as in 2014 to 2016, when China was mired in industrial deflation.

One relatively bright spot is the fact that the steel sector—China’s second- most indebted by the end of 2016—is still in reasonable shape. In contrast to 2015, there were no new steel company bond defaults in 2018 excluding previous delinquents, according to data from Wind. Capacity utilization in Chinese steel mills was holding up as of the third quarter of 2018. By contrast, sectors such as autos and chemicals logged steep falls. Iron and steel profits year to date were still up 50% in November compared with the same period in 2017.

Still, matters are likely to get worse in 2019—meaning China debt worries could soon start spooking markets again. And global industrial companies are in for a rough ride: Chinese capacity utilization tends to move tightly both with metals prices and purchasing managers indexes globally.

The Year of Trump?

If Trump’s iconoclastic style was merely a breach of traditional presidential etiquette, one might argue that his critics were being too fastidious, or were trapped in old-fashioned views of diplomacy. But crudeness can have consequences.

Joseph S. Nye


BEIJING – Time magazine did not choose Donald Trump as its Person of the Year in 2018, but it may do so this year. Trump ended last year facing criticism for announcing troop withdrawals from Syria and Afghanistan without consulting allies (resulting in the resignation of his respected defense secretary, James Mattis) and partially shutting down the government over a Mexican border wall. In 2019, with Democrats having taken over the House of Representatives, he will face increasing criticism of his foreign policy.

Administration supporters shrug off the critics. Foreign policy experts, diplomats, and allies are aghast at Trump’s iconoclastic style, but Trump’s base voted for change and welcomes the disruption. In addition, some experts argue that the disruption will be justified if the consequences prove beneficial for American interests, such as a more benign regime in Iran, denuclearization of North Korea, a change of Chinese economic policies, and a more evenly balanced international trade regime.

Of course, assessing the long-term consequences of Trump’s foreign policy now is like predicting the final score in the middle of a game. Stanford historian Niall Ferguson has argued that “the key to Trump’s presidency is that it is probably the last opportunity America has to stop or at least slow China’s ascendency. And while it may not be intellectually very satisfying, Trump’s approach to the problem, which is to assert US power in unpredictable and disruptive ways, may in fact be the only viable option left.”

Trump’s critics respond that even if his iconoclasm produces some successes, one must assess them as part of a balance sheet that includes costs as well as benefits. They argue that the price will be too high in terms of the damage done to international institutions and trust among allies.

In the competition with China, for example, the United States has dozens of allies and few disputes with neighbors, while China has few allies and a number of territorial disputes. In addition, while rules and institutions can be restraining, the US has a preponderant role in their formulation and is a major beneficiary of them.

This debate raises larger questions about the relevance of personal style in judging presidents’ foreign policy. In August 2016, 50 primarily Republican former national security officials argued that Trump’s personal temperament would make him unfit to be president. Most of the signatories were excluded from the administration, but were they correct?

As a leader, Trump may or may not be smart, but his temperament ranks low on the scales of emotional and contextual intelligence that made Franklin D. Roosevelt or George H.W. Bush successful presidents. Tony Schwartz, who co-wrote Trump’s book The Art of the Deal, notes that “Trump’s sense of self-worth is forever at risk. When he feels aggrieved, he reacts impulsively and defensively, constructing a self-justifying story that doesn’t depend on facts and always directs the blame to others.” Schwartz attributes this to Trump’s defense against domination by a father who was “relentlessly demanding, difficult, and driven…You either dominated or you submitted. You either created and exploited fear, or you succumbed to it – as he thought his elder brother had.” As a result, he “simply didn’t traffic in emotions or interest in others,” and “facts are whatever Trump deems them to be on any given day.”

Whether Schwartz is correct or not about the causes, Trump’s ego and emotional needs often seem to color his relations with other leaders and his interpretation of world events. The image of toughness is more important than truth. Journalist Bob Woodward reports that Trump told a friend who acknowledged bad behavior toward women that “real power is fear…You’ve got to deny, deny, deny and push back on these women. If you admit to anything and any culpability, then you’re dead.”

Trump’s temperament limits his contextual intelligence. He lacked experience, and has done little to fill the gaps in his knowledge. He is described by close observers as reading little, insisting that briefing memos be very short, and relying heavily on television news. He is reported to have paid scant attention to staff preparations before summits with experienced autocrats like Russian President Vladimir Putin or North Korea’s Kim Jong-un. If Trump’s iconoclastic style was merely a breach of traditional presidential etiquette, one might argue that his critics were being too fastidious, or were trapped in old-fashioned views of diplomacy.

But crudeness can have consequences. While pressing for change, he has disrupted institutions and alliances, only grudgingly admitting their importance. Trump’s rhetoric has downplayed democracy and human rights, as his weak reaction to the murder of Saudi dissident journalist Jamal Khashoggi demonstrated. Although Trump has echoed President Ronald Reagan’s rhetoric about the US being a city on the hill whose beacon shines to others, his domestic behavior toward the press, the judiciary, and minorities has weakened the clarity of America’s democratic appeal. International polls show a decline in America’s soft power since he took office.

While critics and defenders debate the attractiveness of the values embodied by Trump’s “America First” approach, an impartial analyst cannot excuse the ways in which his personal emotional needs have skewed the implementation of his goals – for example in his summit meetings with Putin and Kim. As for prudence, Trump’s non-interventionism protected him from some sins of commission, but one can question whether his mental maps and contextual intelligence are adequate to understand the risks posed to the US by the diffusion of power in this century. As tensions grow, reckoning with Trump may well become unavoidable in 2019.

Joseph S. Nye, Jr., is a professor at Harvard University and author of Is the American Century Over? and the forthcoming Do Morals Matter? Presidents and Foreign Policy from FDR to Trump.

Recession And Stocks In Free-Fall: Michael Pento’s 2019

Money manager Michael Pento has been bearish on both stocks and bonds for some time. 2019 is the year, he says, when the big crash finally arrives.

Some Predictions for 2019

Bond Yields Continue to Fall in First Half of Year 

The bond bubble continues to build and become a dagger over the worldwide economy and markets. Wall Street Shills are fond of claiming that global bond yields remain at historically low levels due to central bank manipulations, but this argument is no longer tenable. It was once true, but QE on a net global basis has now gone negative. And the data shows the amount of U.S. publicly traded debt relative to GDP is much greater today than it was prior to the start of the Great Recession-even after adjusted for the size of the Fed’s balance sheet–in other words, taking into account all the debt the Fed has purchased and is still rolling over. 
The amount of publicly traded debt in the U.S. has soared to 58% of GDP. This is up from 29% in 2007 when the U.S. 10-year Note was yielding 5%. The Fed is now selling $50b of bonds each month, with an extra $7.8T in publicly traded debt that it doesn’t own; and that equates to nearly 2x the amount of debt compared to GDP than what existed just prior to the Great Recession. This debt must now be absorbed by the private market and at a fair market price, instead of just purchased mindlessly by the Fed…and yet yields are still falling. This means investors are piling into sovereign debt for safety ahead of the global economic crisis even though they understand that debt is, for the most part, insolvent. 
Recession Begins Prior to Year’s End 
The yield curve continues to invert and presages a recession that begins in late 2019.  
Meanwhile, the nucleus of the next credit crisis (the leveraged loan and junk bond markets) implode; as corporations need to roll over more than $800 billion of debt at much higher interest rates this year. 
My Inflation/Deflation and Economic Cycle Model has 20 components. 19 out of 20 indicators are indicating we are about to enter into a recession. Only initial unemployment claims remain at a positive level. I believe GDP growth in Q1 2019 will have a one handle in front of it because the 2nd derivatives of growth and inflation are slowing significantly. Therefore, we are headed into sector 1 of my Inflation/Deflation and Growth Spectrum; where assets are falling sharply as the economy is deflating. 
Trade War Truce 
The Main Stream Financial Media will continue to obsess over Trump’s twitter account to find out if some U.S. trade delegation met with someone in China and had a nice conversation. And, if President Trump announces that General Tso’s chicken is his favorite meal. 
Trump will end the trade war soon and claim that it was the biggest and greatest deal in human history. Hence, my prediction: the tariffs against China are lifted in Q1 2019. This is what all the perma-bulls are waiting for. But that isn’t going to bail out the market. A trade deal with Mexico was reached back on August 27th, but that didn’t stop its stock market from crashing 20%. 
Debt and Deficits Soar Globally 
Sovereign debt skyrockets at an even faster pace than the breakneck speed witnessed since the Great Recession. In this same vein, in the U.S. the federal budget deficit surged to a record for the month of November to reach a negative $204.9 billion. The Treasury Department says that the deficit for November was $66.4 billion higher than November of ’17. For the first 2 months of this fiscal year, the deficit totaled $305.4 billion, up 51.4% from the same period last year. Deficits this high outside of a recession are both highly unusual and dangerous. 

My Prediction: the U.S. deficit for fiscal 2019 breaches far above $1 trillion; and this type of fiscal profligacy is replete throughout Asia, Europe and in emerging markets. Indeed, there isn’t a shred of prudence found pretty much anywhere in the world. 
This massive increase of $70 trillion in debt since 2007, which adds up to $250 trillion globally, must now rely on the support of investors instead of the mindless and price insensitive purchases of central banks. Therefore, the potential for a 2012 European-style debt crisis occurring on a global basis is likely in 2019. 
Equity Markets Go into Freefall

The U.S. stock market takes its most significant leg down since 2008 in the first half of the year. The economic data and earnings reports will be extremely negative in comparison to the first half of 2018. For instance, Q2 of last year reported GDP growth of 4.2%. However, it is very likely that Q1 of this year will have GDP growth of just around 1% and Q2 could come in negative. 
The total value of the market could drop by 25% and still be at a valuation level that is equal to 100% of GDP. And that assumes GDP doesn’t drop. But at 100% of GDP the market would still be, historically speaking, about twice as overvalued as it was from 1974-1990. Hence, I predict the worst of the stock market is still very much in front of us. The Fed will continue its $50 billion per month of reverse QE-at least until the stock market drops another 20% from here. And, the ECB is now out of its massive €80 billion per month QE program. Therefore, despite the fact that the Fed goes on hold with further rate hikes, asset prices remain in peril–at least until the Fed is actually cutting interest rates and ends Quantitative Tightening. 
D.C. Chaos 
And finally, 2019 will be marked by a conflagration in our government. The year will be marred by budget showdowns and shutdowns, debt ceiling brinksmanship and indictments from Special Prosecutor Robert Mueller. Those hoping for cooperation between Democrats and Republicans on things such as a massive debt-funding infrastructure spending package to save the economy will be greatly disappointed. The cacophony between Democrats and Trump adds to the dysfunction in D.C. and puts added pressure on the market.

Concluding Prediction 

The global bond bubble continues to slam into the reality of the end of central bank support. That is the salient issue concerning economies and markets worldwide.  
Household net worth (think real estate and equity portfolios) as a percent of GDP reached over 525% at the start of Q3 last year. According to Forbes, the average for that figure is 380% going back to 1951. The sad fact is that the “health” of the global economy (however uneven and biased against the lower and middle classes) has become completely reliant upon the perpetual state of these unprecedented asset bubbles.  
Therefore, as they implode they are taking the global economy down with it. 
This process will only intensify throughout 2019. As former Fed Chair Alan Greenspan said recently, “run for cover”…he’s finally got it right.