The growth rate of the global economy is experiencing its weakest patch since the “upswing” in the cycle began in 2009. Of course, it has never been much of an “upswing”, given the depth of the recession which followed the financial crisis at the end of 2008. Still, the big picture seemed to suggest that global GDP was slowly on the mend, if not at a pace which could reduce global unemployment very rapidly. Now, even that modest recovery seems to be at risk.
Yesterday, we saw another leg of the policy response to this renewed slowdown. Monetary easing from the ECB, the Bank of China and the Bank of England followed earlier action by the Federal Reserve. As noted in this earlier blog, the central banks are back in play.
Markets have not been oblivious to this renewed round of easing: since the end of May, global equities have risen by 8 per cent and commodity prices have recently rebounded from their lows in spectacular fashion. Although ”shock and awe” from the central banks seems to have been replaced by a sense of rather tiresome routine, the impact of QE on market psychology has not entirely lost its traction.
That will only last, however, if the current global slowdown proves to be just another mid-year lull in a generally recovering world economy. So what are we to make of recent data?
There is no denying that the business surveys which have just been published for June make bleak reading. The global PMI/ISM readings on output, which usually provide a reliable early signal of global activity in real time, fell by 1.7 points in manufacturing, and by 1.9 points in non manufacturing. These surveys appear consistent with annualised global GDP growth running at around 1 per cent, the lowest reading since the Great Recession ended.
Furthermore, the geographical pattern of data shows that the US economy has now been sucked into the malaise which has affected the eurozone and China for many months. And global new orders are falling more rapidly than before, especially in the export sector. The good news is that excess inventories are also now falling a little, but the necessary adjustment in the inventory cycle is being held back by the generally anaemic behaviour of both retail sales and fixed investment so far this year. Most economists expect the stock cycle to take a while longer to sort itself out.
That is also the message which emerges from the key global leading indicators which this blog tends to rely upon. Financial markets are often very sensitive to small monthly variations in these indicators. The general pattern since the last mini-cycle peaked in November 2011 has been one of progressive weakness, which has shown signs of worsening in Q2. The Goldman Sachs Global Leading Indicator, which is relevant because it contains “hard” global data rather than equity prices, suffered an across-the-board decline last month. Goldman economists noted that this was the most generalised signal of weakening seen since the Lehman crisis.
The pattern of mid-year economic weakness has, of course, been seen before in both 2010 and 2011, and it is possible that quirks of the seasonal adjustment process are still exaggerating the slowdown. But the bigger picture does look troublesome. A glance at the top chart shows that the rebound in global activity from mid 2009 to mid 2011 has not been sustained. There have been mini cycles in the data, but there is no doubt that the world economy is finding it difficult to sustain a growth rate which is at or above its long term trend.
There could be many reasons for this, on both the demand side and the supply side. The most obvious demand-side diagnosis is that, in a climate of widespread deleveraging by the private sector, the onset of fiscal tightening (by around 0.5-1.0 per cent of GDP per annum) has been too much for the system to bear. A important codicil to this analysis would be that quantitative easing by the central banks, though effective in its early stages, has lost the power to overcome these other sources of weakness in demand.
Those of us who have been sympathetic to the fiscal consolidation/QE combination as the least bad way of supporting aggregate demand have some explaining to do. That would include the IMF, the OECD and most policy officials in the developed economies, who are now down-grading their economic forecasts. The first inklings of a coherent response to this problem have come in the UK, with the combined use of the central bank and treasury balance sheets to boost bank lending and infrastructure spending. That could be the start of a more widespead initiative.
On the supply side, the evidence is more debatable. The notion that structural unemployment has risen since 2008 is not well supported by the evidence, though the persistence of very high levels of long-term unemployment may soon start to erode the skills and size of the labour force. Concerns about the sustainability of government debt, and the fiscal cliff in the US, could be undermining fixed investment and the growth of the capital stock, though weak demand is probably the critical problem here. And clearly the structural weaknesses in the periphery of the eurozone are very real, not just figments of German imagination.
But the main problem on the supply side stems from commodity prices, especially oil. Several times in the past few years, rising oil prices have put the brakes on the world economy, raising headline inflation rates despite the large amounts of spare capacity in the domestic economies in America and Europe. That is what happened late last year. With oil prices now off their peaks, this “oil regulator” should soon work to boost economies, which is why the mini-cycle may experience another upswing before the end of 2012.
But on a longer term view, competition for scarce energy resources is clearly making a sustained global recovery even more difficult to achieve. That is one problem which can certainly not be solved by easing fiscal policy.