IN 2017 the global economy broke out of a rut. It grew by 3.8%, the fastest pace since 2011. Surging animal spirits accompanied a rebound in business investment across the rich world. Global trade growth rose to 4.9%, also the fastest rate since 2011. Emerging-market currencies appreciated against the dollar, keeping inflation low and debts affordable. Financial markets wobbled in February, but only after reaching all-time highs. In April the IMF said that the global economic upswing had become “broader and stronger”.
Since then that healthy glow has begun to fade. First, economic surveys in Europe took a turn for the worse (presaging growth in GDP of only 1.6%, annualised, in the first quarter). Then the rest of the world seemed to catch the same cold (see chart 1). In the first quarter America’s growth slowed to 2.3%, annualised, from close to 3% in the preceding six months. At the same time, Japan’s economy shrank by 0.6%, ending a growth spurt sustained since the start of 2016. Investors have begun to wonder if the period of global exuberance is over. Even policymakers in China, which has seemed relatively immune to the slowdown, have taken note of weakening domestic demand. In mid-April they loosened monetary policy slightly by allowing banks to hold fewer reserves.
Meanwhile, the slow upward march of American bond yields—the result of expectations of higher inflation and interest rates—has turned the screw on emerging-market currencies, which have fallen by 5.4% since the start of April (see chart 2). A run on the peso has forced Argentina to ask for an IMF bail-out and raise interest rates to 40%. The Turkish lira has also taken a beating, in part because the president, Recep Tayyip Erdogan, says that low interest rates reduce inflation (see Buttonwood). On May 15th he promised to take more control of monetary policy after the upcoming election.
Make no mistake: world growth has slowed, but it remains strong. Surveys of activity in China, America and Europe are, when combined, higher than they have been 83% of the time over the past decade, according to UBS, a bank. Poor weather may have depressed European growth in early 2018. America’s economy often seems to slow early in the year, only to rebound, a phenomenon dubbed “residual seasonality”. Strong retail sales and high consumer confidence suggest that if a downturn is coming, Americans have missed the memo.
In a way, however, that is part of the problem. Demand is piling up where it is least needed. American core inflation, which excludes volatile food and energy prices, is now 1.9%, according to the Federal Reserve’s preferred measure. That is only just below the central bank’s target. And the economy has yet to feel the full impact of the tax cuts and spending rises President Donald Trump recently signed into law.
Outside America, however, inflation is falling short almost everywhere. In the euro zone it is only 1.2%, no higher than at the end of 2016. The Bank of Japan recently abandoned its pledge to raise inflation to 2% by fiscal year 2019—a target it had already postponed six times. Inflation in most emerging markets has been subdued, too. Even in Brexit Britain, where a big fall in the pound pushed inflation well above the 2% target in 2017, it has tumbled more quickly than expected.
In theory, the world economy would be better off if this demand were spread around. Unfortunately, the mechanism that could achieve that is a dangerous one: a stronger dollar. In theory a rising greenback should allow Americans to buy more imports, stimulating foreign economies. In practice a rising dollar can play havoc with emerging markets that have dollar debts. And because so much trade is invoiced in dollars, a stronger American currency reduces trade between other countries, too. Four of the past five Fed tightening cycles have eventually triggered a crisis in emerging markets.
Yet there are reasons to be more confident this time. Among the ten largest emerging markets, only Turkey and Argentina ran current-account deficits greater than 2% of GDP in 2017. Most have dollar debts that are comfortable compared with the size of their economies.
Another threat talked up by bears is the oil price, which has risen to close to $80 a barrel. They think this will push inflation up further, forcing higher interest rates. But the Fed usually ignores temporary inflation driven by energy prices. And predicting the impact of oil prices on the world economy has become trickier than it was before the shale revolution. Pricier oil now tends to boost American investment. In any case, it is driven at least partly by demand, reflecting healthy growth.
The biggest risk to the world economy remains the possibility of a trade war. Mr Trump is negotiating with China and others with the aim of closing America’s trade deficit. That is difficult to square with a rising dollar sucking in imports. The danger is that slightly slower global growth, combined with ongoing stimulus in America, lays bare this problem and further provokes Mr Trump’s protectionism. That could set off a downturn that would really be worth worrying about.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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