As the G20 nations concluded their fractious meeting in Argentina with a statement that papered over some deep and worrying divisions on climate and trade policies, the latest results from the Fulcrum nowcast models continue to suggest that the global economy is slowing down quite markedly.
This autumn, there have been shades of the more serious market crisis in 2015-16, when a major slowdown in China, together with a tightening by the Federal Reserve, triggered an episode of severe nerves about global deflation.
The good news is that the Fed has now changed its tune, with Jay Powell’s speech and the FOMC minutes last week clearly indicating that the central bank is preparing the markets for a pause in rate hikes after the December meeting.
China, however, still remains a major downside risk to global growth. The latest nowcast has fallen to only 5.2 per cent, much lower than forecast earlier in the year.
Admittedly, the current episode has still not quite reached the extremes of the 2015/16 crisis. Whether or not it does so depends on the eventual success of the trade talks with the US, taken alongside the policy easing currently under way in China. If Beijing’s fiscal stimulus fails to boost domestic demand sufficiently to offset any further tariff increases, the outlook for global growth next year will be quite bleak.
Fortunately, that now looks like a downside scenario, not the base case, for 2019.
The outcome of the Trump/Xi dinner on Saturday represents nothing more than a truce in the escalating trade wars. Entrenched problems remain, notably around US concerns about the protection of intellectual property, and the long term direction of Chinese industrial strategy. It is still very difficult to imagine that these gulfs can be bridged without further threats of trade protection from the Trump administration.
Nevertheless, the planned January increase in the American tariff rate from 10 per cent to 25 per cent on another $200 billion of Chinese exports will now be shelved while talks continue. Furthermore, the threat of extending 25 per cent tariffs to all Chinese exports during 2019 looks less probable than hitherto.
The downside risk from 25 per cent tariffs on all goods would be severe. Many economic simulations have indicated that the damage to Chinese GDP growth next year would be of the order of 1.0-1.5 per cent. This shock could be too large to be handled by the new style of policy easing currently under way in China.
The Chinese economy has been slowing sharply since mid 2018 (see box below), largely as a result of the Xi administration’s determination to reduce leverage in the financial system over the period from 2017-20. This objective is clearly having a major dampening effect on credit growth, with total social financing (a broad aggregate) slowing from 17 per cent in late 2016 to 11 per cent now. These domestic issues have been far more important this year than the direct effects of trade sanctions.
It is clear that the government’s tolerance for a slowing economy has now been exceeded, and policy has been eased on all fronts — monetary, exchange rate, fiscal and regulatory — since mid year. This easing is beginning to take effect, with a rise in local government bond issuance leading to a rebound in infrastructure investment, after a period of shrinkage. Other factors that have supported the economy have been the acceleration of exports to the US to avoid future tariffs, the slide in the exchange rate and the announcement of corporate and personal tax cuts.
The policy measures announced so far fall short of a “traditional” Chinese fiscal stimulus, which has relied mainly on boosting investment spending, especially infrastructure. In fact, the overall package looks rather more like a western-style stimulus that works with longer lags and less certainty than the traditional Chinese approach. It needs time to work.
The US economy is almost certain to slow towards trend next year as tighter financial conditions bite and the fiscal stimulus runs out of steam. Furthermore, growth in Europe may do little better than return broadly to trend from the temporarily depressed rates reported recently.
These possible shifts in the US and EU will, together, reduce global growth by about a quarter of a per cent between now and end 2019. Therefore, China will be the swing economy. If it slows further, from the present 5.2 per cent rate, then the global economy will grow well below trend next year, and the markets will begin to worry seriously about a global recession.
If, on the other hand, the policy easing in China begins to gain more traction, outweighing any further escalation of trade protection, then global growth could rebound from today’s subdued rates.
Assuming Chinese growth recovers to 6.5 per cent by the end of next year — representing a moderate success for policy stimulus — that would directly boost global growth by 0.3-0.4 per cent, taking it slightly above trend as other emerging economies also rebound by the end of 2019. It would also mark the end of turmoil in emerging market assets. The risk of global recession would subside and 2019 would represent a late cycle year in the expansion, not the end of the cycle.
That is the prize that awaits the American and Chinese trade negotiators for success in coming months.
The Fulcrum nowcast report for November shows that the global economy is continuing to slow down, despite growth remaining at a very healthy 3.2 per cent in the US. Global activity is now rising at 3.4 per cent, slightly below trend.
The Eurozone has slowed for temporary reasons and will probably rebound next year. However, the jury is out on the Chinese economy, where growth has now slowed to about 5.2 per cent, similar to the dip seen in the yuan crisis of 2015/16.