Persistent and prolonged use of loose monetary policy to counter the deflationary consequences of demography, globalisation and the technology revolution has only served to distort important price and market signals being sent to the financial system and broader economy.
Cheap money, we would argue, has led to an explosion of capacity, not just directly but also by saving inefficient (zombie) businesses from default.
Bank models
Using models that encompass only a relatively narrow view of the economy (as if it was a simple machine), the world’s central bank policy wizards overstate their influence on the real economy (by divining often spurious cause and effect between the variables on which they are focused). At the same time, they underestimate their effect on financial markets.
This is important because, although the effectiveness of stimulus on the real economy might be open to debate, it is clear from history that taking risks with financial stability – creating financial asset booms that end in crashes – is bad for growth and hugely costly.
Looking ahead, despite continued bullishness about US economic prospects, expectations for global GDP growth continue to fall, with the OECD the latest to cut its expectations for 2015/16.
Our view is that the biggest downward revisions are clearly in the developing world, and among commodity and energy exporters. Some economies, such as Canada’s, are already in recession, and interest-rate policy remains biased towards cutting rates rather than any kind of normalisation.
With growth decelerating, much of the world is seeing its currency units fall sharply versus the dollar, as giant ‘carry trades’ – which have been popular in recent years – unwind.
Global growth in dollar terms appears to be turning down, with obvious implications for sovereigns and corporations that have borrowed heavily in hard currency.
Not surprisingly, growth in cashflows and profits is also decelerating and credit investors are demanding a wider spread over government bonds (ie, risk spreads are widening). Given the scale of the credit expansion in this cycle, we should expect to see a sharp rise in the number of defaults, up from the extremely low levels seen in recent years.
A backdrop of falling commodity prices is, however, a positive for western consumers, and it should help bolster disposable incomes at the lower end of the scale. The problem is that sharp and broadly-based falls in commodity prices have in the past been associated with economic and financial market stress, and it is hard to see why this time should be different.
Equities peak
The weakening global growth cycle and imbalances between supply and demand have been flagged for some time in sovereign bond and credit markets.
More recently, commodities such as oil and industrial metals and emerging market currencies have confirmed the trend in a dramatic fashion. Equity markets seem to have got the message at last, with equities peaking last spring and subsequently experiencing elevated volatility.
The reason for our focus on the US is the sharp contrast between the expectations for that economy and the trends in the rest of the world. If the US is indeed on a path to normalisation, we need to believe it is able to decouple from other economies.
Given the emerging world, and particularly China, have been the engines of global growth in this cycle, such a decoupling is unlikely (just as decoupling of emerging markets from the US proved impossible in 2008). If current trends prevail, it seems increasingly unlikely the Fed will meaningfully raise rates in the near term.
