A Summer of Worry
Aren’t we glad we have a crisis again?
The prophets of doom did not leave a single stone unturned to find signs of the next crisis. Ecco qua, Italy delivered a phenomenal political turmoil that created chaos in the financial markets. Italy is not the only crisis country right now: Spain and Portugal are seeing higher interest rates while Turkey and Argentina suffer a full-blown currency crisis. The first experts are already warning about a major financial crisis.
Let us put this into perspective
In 2017 the global economy grew by 3.8%, the fastest pace since 2011. 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 some clouds have appeared. First, economic surveys in Europe indicated GDP growth of only 1.6%, annualized, in the first quarter. Then, in the first quarter America’s growth slowed to 2.3%, annualized, from close to 3% in the preceding six months. At the same time, Japan’s economy shrank by 0.6%, ending a growth spurt since the start of 2016. Even China, which has seemed relatively immune to the slowdown, has loosened monetary policy slightly by allowing banks to hold fewer reserves.
In the US, the slow upward march of bond yields has put pressure on emerging-market currencies, which have fallen by 5.4% since the start of April. 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, Turkey and Argentina are the only two of the top ten emerging markets countries ran current-account deficits greater than 2% of GDP in 2017.
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. Strong retail sales and high consumer confidence in the US suggest that if a downturn is coming, Americans have missed the cue.
The real problem is that demand is growing where it is least needed. American core inflation, which excludes food and energy prices, is now 1.9%. 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 increases Mr. Trump recently signed into law. Outside the US, however, inflation is falling short almost everywhere. In the euro zone it is only 1.2%, short of the ECB’s 2% target – although German inflation hit 2.2% in May for the first time. The Bank of Japan recently abandoned its pledge to raise inflation to 2% by fiscal year 2019. Even in Britain, where a big fall in the pound pushed inflation well above the 2% target in 2017, it has fallen more quickly than expected.
The world economy would certainly be better off if this demand were spread around. Unfortunately, the mechanism that could achieve that is a dangerous one: a stronger dollar. A rising greenback should allow Americans to buy more imports, stimulating foreign economies. Alas, Mr. Trump is negotiating trade agreements 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, exacerbates this problem and further induces Mr. Trump’s protectionism. That could set off a downturn that would really be worth worrying about.
As long as our current economic hotspots such as Italy remain local, they can surely be handled and will not drag the world economy into a major crisis. We need to watch Mr. Trump, though. Increased volatility for now offers trading opportunities that we can seize. We are happy to share some of our ideas with you.
Switzerland, June 1st, 2018