This article first appeared in the Indian journal Economic and Political Weekly on February 9, 2019.
Abstract: The global economy is heading towards a downturn. However, is the world prepared to deal with the consequences? Whether it is a slowdown or recession, it remains to be seen as to what the future would hold for the banking systems of Eurozone and China, and the global stocks in general.
When the International Monetary Fund (IMF) issued its World Economic Outlook Update in January 2018, the future looked bright. Indeed, even the title of the update was very optimistic: Brighter Prospects, Optimistic Markets, Challenges Ahead. And under the cheer-leadership of the IMF, an overwhelming consensus was formed. The cyclical upswing underway since mid-2016 had continued to strengthen, producing in 2017 the broadest synchronised global growth upsurge since 2010, and the growth would last as far as the eye could see. Here, what is meant by global growth is the growth of the world gross domestic product (GDP) or the world income.
It turned out that 2018 was a major disappointment and the IMF’s World Economic Outlook Update in January 2019, A Weakening Global Expansion, was a bit cautious. Christine Lagarde, the IMF’s managing director, said:
Even as the global economy moves forward, the risks that lie ahead are getting greater. Does that mean a global recession is around the corner? No. But the risk of a sharper decline in global growth has certainly increased.
So, we are debating whether 2019 will be the year of synchronised global slowdown or the year of synchronised global recession, with the IMF dismissing the possibility of a global recession.
What Is a Global Recession?
The IMF estimated the global growth for 2018 at 3.7% and expects the global growth for 2019 to be at 3.5%. But, its sister institution, the World Bank, was way gloomier. The World Bank estimated the global growth for 2018 at 3% and expects the global growth for 2019 to be at 2.9%. So, we are not so sure if the global growth for 2018 was at 3.7% or 3% and whether to expect a 3.5% or 2.9% growth in 2019. It depends on whether you choose to believe the IMF or the World Bank.
But how do we define what a global recession is? The answer depends on to whom the question is directed. Prior to the global financial crisis (GFC) that started in the summer of 2007, the IMF used to define a global recession as global growth of less than 2% or 3% depending on who the director of research at the time was. But more often than not, when global growth fell to 3% or below, the IMF called it a global recession.
The GFC changed all that. Olivier Blanchard, the director of research of the IMF between September 2008 and October 2015, objected to calling a global growth of less than 3% a global recession in 2008, when global growth was already below 3%. Now, the IMF has a very complicated way of defining what a global recession is.
But, if we stick with the older IMF definition and choose to believe the World Bank, the world was already in global recession in 2018, which is expected to continue in 2019. If we do not do this, then there was no global recession in 2018 and, as Lagarde said, a global recession is not around the corner.
However, a new survey of chief executives from the Conference Board—a global, independent business membership and research association—indicates that the possibility of a global recession ranks as the top concern on the minds of corporate leaders as they head into 2019 (Weber 2019). So, we had better wait and see what 2019 will bring at this front, although Reiermann (2019) informs us that Germany has already begun getting ready for the worst.
The Financial Stability Front
The IMF issued its last Global Financial Stability Report in October 2018. The report was titled: ‘A Decade after the Global Financial Crisis: Are We Safer?’ And the assessment was that we were not safe. In the foreword of the report, Tobias Adrian wrote:
Looking ahead, clouds appear on the horizon. The global economic recovery has been uneven and inequality has risen, fuelling inward-looking policies and contributing to increased policy uncertainty.
Adrian also wrote:
The ratio of total nonfinancial sector debt to GDP in jurisdictions with systemically important financial sectors stands at an all-time high of 250 percent, asset valuations remain stretched across several sectors and regions, and underwriting standards are deteriorating, including in many segments of market-based finance.
Some major concerns in the report were (Inman 2018):
(i) Failure of governments and regulators to push through all the reforms needed to protect the system from reckless behaviour;
(ii) Global debt levels well above those at the time of the last crash in 2008;
(iii) Dramatic rise in lending by the so-called shadow banks in China, and the failure to impose tough restrictions on insurance companies and asset managers; and
(iv) The growth of global banks such as JP Morgan and the Industrial and Commercial Bank of China to a scale beyond that seen in 2008, leading to fears that they remain “too big to fail.”
And on 15 January 2019, the Institute of International Finance—the global association of the finance industry—released its last Global Debt Monitor results under the title Devil in the Details. Four of the important results they shared are:
(i) Global debt has grown by over 12% since 2016, reaching $244 trillion or 318% of the world GDP in Q3 2018, although this is slightly lower than the all-time high of 320% of the world GDP in Q3 2016.
(ii) The corporate sector accounted for over a third of the rise, putting debt/GDP at a record high of 92% of the world GDP.
(iii) Risk of dollar funding shortages: dollar-denominated liabilities of non-United States (US) banks stand at $13.3 trillion (21% of the world GDP).
(iv) Rollover risk is high: $3.9 trillion of emerging market bonds/syndicated loans come due through end-2020.
One important financial event that is not mentioned in the above reports is the global stock market slump of 2018. The world stock market capitalisation as measured by the Bloomberg WCAUWRLD index reached its all-time peak of $87.79 million on 28 January 2018 and, after several downwardly steps during the year, bottomed at $66.02 million on 26 December 2018—about a 25% drop in 11 months.
This huge drop forced the major central banks to make a U-turn from their monetary tightening stance that they have been advertising for quite some time and, after massive liquidity injections in major jurisdictions, the global stocks enjoyed their best January in 2019 since 1987, with a more than 20% gain in a single month. And this happened for no economic reason other than a massive liquidity injection by major jurisdictions and the U-turn by the major central banks, including the Federal Reserve System (Fed), the US central bank.
The Fed’s announcement came on 31 January 2019. It signalled that it would be patient about further rate increases and flexible about unwinding its balance sheet. And only seven days earlier, on 24 January 2019, the European Central Bank had announced that it would keep key interest rates at their present levels through the summer of 2019 and “longer, if necessary,” and although its bond-buying programme had ended, it planned to reinvest cash from maturing bonds for an extended period of time. Last but not least, on 25 January 2019, the People’s Bank of China (PBC) launched a central bank bills swap presumably to support liquidity of banks’ perpetual bonds and to encourage banks to replenish capital through perpetual bond issuance, which Frances Coppola called the “Great Chinese Bank Bailout” (Coppola 2019).
Unprepared for Recession
The person who put these together was no other than the first deputy managing director of the IMF, David Lipton. At a meeting of the American Economic Association in Atlanta, Lipton told the Financial Times on 6 January 2019 that the leaders of the world’s largest countries are dangerously unprepared for the consequences of a serious global slowdown (Smith and Greeley 2019). Lipton said,
The next recession is somewhere over the horizon, and we are less prepared to deal with that than we should be … [and] less prepared than in the last crisis [in 2008].
Given all of this, if a global recession hits sooner than the IMF expects, who knows what may happen to the banking systems in the Eurozone and China—in the case of China, also to the shadow banking system—or to the global stocks, in general, and the US stocks, in particular, or to all of these, as financial crises tend to be contagious? Alternatively, if a financial crisis originates from any of these and spreads, who knows what may happen to the global economy?
Let me now conclude with the lyrics of one of my favourite songs, La Sagrada Familia from the Gaudi album by Alan Parsons Project:
Who knows where the road may lead us, only a fool would say
Who knows wha’s been lost along the way
Look for the promised land in all of the dreams we share
How will we know when we are there? How will we know?
Only a fool would say.
Coppola, Frances (2019): “The Great Chinese Bank Bailout,” Forbes, 29 January.
Inman, Phillip (2018): “World Economy at Risk of Another Financial Crash, Says IMF,” The Guardian, 3 October.
Reiermann, Christian (2019): “Germany Prepares for an Economic Downturn,” Spiegel Online, 8 January.
Smith, Colby and Brendan Greeley (2019): “World Unprepared for Slowdown, says IMF’s Lipton,” Financial Times, 6 January 2019
Weber, Lauren (2019): “CEOs Say Recession Is Top Worry for 2019,” The Wall Street Journal, 16 January.January, 2019
T Sabri Öncü ([email protected]) is an economist based in İstanbul, Turkey.