Did you miss IS THE FED IN LEFT FIELD, AGAIN?
The Emerging Slump
(…) That the slowdown in China is at the heart of the emerging world’s troubles should come as no surprise—the country currently accounts for 30 percent of global industrial production, double the proportion in 2008. Chinese export growth has slowed from an annual average of 25 percent between 2003 and 2007 to just 8 percent between 2010 and 2013. Manufacturing investment growth has fallen from nearly 50 percent in 2007 to single digits in 2015. (…)
But that slowing growth presents a serious challenge to those countries that have become important trading partners with China. Asian countries, in particular, have come to depend on China’s appetite for imports—Korea, Malaysia, and Taiwan export twice as much to China as a share of their GDP than they do to Europe. China’s waning appetite for palm oil, for example, has hit Malaysia, Indonesia, and Thailand particularly hard. Thailand has also suffered from a decline in the number of Chinese tourists this year.
While many Asian central banks began easing monetary policy at the beginning of the year to combat slowing growth and the threat of deflation borne of low oil prices, and most (save Malaysia and the Philippines) are still in easing mode, a number of governments have tightened fiscal policy. India has removed government controls on the price of diesel fuel, while Indonesia did the same thing and got rid of gasoline subsidies to boot. For its part, Thailand ended an expensive rice subsidy in 2014. While Indonesia and Thailand have both introduced stimulus packages in recent months, Credit Suisse doesn’t consider either one particularly meaningful. (…) All told, Credit Suisse expects growth in every Asian country except India and the Philippines to miss consensus forecasts this year.
The difficulties extend beyond Asia. Prices for iron ore, of which Brazil is one of the world’s largest producers, have declined alongside Chinese demand, hurting the mining industry. Brazil is also coping with a corruption scandal at its largest oil company and has no room for either fiscal or monetary easing. The central bank is battling high inflation with interest rate hikes, and credit rating agencies have threatened a downgrade if the government can’t reduce its deficit. Brazil has exported its way out of prior growth slumps, but with sluggish Chinese demand for the commodities that account for two-thirds of its exports, that trick will be harder to pull off in the current environment. Indeed, Credit Suisse economists expect the Brazilian economy to contract both this year and next.
China isn’t to blame for everything. The collapse in oil prices—Brent crude has dropped to $47 a barrel from its June 2014 peak of nearly $115—has been incredibly damaging to energy-producing economies in the emerging world. Russia’s recession worsened in the second quarter of 2015, with a 4.6 percent decline in GDP. In Malaysia, the oil and gas sector accounts for one-third of government revenues—hence the aforementioned spending cuts.
Finally, emerging markets will have to contend with any hike in interest rates by the U.S. Federal Reserve. Their currencies are already doing so, battered by the combination of an expected rate hike, weak exports, and soft domestic demand. Many have dropped significantly against the dollar since the beginning of the year, including the Turkish lira (-31 percent), Brazilian real (-46 percent), Malaysian ringgit (-24 percent), and Russian ruble (-17 percent).
With emerging markets on the back foot, any global growth is going to come from developed markets, particularly the U.S. and Europe. After declining for five consecutive months, U.S. industrial production is growing again, and car sales in July were the highest in nearly a decade. In Europe, consumer and business confidence has been strong, retail sales are above trend, and housing demand is improving.
For now, it looks like the growth trajectories of the developed and emerging markets are diverging, with developed economies proving resilient to both weakness in China and the knock-on effects in other economies. If things get much worse in emerging markets, though, we might just find ourselves back at one of those times when everybody’s back in sync.
The world economy as we know it is about to be turned on its head The demographic ‘sweet spot’ is vanishing. We are on the cusp of a complete reversal, spelling the end of corporate hegemony
Workers of the world are about to get their revenge. Owners of capital will have to make do with a shrinking slice of the cake.
The powerful social forces that have flooded the global economy with abundant labour for the past four decades years are reversing suddenly, spelling the end of the deflationary super-cycle and the era of zero interest rates.
“We are at a sharp inflexion point,” says Charles Goodhart, a professor at the London School of Economics and a former top official at the Bank of England.
As cheap labour dries up and savings fall, real interest rates will climb from sub-zero levels back to their historic norm of 2.75pc to 3pc, or even higher.
The implications are ominous for long-term US Treasuries, Gilts or Bunds. The whole structure of the global bond market is a based on false anthropology.
Prof Goodhart says the coming era of labour scarcity will shift the balance of power from employers to workers, pushing up wages. It will roll back the corrosive inequality that has built up within countries across the globe. (…)
Prof Goodhart and Manoj Pradhan argue in a paper for Morgan Stanley that this was made even sweeter by the collapse of the Soviet Union and China’s spectacular entry into the global trading system.
The working age cohort was 685m in the developed world in 1990. China and eastern Europe added a further 820m, more than doubling the work pool of the globalised market in the blink of an eye.
“It was the biggest ‘positive labour shock’ the world has ever seen. It is what led to 25 years of wage stagnation,” said Prof Goodhart, speaking at a forum held by Lombard Street Research. (…)
Cheap labour held down global costs and prices. China compounded the effect with a factory blitz – on subsidised credit – that pushed investment to a world record 48pc of GDP and flooded markets with cheap goods – first clothes, shoes and furniture, and then steel, ships, chemicals, mobiles and solar panels.
Lulled by low consumer price inflation, central banks let rip with loose money – long before the Lehman crisis – leading to even lower real interest rates and asset bubbles. The rich got richer.
This era is now history. Wages in China are no longer cheap after rising at an average rate of 16pc for a decade.
The yuan is overvalued. It has appreciated 22pc in trade-weighted terms since mid-2012, when Japan kicked off Asia’s currency war. Panasonic is switching production of microwaves from China back to Japan.
But the underlying causes of the deflationary era run deeper. The world fertility rate has steadily declined to 2.43 births per woman from 4.85 in 1970 , with a precipitous collapse over the past 20 years in east Asia.
The latest estimates are: India (2.5), France (2.1), US (two), UK (1.9), Brazil (1.8), Russia and Canada (1.6), China (1.55), Spain (1.5) Germany, Italy, and Japan (1.4), Poland (1.3) Korea (1.25), and Singapore (0.8). As a rule of thumb, it takes 2.1 to keep the population on an even keel.
The numbers of working-age rose sharply relative to children and – for a while – the elderly. The world dependency ratio dropped from 0.75 in 1970 to 0.5 last year. This was the sweet spot.
“We are on the cusp of a complete reversal. Labour will be in increasingly short supply. Companies have been making pots of money but life isn’t going to be so cosy for them anymore,” said Prof Goodhart.
The dependency ratio has already bottomed out in the rich countries. It is now rising far more quickly than it fell as baby boomers retire and people live much longer.
China will face a double hit, thanks to the legacy effects of the one-child policy. “They kept it going 15 years too long, disastrously,” said Prof Goodhart. China’s workforce is already shrinking by 3m a year.
It is widely assumed that the demographic crunch will pull the world deeper into deflation, chiefly because that is what has happened to Japan – probably for unique reasons – since it pioneered mass dotage 20 years ago.
The Goodhart paper makes the opposite case. Healthcare and ageing costs will drive fiscal expansion, while scarce labour will set off a bidding war for workers, all spiced by a state of latent social warfare between the generations. “We are going back to an inflationary world,” he said.
China will no longer flood the world with excess savings. The elderly will have to draw down on their reserves. Companies will have to invest again in labour-saving technology, putting their great stash of idle money to work.
We will see a reversal of the forces that have pushed the world savings rate to a record 25pc of GDP and created a vast pool of capital spilling into asset booms everywhere, even as the global economy languishes in a trade depression.
The “equilibrium rate” of real interest will return to normal and we can all stop talking about “secular stagnation”. Central banks can stop fretting about the horrors of life at the “zero lower bound” (ZLB), and they are certainly fretting right now. (…)
Professor Goodhart makes large assumptions. He doubts that robots will displace workers fast enough to offset the labour shortage, or that greying nations are culturally able to absorb enough immigrants to plug the jobs gap, or that India and Africa have the infrastructure to repeat the “China effect”.
The world has never faced an ageing epidemic before so we are in uncharted waters. What is clear is that the near vertical take-off of the dependency ratio is about to shatter all our economic assumptions.
The last time Europe’s serfs suddenly found themselves in huge demand was after the Black Death in the mid-14th century. They say it ended feudalism.
Germany’s Immigration Challenge
I doubt that it will work out as politicians hope. In theory we agree: well-educated people come to Germany to help us deal with the demographic crisis we face. The reality is that a big part of the immigrants will not be able to fulfill these hopes as they are illiterate, etc. We would have to invest heavily to make this happen, but politicians shy away from doing so. I have summarized what the scenarios are and what we would have to do to make it happen in this two-part comment for theGlobalist, which you might want to have a look at. To be clear: Germany looks like ending up with more problems than less if we don’t change gears fast.