As Global Order Crumbles, Risks of Recession Grows (#GotBitcoin?)
Investors and business cope with new normal of resurgent nationalism, retreating globalization. As Global Order Crumbles, Risks of Recession Grow (#GotBitcoin?)
When assumptions about how the world works are shattered, a global downturn is often the result. The world learned in the early 1970s that the era of cheap oil was over, in the early 1980s that countries could default, and a decade ago that American mortgages and global banks aren’t safe.
Today, a similar rethink of globalization is under way. From Washington to Buenos Aires, nations’ mutually reinforcing commitment to open markets is disintegrating. In response, investors are rearranging portfolios, businesses are rethinking investments and policy makers are struggling to respond—all of which are pushing the global economy closer to recession.
Investors believe central banks—the last bastion of the technocratic, globalized elite—can use their limited ammunition to stave off recession. Yet central banks may be dragged into the competitive fray.
Nationalism and populism hit the headlines in 2016 when Britons voted to leave the European Union and Donald Trump was elected U.S. president. This was, initially, seen as a backlash against technocratic elites’ indifference to cultural and economic anxiety brought on by globalization, free trade and uncontrolled immigration.
In the past month it has become clear that nationalists aren’t simply correcting globalists’ excesses; they aim to supplant them altogether. After two years of fruitless efforts to negotiate an exit from the EU with most commercial relations intact, Britain now has a prime minister, Boris Johnson, prepared to make a clean break by Oct. 31 no matter the economic cost.
Mr. Trump’s early protectionist strikes at traditional allies were contained by countervailing forces at home and abroad. But the collapse of trade talks with China foreshadows a more fundamental unraveling of rules of economic engagement between the world’s economies. Having abandoned for now efforts to write a new rulebook, the U.S. and China have resorted to ad hoc, brute-force tariffs, devaluation and retaliation, which Tuesday’s surprise tariff reprieve simply underscored.
Elsewhere, Italy’s deputy prime minister, Matteo Salvini, leader of the anti-EU, anti-immigrant League party, is seeking to bring down his own coalition in hopes new elections will put him in control of the government. A trade war is brewing between American allies South Korea and Japan over ancient, unhealed wounds. Argentina’s peso and stock market crashed this week when Peronists, whose history of populism and protectionism saddled the country with its current woes, became the favorite to form its next government.
For the past two years, the U.S. and world economies shrugged off nationalism and populism. Protectionism was contained and more than offset by positives such as Mr. Trump’s tax cut and deregulatory drive. It can no longer be ignored: Businesses and investors, unsure of what if any rules will govern international commerce, are retreating from risky investments.
In Britain, Brexit uncertainty has brought business investment to a halt, contributing to—likely temporary—second-quarter economic contraction. Germany, perhaps the most trade-sensitive of the major economies, may be in recession: Its economy contracted in the second quarter, according to figures released Wednesday. Both the U.S. and China have seen exports drop and growth slow. American manufacturing has been hit by the slump in exports and investment.
The stock market’s wobbles have been amplified by companies most exposed to the world economy, according to Parag Thatte of Deutsche Bank . The 100 most globally exposed blue-chip companies’ profits are down 3% in the past year, while profits of the most U.S.-focused are up 5.5%, he estimates.
Globalization has suffered temporary setbacks in past decades. This time feels different. The U.S., which led in creating global institutions such as the World Trade Organization, now leads in crippling them. In the latest issue of Foreign Affairs, trade economists Chad Bown and Douglas Irwin note that Mr. Trump’s use of national security to justify tariffs and quotas on steel, aluminum and auto imports broke with 75 years of U.S. practice: “The Trump administration recently stood alongside Russia to argue that merely invoking national security is enough to defeat any WTO challenge to a trade barrier.”
The U.S. has in the past used its economic, military and moral weight to promote economic integration among and tamp down tension between allies. “We would have put our arms around the shoulders of the conflicting parties and said, now come on guys, let’s talk this through,” says Dan Price, who served as an economic diplomat in the Reagan administration and both Bush administrations.
Mr. Trump by contrast has cheered Britain’s split from the EU and done little to contain the flare-up between Japan and South Korea. Says Mr. Price, “Once people think there is no one looking after the collective interest, that there is no moderating force in the room, once you have the U.S. by its example legitimizing unilateralism, it removes the inhibitions from others.”
This hasn’t become a crisis or recession because the leverage and financial interconnections that propagate panic across borders are largely absent while healthy labor markets have buoyed consumers. Unlike in the 1970s and 1980s, interest rates are low, even negative.
But disruptive unilateralism could eventually extend to currencies and monetary policy.
China let the yuan drop after Mr. Trump ratcheted up tariffs. Though justifiable based on economics, investors saw it as a sign that China wasn’t seeking a truce in the trade war, says Barry Eichengreen, an economic historian at the University of California, Berkeley.
“Trump doesn’t like it when the currencies of countries like China, Korea and Vietnam decline against the dollar. So he is likely to threaten additional tariffs.” And to the extent that trade policy is the primary burden on global confidence now, central banks “can do little more than begin to stanch the bleeding.”
Poor Chinese And German Economic Data Fan Fears Of Global Slowdown
The European Union, with a weakening Germany at it core and the mounting prospect of losing the U.K. without a negotiated exit, looks particularly fragile.
Fears rose of a spiraling economic slowdown in Europe and Asia after Germany said its economy shrank in the second quarter and China reported a raft of weak data.
The bad news from two industrial powerhouses that are closely interlinked by trade and foreign investment added to market concerns about the state of the global economy that have prompted a flight into safe assets. U.S. stocks and bond yields fell on Wednesday.
The European Union, with a weakening Germany at it core and the mounting prospect of losing the U.K. as a member without a negotiated exit on Oct. 31, looks particularly fragile. Recent eurozone data showed growth in the narrower group of countries that use the euro had all but ground to a halt.
In Germany, gross domestic product contracted 0.1% in the three months to June, with economists and government leaders largely blaming the cool-down in Germany’s export-driven economy on the uncertainty caused by the U.S.-China trade war and the prospect of an abrupt Brexit.
Meanwhile, the jobless rate in Chinese cities rebounded in July to its highest level since regular reporting of the data began, and figures on factory production, consumption, property investment and other key readings were lower than expected.
Economists and government planners said China’s dispute with the U.S. has dented confidence among its manufacturers, despite a surprise jump in exports in July. Anticipation is growing that China will have to deploy additional stimulus measures to keep the economy growing by its 6-6.5% target.
The Chinese data could portend more pain for Germany, whose car makers and capital-goods manufacturers are among the most successful Western businesses in China. The country was Germany’s third-largest export market last year after the U.S. and France.
The persistent weakness of the Chinese economy means Germany’s will likely stagnate through next year, said Jörg Krämer, chief economist at Commerzbank in Frankfurt, who expects German GDP to grow just 0.8% in 2020.
Price-adjusted exports to China from the eurozone rose by an average of 14% on the year in 2017, but that slowed to 1.5% in the five months through May 2019, according to Commerzbank.
The latest data from Germany adds pressure on governments to unleash stimulus measures of their own.
“The new figures are a wake-up call and a warning,” said Germany’s minister of the economy, Peter Altmaier, in a statement. “We are in a weak growth phase but not yet in a recession, which we can avoid if we take necessary measures. Politicians and businesses must now act together.”
Berlin has faced pressure to loosen its strict fiscal policy to help drum up consumer demand and investment at home to offset the slump in exports. It has resisted so far, though it is planning moderate tax cuts and a new environmental policy, to be unveiled this fall. Mr. Altmaier said Wednesday corporate tax should be reduced, and investment into digitization and future technologies accelerated—a contentious topic of discussion in the government.
Central banks in Asia already have begun cutting interest rates. India and New Zealand were among the first, ahead of the Federal Reserve’s rate cut in late July, and they cut rates again last week along with Thailand and the Philippines.
The latest data from Germany will likely now heap additional pressure on the European Central Bank to launch a new stimulus package at its next policy meeting on Sept. 12 to help revive confidence. ECB President Mario Draghi has promised a series of new measures, which could include interest-rate cuts and hundreds of billions of euros in bond purchases.
“Trade conflicts, global uncertainty and the struggling automotive sector have finally brought the German economy down on its knee. In particular, increased uncertainty, rather than direct effects from the trade conflicts, have dented sentiment and hence economic activity,” said ING’s chief economist for Germany, Carsten Brzeski.
Early indicators and business sentiment surveys point to another weak performance in the third quarter. That could potentially indicate a recession, defined by economists as two consecutive quarters of shrinking output.
Attention is now focusing on just how far the trade dispute between Washington and China will go.
One U.S. official involved in the talks said a new round of face-to-face talks with China in Washington next month is unlikely to progress if Beijing continues to resist making structural changes to allow U.S. businesses to compete on what they say is a more even footing.
Wall Street, though, received a lift this week after the Trump administration suspended plans to impose new tariffs on about $156 billion in goods from China, including smartphones, laptops, toys, videogames and other goods, that were supposed to take effect on Sept. 1. “We’re doing this for Christmas season, just in case some of the tariffs would have an impact on U.S. customers,” President Trump said. The Dow Jones Industrial Average rose 1.4% on Tuesday before falling again on Wednesday. The yield on the U.S. 30-year Treasury bond fell to a record low.
The mood is more downbeat in Germany and much of the rest of Europe. German manufacturing output has been shrinking this year despite a small gain in GDP in the first quarter. Several large German companies have blamed U.S.-China trade tensions for disappointing results, including software maker SAP SE , chemicals company BASF SE and engineering group Siemens AG .
The yield on the German government’s 10-year bond touched a fresh record low of minus 0.624% in Wednesday morning trading, according to Tradeweb.
In the eurozone, seasonally adjusted industrial production fell 1.6% in June from May, and dropped 1.5% on month in the wider EU, according to estimates from Eurostat, the EU statistical office.
Seasonally adjusted gross domestic product grew 0.2% in the eurozone and the EU in the second quarter of 2019 compared with the previous quarter, the Eurostat estimate said. The economy grew 0.4% in the eurozone and 0.5% in the EU in the first quarter.
Germany was the only eurozone country whose economy shrank. Outside the eurozone, Britain and Sweden also contracted.
Some EU exporters ultimately might benefit if China’s businesses decide to switch U.S. products for European ones, some analysts say. But the uncertainty surrounding the trade conflict between the world’s two largest economies appears to set to continue overshadowing whatever happens in Europe, Asia and other parts of the economy.
Companies in particular will likely find it difficult to plan and invest without knowing how the trade tensions will play out.
“This is especially difficult in an export-oriented economy like Germany’s,” said Clemens Fuest, president of the Ifo institute, an independent economic think tank.
Rising Repo Rates Fuel Concern Over Mounting U.S. Debt
Elevated cost to borrow cash overnight using Treasurys as collateral highlights widening deficits.
The cost to borrow cash overnight using Treasurys as collateral has risen, fueling investor concern that bond dealers could become inundated with U.S. debt as the government funds widening budget deficits.
The rate that lenders have charged for cash in the market for Treasury repurchase agreements, or repos, was 2.183% on Monday, compared with the 2.1% that the Federal Reserve pays banks to hold excess reserves. The difference has averaged about 0.2 percentage point since the start of July, twice what it was this year through June.
The elevated repo rate is a sign of the cost of bigger budget deficits, even as yields on 10- and 30-year Treasurys are near record lows. As the government has borrowed more to make up for lower tax revenue stemming from the 2017 corporate tax cuts, bond dealers—who serve as underwriters for the government’s debt—have wound up holding record amounts of Treasurys on their balance sheets.
In the Treasury market, maturities generally range from four weeks to 30 years. When demand from investors rises for Treasurys with fixed interest payments, the prices of those securities rise and their yields fall. In the repo market, when there is a growing supply of bonds that dealers are using as collateral, lenders can charge more for loans.
Although the repo rate has risen by a relatively small amount, it makes some investors and analysts nervous.
“We’re at a time of heightened tensions in the global economy,” which adds to concern about a market at the center of the financial system, said Glenn Havlicek, a former banker who is now chief executive of GLMX. His firm provides technology to repo trading desks, with the aim of making it easier to carry out transactions and report pricing.
“Everybody’s got a toe in the repo market,” Mr. Havlicek said. If there were a problem, “everybody would be affected.”
The potential for risk emanating from the repo market was demonstrated during the financial crisis in 2008. As banks scrambled to maintain access to cash as asset prices fell, some firms inflated the value of their collateral to borrow more. As these borrowers lost access to cash in the repo market, a ripple effect was created, undermining confidence in markets as they became unable to sell or finance their assets.
That scenario is unlikely now. Tighter regulations and structural changes in the market have reduced the chances that higher repo rates will cascade into systemic problems, Mr. Havlicek said.
Still, higher repo rates pose a problem for investors who borrow cash to finance asset purchases because the increase raises their costs. Boosts in repo rates—which tend to occur at the end of months and quarters, when banks try to hold more cash on their balance sheets—are also a concern because they can contribute to surges in volatility across markets.
The rising cost to borrow using repos is significant as the New York Fed, other regulators and big banks shift these funding agreements from an isolated corner of financial markets to a more central role—a move set to affect trillions of dollars of business and consumer debt.
Analysts expect repo rates to rise further because of a coming wave of new debt, a result of the two-year budget agreement signed by President Trump earlier this month. That deal is expected to lead to an increase in short-term government bill sales.
Repo rates are also attracting more attention because they are used in setting a short-term reference rate created by the Fed, known as the secured overnight financing rate, or SOFR.
A group of banks and regulators overseen by the New York Fed is pushing for SOFR to replace the discredited London interbank offered rate, a short-term benchmark used in $200 trillion of financial contracts including business loans, mortgages and derivatives.
“Benchmark reform and the integration of SOFR into financial markets makes repo everybody’s problem,” said Joshua Younger, head of U.S. interest-rates derivatives strategy at JPMorgan.
IMF and World Bank’s New Leaders Warn of Deteriorating Global Outlook
Their remarks will set the tone for next week’s annual meetings in Washington.
The new leaders of the International Monetary Fund and World Bank warned in twin speeches of a deteriorating global economic outlook, just a week before they will lead the annual meetings of their institutions for the first time.
“The global economy is now in a synchronized slowdown,” said Kristalina Georgieva of Bulgaria, the former No. 2 official at the World Bank, who took the helm of the IMF a week ago.
Her counterpart, David Malpass, a former U.S. Treasury official who became the World Bank’s president in April, offered his own assessment in a speech at McGill University, saying that in June the World Bank had forecast 2.6% global growth in 2019—the slowest in three years—and “we now expect growth to be even weaker than that, hurt by Brexit, Europe’s recession and trade uncertainty.”
Their remarks set the tone for the IMF and World Bank meetings in Washington, where most of the world’s finance ministers and central bankers will be gathering. The new duo, both economists by training, represent a contrast from their predecessors. Christine Lagarde, the former IMF leader, was a lawyer and former French finance minister, while Jim Yong Kim, formerly at the World Bank, was a doctor and former university president.
The global economy they face presents a sharp reversal from two years ago when 75% of the world was accelerating, said Ms. Georgieva, noting that in 2019 the IMF now expects slower growth in 90% of the world and that “the widespread deceleration means that growth this year will fall to its lowest rate since the beginning of the decade.”
Many economists agree that trade tensions loom heavily over the global economy. Ms. Georgieva said that according to IMF research, the cumulative economic loss from the trade war could amount to $700 billion by 2020, or about 0.8% of global gross domestic product.
But the attendees at the IMF and World Bank meetings aren’t the trade officials who could resolve those tensions, and Ms. Georgieva and Mr. Malpass both highlighted the policies that fiscal and monetary authorities could take to boost their economies.
“Trade uncertainty is an important factor in the slowdown,” Mr. Malpass said in an interview with The Wall Street Journal, but “growth could accelerate if the nontrade aspects of this were improved.”
Mr. Malpass highlighted what could be a major policy focus for finance ministers: “If developed countries made changes in their government spending practices that were more pro-growth, and their tax practices were more pro-growth.” For central bankers, he suggested: “Getting to this frozen capital. Understanding why it is that negative interest rates don’t seem to be stimulative becomes an important part of this challenge.”
The economy doesn’t necessarily need to deteriorate further, he said.
“My thought is the slowdown is what’s in the data now,” he said. “The question is what policy changes will be made to change the course of the slowdown.”
For her part, Ms. Georgieva singled out three countries—Germany, the Netherlands and South Korea—as places that could benefit from increasing government spending.
“Our research shows that changes in spending are more effective and have a multiplier effect when countries act together,” she said an event at the IMF’s offices in Washington. “If the synchronized slowdown worsens, we may need a synchronized policy response.”
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