Nariman Behravesh is Chief Economist at the consulting firm IHS Inc. and author of Spin-Free Economics: A No-Nonsense, Nonpartisan Guide to Today’s Global Economic Debates (McGraw-Hill). To hear more of Nariman’s insights, register for the CFO Forum where he will join a panel of recognised CFOs.
Most people would agree that the current global expansion is the most disappointing in recent memory. Rather than the proverbial V-shaped rebound after a deep recession, this time the shape was more like a flat U (following a one-year bounce in 2010). Since 2009, growth among the developed economies has averaged only 1.9%, compared with 2.6% in the 1990s. That said, the expansion of the 2010s is entering its ninth year, and is now one of longest in recorded history—though not as long as the 26-year Australian expansion! This relative longevity has stimulated a rather intense debate between those who feel that the expansion could wither away soon and those who believe that it could become the longest ever. To accomplish such a feat, the world would have to avoid a recession in the next couple of years. Is this likely?
The usual recovery killers are low-level threats for the moment …
There is merit to the oft-heard adage that recoveries don’t die of old age—they are killed off by shocks of one kind or another. But not all shocks are created equal. Some are far more threatening to growth than others. The top expansion killers include:
• Monetary (over) tightening. Many of the postwar expansions have ended because central banks have reacted to late-expansion increases in inflationary pressures by stepping hard on the monetary brakes. Since, for the moment, inflation is quiescent, the risks of such a scenario in the next couple of years is relatively low.
• Oil shocks. High oil prices were a primary or contributing cause of recessions in the mid-1970s, early 1980s and early 1990s. Fortunately, with oil markets beset by excess production, the chances of an oil shock look remote—of course, barring an unforeseen geopolitical event that could curtail oil supplies from the Middle East.
• Bursting asset bubbles. The recessions of both 2001 and 2007–09 were, in large part, caused by bursting asset bubbles—high-tech in the case of the former and housing in the case of the latter. While the subject of some disagreement, there is little conclusive evidence of bubbles in any global asset markets—although stock and bond markets around the world are vulnerable to increases in US interest rates.
… And not all shocks cause recessions …
The resilience of the global economy to shocks is remarkable. In the past three decades the following shocks barely dented growth: the 1987 stock market crash, the 1997 Asian Financial Crisis, the 2011 stock market correction (when the US came close to not passing the debt ceiling extension), the 2011–12 European Debt Crisis, the 2015 Shale Oil Bust, and the mid-2015 and early 2016 financial tremors in China.
Some pundits worry that a China meltdown could cause the next global recession. While possible, such a scenario is improbable. The exposure of developed economies to China trade is especially low (typically 5% of GDP or less). Moreover, a Chinese financial bust is unlikely to drag down US and European financial institutions—again, because Chinese debt is a small part of their portfolios. If a China meltdown were to spread to other parts of the world (e.g., the rest of Asia and the emerging world), then the impact on the developed economies would be larger.
… But policy mistakes are possibly the biggest threat now
In the past, bad policies have either caused recessions or made them worse. Conversely, good policies (especially by the central banks) have also helped cushion the impact of shocks, such as the stock market crash of 1987 and the Asian and European financial crises.
But policy mistakes are always a risk, and four in particular could threaten this expansion:
• A central bank mistake. The world’s key central banks could either tighten prematurely, doing “too much too soon,” or wait too long to tighten and let inflation get out of control, ending up having to do “too much too late”—an error they have made many times in the past.
• Fiscal debacle. If chaos in Washington means that no budget is passed and the debt ceiling is not raised, the impact on consumer, business, and investor confidence—and, therefore, on the US economy—could be calamitous.
• Trade war. If the United States—deliberately or accidentally—begins a trade war with Australia, China, Canada, Mexico, Europe, or other trading partners, the damage to the world economy could be massive.
• Mismanagement of China’s debt overhang. If the poor handling of China’s high debt levels leads to a renewed flight of capital and a plunge in the currency, the ramifications for the rest of Asia (including Australia) and other parts of the world could be dire.
While quite worrisome, the danger of such policy mistakes seems contained—for the moment. Barring policy mistakes and assuming that inflation remains low (precluding the need for central banks to slam on the brakes), this expansion can go on for a while longer. Despite (or perhaps because of) tepid growth, the global economy has proved to be resilient and there are few, if any, threatening imbalances. Left to its own devices, this economic recovery could break the longevity record.