Uncertain times ahead for the global economy

An air of uncertainty pervades the global economy as it is buffeted by deflationary impulses, falling demand, currency wars and plunging commodity prices. A number of flashpoints within a fragile global financial system - rendered more vulnerable by the phenomenal growth of debt (both public and private) - threaten the stability of the whole system. Jayati Ghosh surveys the bleak international terrain.

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WHO would have thought, even a few years ago, that the spectre facing the world economy would be that of deflation? It is true that deflationary impulses have been quite strongly evident in Europe, particularly the eurozone, for some time now. But this has now spilled over into other important markets, and is reflected not only in the sharp drop in global commodity prices but also in slowing inflation rates in many regions that were earlier thought to be less affected, including the US and important emerging markets.

In the United States, although consumer expenditure has pushed the much-acclaimed recovery in that economy, the data for the last quarter of 2014 indicate that gross domestic product (GDP) in real terms grew by only 2.6% over the previous year. And it is not clear how much consumption will continue to contribute to the recovery, since wage growth actually slowed in the same quarter. Employment costs increased by only 0.6% in the fourth quarter of 2014 and in the month of December 2014, average hourly earnings of US workers actually fell by 0.2%.

So it continues to be the case that the economic gains from this recovery have been concentrated among the rich and especially those receiving most of their incomes from profits and rent. Despite some recent increase in employment rates, median wages have barely risen and income inequality has increased even beyond the 'historic' highs. Obviously, this pattern of recovery suggests less-than-vibrant demand expansion in the US. And in any case, since the US current account deficit has been shrinking since 2012 despite its output expansion, in terms of the global economy the net demand impulse will certainly not be as strongly positive as it was before the global financial crisis - indeed, it could even be negative.

In Europe, the era of uncertainty continues. Deflation in the eurozone has resulted not just from the sovereign debt crises in some of the peripheral countries, but even more from the heavy-handed and continued insistence on fiscal austerity. This insistence on fiscal consolidation has, remarkably enough, not just been confined to deficit economies with debt problems, even though it has been especially strong in those countries.  But even countries with current account surpluses - such as Germany - that should really focus on taking up the slack, increasing domestic consumption and providing markets for countries forced into 'distress exports', have been effectively doing the opposite. They too now emphasise fiscal consolidation, which is simply another term for cutting public spending that is directed to realising the social and economic rights of their citizens.

So Europe is now in a classic 'liquidity trap' situation, in which very loose monetary policy and low to zero nominal interest rates are still unlikely to do much to lift investment. This means that the much-hyped purchase of sovereign debt by the European Central Bank (which is the European Union's typically convoluted form of quantitative easing) is not going to have much positive effect. As inflation rates fall and turn negative, the debt burden of households, companies and governments becomes greater in real terms, making it harder for them to repay and forcing them to cut back on other expenditure. The downward spiral of debt deflation that this entails was already described by Irving Fisher in the 1930s, but all that seems to have been forgotten by today's policymakers.

It is true that the victory of Syriza in the elections in Greece provides some hope that at least some of these policies will be sought to be reversed in that country, whose people have already suffered so much. But the impact on the rest of Europe - and indeed, on the eurozone - of such a shift is anything but clear. If the creditor countries and the European establishment persist in their refusal to write off or restructure at least some of the Greek debt, then many bets must be off in terms of the outlook for the monetary union. But whatever happens, for the immediate future it is next to impossible for the European economy to provide a positive stimulus for global demand. Quite the opposite, in fact - generalising the German strategy of running export surpluses to the entire eurozone would be the only way to keep the monetary union together.

Add to this the deceleration of Chinese growth, which appears to be much sharper than previously anticipated. The government in China has been revising downwards its output growth projections in every quarter, yet even so the actual output has been lower than the forecasts over the previous year. Some of this is clearly because of lower export demand from the US and the EU - but a significant proportion also reflects the rebalancing of the economy towards domestic demand, which is a process that has to involve some pain as well as gain for wage earners. This changes both the volume and the structure of China's import demand, which is bad news not only for primary product exporters who had benefited from China's voracious appetite for food and raw material imports, but also for exporters of manufactured goods that were integrated into global value chains around China as a hub.

This helps to explain the dramatic collapse of oil prices as well as several other mineral and agricultural prices over the past year. It is true that there is also probably some overshooting of prices in these markets, once again driven by speculative activity in futures markets. But whatever the causes, the implications of this decline have been quite severe for many countries whose economies are dependent on such exports. Already Russian bonds have been relegated to junk status by at least one credit rating agency, as the falling oil prices achieve what Western sanctions against Russia (for the war in Ukraine) had not managed to do. Venezuela is suffering from many shortages and high inflation; other oil producers in Latin America and Africa are also in growing distress; and mineral and agricultural exporters have also seen export volumes and values get slashed. Many 'emerging markets' seem to be retreating at the moment. And there are of course adverse implications for those who had placed financial bets on rising commodity prices, although it is not clear whether this in itself will have severe repercussions in terms of impending financial crisis. Rather, it seems more likely that deflation will foster other uncertainties that will combine with financial volatility to create brittle and unstable conditions in international trade and payments.

In Asia, the fall of commodity prices may be a boon for many countries, since the region is predominantly oil-importing. But a particular form of deflation is likely to have devastating consequences nonetheless: the fall of asset prices, particularly the unwinding of real estate and housing that had experienced a debt-driven boom. Across Asia, real estate and housing prices had levitated upwards as governments responded to the Great Recession of 2008 by providing tax relief and other incentives and ensuring cheap credit for such loans (to both those who purchased houses and those who constructed them). Indeed, consumer credit of different forms (for housing, automobiles, other consumer durables, credit cards as well as student loans) had become the dominant form of bank lending in many Asian countries such as Malaysia and South Korea. Such debt-driven expansion of consumption usually ends in tears. For housing loans, since the value of the underlying asset is critical in making such loans viable, one important indicator is house prices, and these are now stagnant or falling across most Asian markets except Hong Kong.

This is the depressed global economy in which we are likely to see some increase in US interest rates in the current year. If and when that happens, there may well be another run on markets across the world, emerging or otherwise, leading to more economic instability and certainly more negative impulses for growth. The parallels with the 1930s are startling but sweeping: deflation and in some places actual depression; volatile capital flows; jittery and fluctuating stock markets and other asset markets; and the eruption of small-scale but potentially larger wars in different parts of the world but especially in Ukraine and the Middle East.

These are certainly interesting times, but they might end up making us wish for the more boring periods.u

Jayati Ghosh is an economics professor at Jawaharlal Nehru University in New Delhi.

*Third World Resurgence No. 293/294, January/February 2015, pp 12-13