Despite anxieties, the green shoots of global recovery are real
“IF WINTER comes,” the poet Shelley asked, “can Spring be far behind?” For the best part of a decade the answer as far as the world economy has been concerned has been an increasingly weary “Yes it can”. Now, though, after testing the faith of the most patient souls with glimmers that came to nothing, things seem to be warming up. It looks likely that this year, for the first time since 2010, rich-world and developing economies will put on synchronised growth spurts.
There are still plenty of reasons to fret: China’s debt mountain; the flaws in the foundations of the euro; Donald Trump’s protectionist tendencies; and so on. But amid these anxieties are real green shoots. For six months or so there has been growing evidence of increased activity. It has been clearest in the export-oriented economies of Asia. But it is visible in Europe, in America and even, just, in hard-hit emerging markets like Russia and Brazil.
The signals are strongest from the more cyclical parts of the global economy, notably manufacturing. Surveys of purchasing managers in America, the euro zone and Asia show factories getting a lot busier (see chart 1). Global trading hubs such as Taiwan and South Korea are bustling. Taiwan’s National Development Council publishes a composite indicator that tracks the economy’s strength: blue is sluggish, green is stable and red is overheating. The overall economy has been flashing green lights for seven months and is pushing up towards the red zone.
This reflects, among other things, demand for semiconductors around the world; this February exports from Taiwan were up by 28% compared with 2016. Although that is the most striking example, exports are up elsewhere in the region, too. South Korea’s rose by 20% in February compared with a year earlier. In yuan terms, China’s were 11% higher in the first two months of 2017 than in 2016.
This apparent vigour is in part just a reflection of how bad things looked 12 months ago; suppliers who overdid the gloom in early 2016 are restocking. Asia’s taut supply chains also owe something to the two-to-three-year life-cycle of consumer gadgetry. On March 10th LG Electronics launched its new G6 smartphone. Its larger rival, Samsung, is due to unveil its Galaxy S8 phone by the end of the month; a new iPhone will be out later this year.
But the signs of life run deeper than just those specifics would allow. Business spending on machinery and equipment is picking up. A proxy measure based on shipments of capital goods constructed by economists at JPMorgan Chase, a bank, suggests that worldwide equipment spending grew at an annualised rate of 5.25% in the last quarter of 2016.
The good news goes beyond manufacturing, too. American employers, excluding farms, added 235,000 workers to their payrolls in February, well above the recent average. The European Commission’s economic-sentiment index, based on surveys of service industries, manufacturers, builders and consumers, is as high as it has been since 2011. After a strong fourth quarter, the Bank of Japan revised up its forecast for growth in the current fiscal year from 1% to 1.4%. Such optimism raises two big questions: what is behind this nascent recovery and will it take hold?
Lilacs from the dead land
The revival’s roots can be traced to the early months of last year, when a possible calamity was averted. At the end of 2015 stockmarkets tumbled in response to renewed anxiety about China’s economy. Prices at the factory gate, which had been falling steadily for several years, had started to plunge. There were fears that China would be forced to devalue its currency sharply: a cheaper yuan might spur China’s oversupplied industries to export more, fatten profits and service their growing debts.
Such a desperate measure would, in effect, have exported its manufacturing deflation to the rest of the world, forcing rivals to cut prices or to devalue in turn. The expectation that China’s economy was weakening pushed raw-material prices to their lowest level since 2009. The oil price briefly sunk below $30 a barrel. That worsened the plight of Brazil and Russia, already mired in deep recessions. It also intensified the pressure to cut investment in America’s shale-oil industry.
To stabilise the yuan in the face of rapid outflows of capital, China spent $300bn of its foreign-currency reserves between November 2015 and January 2016. Capital controls were tightened to stop money leaking abroad. Banks juiced up the economy with faster credit growth. With capital now boxed in, much of it flowed into local property: house prices soared, first in the big cities and then beyond. Sales taxes on small cars were reduced by half. Between them, these controls and stimuli did the trick.
Soon stocks of raw materials that had been hurriedly run down started to look skimpy. Iron-ore prices jumped by 19% in just one day last March. Curbs on Chinese coal production underpinned a mini-revival in global prices. Steel prices rose sharply, helped by the closure of a few high-cost mills as well as more construction spending. Oil climbed back above $50 a barrel (though it has slipped back a bit recently).
By the end of the year producer-price inflation in China—and across Asia—was positive again. And China’s nominal GDP, which had slowed more than real GDP, sped up again (see chart 2). Central bankers, who had been employing various measures to forestall global deflation, were mightily relieved. On March 9th Mario Draghi, boss of the European Central Bank (ECB), proudly declared that the risk of deflation had “largely disappeared”.
His relief was a recognition that, though a surge in inflation will flood the economy’s engine, a gentle dose can serve as a helpful lubricant. At a global level, a bit more factory-gate inflation lifts profits, since a lot of manufacturers’ production costs are largely fixed. Fatter profits not only make corporate debt less burdensome, they also free cash for capital spending, which creates further demand for businesses in a virtuous circle.
Since worries about China and deflation receded, spending on things that show some faith in future income has indeed begun to stir. A revival in producer prices and thus profits is leading to business investment around the world. In the last quarter of 2016 business spending in Japan rose at an annualised rate of 8%, according to official GDP figures. Gartner, a tech consultancy, predicted in December that consumers and companies would increase their spending on IT by 2.7% in 2017, up from 0.5% in 2016. John Lovelock, a research analyst at Gartner, says the biggest jump in spending is forecast for the Asia-Pacific region.
Continuous as the stars that shine?
In America imports of both consumer goods and capital goods are up. There has been speculation that the “animal spirits” of business folk have been lifted by Mr Trump’s election in November, and that cuts in tax and regulations, and a subsequent return of the estimated $1trn of untaxed cash held abroad by companies based in America, will fuel a big boom in business investment.
But James Stettler, a capital-goods analyst at Barclays Capital, notes that “no one’s really pushing the button on capex yet”. And companies which might benefit from an investment boom are not getting carried away. In a recent profits statement Caterpillar, a maker of bulldozers and excavators, said that, while tax reform and infrastructure spending would be good for its businesses, it would not expect to see large benefits until at least 2018. So far the recovery in global capital spending is in line with what you would expect from the recovery in global profits, says Joseph Lupton of JPMorgan Chase (see chart 3).
The signs of recovery are encouraging. But can they be trusted? The last few bursts of optimism about the global economy all petered out. In 2010 the rebound from a deep rich-world recession was pulled back to earth by the sovereign-debt crisis in the euro area. As soon as Europe gingerly emerged from recession in mid-2013, hints from America’s Federal Reserve that its bond-buying programme would soon tail off prompted a stampede out of emerging markets. This “taper tantrum” blew over in a few months, but it had repercussions. The prospect of tighter monetary policy in America, however distant, hit the supply of credit in emerging markets. The squeeze was made worse in 2014 when the oil price fell from over $100 a barrel to half that in just a few months. The price of other industrial raw materials, which had settled onto a plateau after peaking in 2011, began to fall. The subsequent slump in investment was enough to drag big commodity exporters, such as Brazil and Russia, into recession.
Even so, by the end of 2015 the Fed was sufficiently confident about the outlook to raise its benchmark interest rate by a quarter of a percentage point, the first such increase in a decade. More increases were expected in relatively short order. But the jitters about China, and then Brexit, meant that it was a full year before the next. It has now followed up with another increase in much shorter order (see article).
False dawns were perhaps to be expected: recoveries from debt crises are painfully slow. Spending suffers as borrowers whittle away their debts. Banks are reluctant to write off old, souring loans and so are unable to make fresh new ones. And the world has had to shake off not one debt crisis, but three: the subprime crisis in America; the sovereign-debt crunch in Europe; then the bust in corporate borrowing in emerging markets.
But the initial and most painful stage of economic adjustment in emerging markets is coming to an end. Current-account deficits have narrowed, leaving most countries less reliant on foreign borrowing. Their currencies are a lot more competitive. And interest rates are high, so there is scope to relax monetary policy to boost demand (see chart 4). Business spending is already rising in response.
The breadth of the improvement—from Asia to Europe and America—makes for greater confidence that a pick-up is in train. A broad trend is a good proxy for an established trend, notes Manoj Pradhan of Talking Heads Macro, a research firm. Nevertheless, some countries are in better shape than others. India and Indonesia recovered quickly from the taper tantrum; their GDP growth has been fairly strong and steady. At the other end of the spectrum, Turkey and (to a lesser extent) South Africa look unlikely to see a big revival soon.
In the middle, there are signs that brutal recessions in two of the largest emerging markets, Russia and Brazil, are slowly coming to an end. Inflation in both countries is receding, restoring spending power to consumers. In Russia inflation fell to 4.6% in February, down from a peak of 16.9% two years ago. In the three months ending in September, GDP growth probably turned positive, according to the central bank, which has cut its main interest rate from 17% in January 2015 to 10% today; more cuts are likely. Manufacturing activity grew in each of the seven months to February, according to a survey of purchasing managers published by Markit, a data provider.
Brazil’s economy shrank again in the final months of 2016, but with inflation tumbling towards the 4.5% target, its central bank has cut its benchmark rate by two percentage points, to 12.25%, since October. Further cuts are again likely. Other commodity-producers in Latin America (bar Mexico, where the peso has weakened since Mr Trump was elected) are also relaxing monetary policy.
The recent buds relax and spread
That is the bull case. What of the risks? One is that tighter commodity markets will stymie consumer spending in the rich world by raising prices. But core measures of inflation that strip out volatile things like food and energy costs remain low: nowhere in the rich world have they reached the 2% rate that is the goal of central banks, the rate seen as necessary for a “normal” cyclical recovery. America is closest to that target; the index preferred by the Fed puts America’s inflation at 1.9%, with the core rate at 1.7%. In Europe the core rate is stuck below 1%, with wage growth of around 1.3% last year; but oil prices have pushed headline inflation back to 2%.
There is also the risk of expecting too much. A pick-up in global aggregate demand is good news. But growth rates will always be constrained by how fast the workforce can expand and how much extra output can be squeezed from each worker. In lots of places there is scope for jobs growth; but in America, Japan, Germany and Britain the labour market is already quite tight. With America close to full employment, wage growth has picked up to 2.8%, which is consistent with 2% underlying inflation if productivity growth stays around 1%. Pay is growing fastest in less well-paid industries, such as construction, retailing, hospitality and haulage, according to Morgan Stanley, a bank.
Wages might perk up yet more if productivity improved. But the post-crisis slump in productivity growth that has affected both rich and developing countries shows no sign of ending. In America output per hour rose by 1.3% in the year to the final quarter of 2016. Europe has not been able to match even that dismal rate. It would take an astonishing shift in productivity for America’s economy to manage the 4% GDP growth promised by Mr Trump. A less fanciful view is that American GDP growth might top 2% this year, a bit better than is expected for Europe. Continued investment, and possibly deregulation, could improve productivity somewhat; but they will not provide a step change. Without one, rich-world interest rates are likely to stay well below the levels that were considered normal before 2007.
It is not hard to imagine things that might yet derail the recovery. Though there is a cast-iron consensus that nothing bad will be allowed to happen before the big Communist Party congress in the autumn, China’s growing debt pile could still bring markets tumbling down. Populist victories in Europe’s various elections could bring about a crisis for the euro. Even if they do not, an end to the ECB’s bond-buying programme, which has kept government-borrowing costs at tolerable levels and even allowed a bit of fiscal stimulus to lift the economy, will lay bare the euro’s still-unfixed structural problems.
The Fed might tighten policy too quickly, driving up the value of the dollar and draining capital (and thus momentum) from a recovery in emerging markets. Or Mr Trump might make good on the repeated threats he made in his campaign to raise import tariffs on countries he considers guilty of unfair trade, thus taking a decisive step away from globalisation just as the world’s main economic blocs are at last starting to get into sync.
These risks are not new or surprising. What brings a freshness to the air is that a cyclical recovery has managed to overcome them. There may actually be some rosebuds to gather, for a while.
This article appeared in the Briefing section of the print edition under the headline "From deprivation to daffodils"
From the March 18th 2017 edition
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