It is typical that, in periods of market panic, we get all kinds of alarming news and assessments. China is going to have a mother of all collapses. Singapore banks are going to crash. The US economy is weakening, depriving the world economy of its most powerful growth engine. And so on. The gloom and doom seems never ending.
But the reality is quite different if we take a sober look at the hard facts, then a number of opinions that have compounded the depressed investor psychology turn out to be quite misplaced.
‘The global economy is decelerating, we could see a recession’
This really does not stand up to examination.
- Even in the downgraded economic forecasts of the International Monetary Fund (IMF) and World Bank, most countries are likely to see a somewhat better year this year than last. Both agencies project that growth in 2016 will rise a little over 2015 — the US, Japan, the eurozone, the UK, India and Mexico are all seen accelerating modestly while growth in Brazil and Russia is seen as less negative than in 2015. Among the large economies, only China is expected to do worse; and
- On our calculations, countries accounting for more than two-thirds of the world economy will see somewhat better growth this year than last year. One would think that’s a pretty good record.
So, what about China? Yes, China is in a bad situation and if its policymakers mishandle things, it could get worse. But, first, we need to take note of a few basic realities:
- The potential impact on Asian exports is negative but not alarmingly so. China is about 13% of the world economy and about 10% of world imports. Its imports are less in the form of consumer goods but more in natural resources, intermediate goods and capital goods. Economic weakness in China will certainly hurt commodity exporters — but they have already taken a huge hit. How much lower can commodity prices go, if the rest of the world economy is recovering? Capital goods exporters such as Germany, Japan, South Korea and the US may suffer — but so far, the damage from China has been offset by growth elsewhere. As for intermediate goods, much of this is utilised in its export processing plants and not meant for domestic use. So, the damage from a Chinese slowdown will not be acutely felt; and
- China’s financial stresses do matter. China’s huge debt, especially the pile of foreign currency- denominated debt is certainly a risk — especially if the Chinese renminbi were to be depreciated sharply. But why would policymakers do that unless they were mad? Furthermore, China has the fiscal firepower to bail out its banks, if it ever comes to that end. For the global economy to be seriously damaged, most of this debt would need to go bad and start toppling the largest banks in the world, which would then cause financial ructions so severe that the world economy could indeed sink. But nothing in the data on debt, repayment capacity and bank capital ratios suggests that this is a likely scenario.
‘Oil price falls are a sign of bad times’
The pessimistic argument is that:
- Such a sharp fall in oil prices usually signals a weak global economy;
- Sharp falls in oil prices will cause overleveraged oil/gas related firms to go bust while increasing pressures on highly indebted oil-exporting countries — some of which, like Venezuela, could also go broke and default on debt, precipitating financial stresses that could trigger weakness in the world economy; and
- Oil exporters now make up a larger proportion of world GDP, so the net gain of a large fall in oil prices is moot. The facts, however, suggest a more positive read:
- Rising supply, not demand, is the main driver of lower oil prices — owing to non-conventional sources such as shale coming onstream and, more recently, because Iran is able to export again as sanctions were lifted;
- Demand weakness is overstated. According to estimates by the International Energy Agency, China’s demand for oil products will grow 3.1% in 2016, down from an estimated 5.6% in 2015. In the developed countries, oil intensity has fallen, limiting the upside to oil demand from the fall in oil prices. The fall in oil intensity is a good thing — more efficient use of energy, reduced energy dependence of an increasingly services-dependent economy and the rise of renewable energy substitutes for oil;
- There are vastly more oil consumers than oil producers. The fall in oil prices is therefore a clear positive, not negative, for global growth; and
- Lags in the economy explain the slow emergence of the upside from low oil prices. Oil-exporting countries experience large falls in oil revenues immediately on the fall in oil prices and they slash their budgets quickly. Similarly, companies servicing the oil industry or actually producing the oil see their revenues fall dramatically and slash hiring and capital spending swiftly. So, the negative effects of oil are felt quickly. But the positive effects take time to come through — consumers that benefit from higher real spending power and businesses that benefit from lower costs need time to be convinced that the fall is a long-lasting one. Only after a lag will they step up spending — and this lag is even longer this time because we just had a mother of a global crisis that has made economic agents doubly cautious.
In short, the balance between the negative and positive effects will swing sharply to a net positive this year, producing a big upside to global growth.
‘Commodity price collapse is a bad thing’
As oil prices have fallen, we have also seen a huge fall in all kinds of commodity prices. The Bloomberg Commodity Index is down 28% from a year ago; copper has fallen 21% in the past 12 months, as has zinc. Iron prices have declined 34% y-o-y; coal has fallen 19%. Not surprisingly, commodity-exporting countries from Australia to Zambia are experiencing a downturn as commodity exports fall and declining commodity-related revenues depress incomes. Still, the hard facts suggest that the impact is not as bad as claimed:
- Not all commodity exporters are doing badly. Australia and Malaysia have seen economic growth hold up reasonably well — their economies are diversified and flexible enough to accommodate big shocks such as sharp falls in export earnings; and
- It is the undiversified commodity exporters and/or those who made macroeconomic policy errors that are doing badly — for example, Brazil, Russia and South Africa. These countries were complacent during the boom years, allowing fiscal and monetary policies to be too loose and undisciplined. They did not use the gains from the huge commodity up-cycle to build up reserves for the inevitable fall in prices. The current economic pains are payback for the lack of fiscal rectitude during the boom years.
More than this, we would argue that the fall in commodity prices is actually a big positive for the world economy:
- There are lots of winners from lower commodity prices. Input prices have fallen sharply, reducing costs of production across many industries and boosting profit margins or reducing prices to consumers. How can this be a bad thing?
- More importantly, the fall in commodity prices removes a crutch from policymakers in commodity exporting nations that enjoyed nearly a decade of “lazy growth” — where growth came from rising prices rather than the heavy lifting of building infrastructure, deregulating damaging policies and improving business and policy processes. But it is these latter policies — not high commodity prices — that make for sustainable and high-quality growth. Commodity markets are highly cyclical, they may go up for several years but eventually they correct and fall painfully. Complacently profiting from inflated commodity prices is not the path to true economic development; and
- Moreover, high commodity prices usually boost the exporting country’s currency, thus making their non-commodity exports less competitive. In some countries, this leads to the phenomenon of “premature deindustrialisation”, where the share of manufacturing in the economy actually declines. Yet, it is manufacturing that is needed for sustained improvements in living standards, worker skills and the body of skills and knowledge that produces the transformation in a country’s capacity that is the true mark of economic development. In other words, the fall in commodity prices:
- Will help countries that are net importers of economically sensitive commodities such as iron ore, copper, zinc, aluminium, rubber and coal. That set of winners is actually a large one, including most Asean countries (remember that Asean mainly exports food-related crops such as rice, crude palm oil, coffee and cocoa), India, Sri Lanka and so on; and
- Will force, and is already resulting in, much better economic policies in exporters of economically sensitive commodities, which in turn will produce higher-quality growth and development in time.
‘We are in a deflationary situation and deflation is always bad’
We are now in a period of very low consumer price inflation or even outright deflation in many countries. This is helping to preserve consumers’ purchasing power as well as their savings. So, why should that be a bad thing?
There is such a thing as bad deflation, which is the product of bad monetary policies that undermine growth and spending. But that is not the problem we have today. At a time of ultra-easy monetary policy, it is hard to say that overly tight monetary policies are causing the low inflation we are witnessing today.
Sure, low inflation or outright deflation could mean that highly indebted companies, countries and individuals cannot rely on price rises diminishing the value of the debt they took to get out of their overleveraged positions and this could have untoward effects. But are we saying that the only solution to excessive debt is to reward those who misguidedly loaded themselves with debt, by reducing the real value of their debt? What about the hardworking savers, who will be penalised in the process? Is this the right set of incentives to create in any economy — rewarding the misguided and penalising those who work hard and save for their retirement?
The solution to excessive levels of debt lies elsewhere — in debt restructuring and bank recapitalisation, not in penalising prudent savers and investors. Today’s low inflation is something to be celebrated, not something to weep over.
The bottom line
The world economy does face challenges, such as what is going on in China and the rising evidence of financial stresses in pockets of the world economy. But the overall picture is still reasonably good, with global growth likely to be at least a tad stronger than last year. So long as there are good engines of growth, the potential risks can be contained or mitigated.
So, to those who believe that Singapore banks are going to crash or the world is going to end, please take a deep breath and calm down. Unless there is some geo-political shock that no one can predict, the world will be generally a safe and pleasant place.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy.
This article appeared in the Corporate of Issue 716 (Feb 22) of The Edge Singapore.