Nouriel Roubini writes: Since the beginning of the year, the world economy has faced a new bout of severe financial market volatility, marked by sharply falling prices for equities and other risky assets. A variety of factors are at work: concerns about a hard landing for the Chinese economy; worries that growth in the United States is faltering at a time when the Fed has begun raising interest rates; fears of escalating Saudi-Iranian conflict; and signs – most notably plummeting oil and commodity prices – of severe weakness in global demand.
And there’s more. The fall in oil prices – together with market illiquidity, the rise in the leverage of US energy firms and that of energy firms and fragile sovereigns in oil-exporting economies – is stoking fears of serious credit events (defaults) and systemic crisis in credit markets. And then there are the seemingly never-ending worries about Europe, with a British exit (Brexit) from the European Union becoming more likely, while populist parties of the right and the left gain ground across the continent.
These risks are being magnified by some grim medium-term trends implying pervasive mediocre growth. Indeed, the world economy in 2016 will continue to be characterized by a New Abnormal in terms of output, economic policies, inflation, and the behavior of key asset prices and financial markets.
So what, exactly, is it that makes today’s global economy abnormal?
First, potential growth in developed and emerging countries has fallen because of the burden of high private and public debts, rapid aging (which implies higher savings and lower investment), and a variety of uncertainties holding back capital spending. Moreover, many technological innovations have not translated into higher productivity growth, the pace of structural reforms remains slow, and protracted cyclical stagnation has eroded the skills base and that of physical capital.
Second, actual growth has been anemic and below its potential trend, owing to the painful process of deleveraging underway, first in the US, then in Europe, and now in highly leveraged emerging markets.
Third, economic policies – especially monetary policies – have become increasingly unconventional. Indeed, the distinction between monetary and fiscal policy has become increasingly blurred. Ten years ago, who had heard of terms such as ZIRP (zero-interest-rate policy), QE (quantitative easing), CE (credit easing), FG (forward guidance), NDR (negative deposit rates), or UFXInt (unsterilized FX intervention)? No one, because they didn’t exist.
But now these unconventional monetary-policy tools are the norm in most advanced economies.
Some alleged that these unconventional monetary policies were a form of debasement of fiat currencies.
Instead, inflation is still too low and falling in advanced economies, despite central banks’ unconventional policies and surging balance sheets.
The reason ultra-low inflation remains a problem is that the traditional causal link between the money supply and prices has been broken. One reason for this is that banks are hoarding the additional money supply in the form of excess reserves, rather than lending it (in economic terms, the velocity of money has collapsed). Unemployment rates remain high, giving workers little bargaining power. And a large amount of slack remains in many countries’ product markets, with large output gaps and low pricing power for firms (an excess-capacity problem exacerbated by Chinese overinvestment).
And now, following a massive decline in housing prices in countries that experienced a boom and bust, oil, energy and other commodity prices have collapsed.
The recent market turmoil has started the deflation of the global asset bubble wrought by QE.
How long markets not only ignore the real economy, but also discount political risk?
Welcome to the New Abnormal for growth, inflation, monetary policies, and asset prices, and make yourself at home. It looks like we’ll be here for a while.
