The world economy has had a rough start in 2016, and it will
continue to be characterized by a new abnormal: in the behavior of
growth, of economic policies, of inflation and of key asset prices and
financial markets.
First, potential growth in developed markets and emerging
markets has fallen, and actual growth will remain below this weak
potential.
That potential has fallen because of the burden of high
private and public debt, population aging—older people tend to save more
and invest less—and a variety of uncertainties that keep capital
spending low.
Meanwhile, technological innovations haven’t translated
yet into higher productivity growth at the aggregate level, while
structural reforms aren’t moving fast enough to increase potential
growth.
There’s also “hysteresis”—the way that protracted cyclical
stagnation can weigh down potential growth, since human and physical
capital become more obsolete if they aren’t used at full capacity.
What actual growth we’ve seen has been anemic, below its
potential as a painful process of deleveraging has been under way, first
in the U.S., then in Europe and now in emerging markets, to stabilize
and reduce high levels of private and public debts and deficits.
At the same time, economic policies—especially
monetary—have become increasingly unconventional, and the distinction
between monetary and fiscal policy has become more blurred.
Ten years
ago, who had heard of terms such as ZIRP (zero-interest-rate policy), QE
(quantitative easing), CE (credit easing), or UFXInt (unsterilized FX
intervention)? These esoteric and unconventional monetary-policy tools
are now the norm in most advanced economies, and even some emerging
market ones as well.
Some critics incorrectly argued that these unconventional
monetary policies—and the accompanying mushrooming of the balance sheet
of central banks, which they saw as an alleged form of debasement of
fiat currencies—would lead to hyperinflation, a collapse in the value of
the U.S. dollar, a sharp rise in long-term interest rates and the price
of gold and other commodities, even the replacement of standard
currencies with cryptocurrencies like Bitcoin.
Yet none of that
happened—inflation is still too low and falling in advanced economies,
while long-term interest rates have kept on falling in the past few
years. The value of the dollar has surged at historic rates even as
commodity prices have fallen sharply—with gold dropping by some 25% in
2015—even as Bitcoin has been the worst-performing currency in 2014–15,
if one could even call it a currency.
In spite of the ballooning balance sheets of central banks
and the unconventional policies that were supposed to debase fiat
currencies, inflation is too low and falling in advanced economies, and
even in many emerging markets. Central banks now need to try to avoid
low-flation, if not outright deflation.
The traditional connection
between the money supply and prices—as more money is pushed into the
system, prices should go up—has collapsed for two reasons. One, banks
are hoarding the additional supply of money in the form of excess
reserves rather than lending it. Two, there is still a lot of slack in
many countries. Goods markets have large output gaps, with the excess
capacity now exacerbated by the overinvestment by China. In labor
markets, unemployment rates are still too high and workers have too
little wage bargaining power.
That slack is clear in real estate markets
in countries that had a housing boom and bust, and now in commodity
markets where the prices of oil, energy and other raw materials have
collapsed thanks to various factors, including the slowdown of China,
the surge of supply in energy and industrial metals thanks to new
discoveries and overinvestment in new capacity, as well as a strong
dollar that weakens the price of commodities.
Real interest rates are very low and many asset prices too
high relative to their underlying fundamental value in equities, real
estate, credit and government bonds. We have negative nominal interest
rates at the policy level in most of Europe—including the euro zone,
Switzerland, Denmark and Sweden.
There are now over $2 trillion
equivalent of government bonds at maturities all the way to 10 or 20
years that provide a negative nominal yield in the euro zone, the rest
of Europe and Japan. Why would investors lend to governments at a
negative nominal yield for 10 years when they could instead hold cash
and at least earn a zero yield?
It is indeed a new abnormal for growth, inflation, monetary
policies and asset prices—and it is likely to stay with us in 2016 and
well beyond.
Read more: The New Abnormal for a Troubled Global Economy - by Nouriel Roubini
