Global recovery looking fragile

“The only thing we have to fear is fear itself.”

This was Franklin D Roosevelt’s assurance to the US electorate when sworn in as US President at his first inauguration in 1933. 

Unfortunately he was wrong. The US remained mired in depression for another nine years, until bailed out by World War 2. “Fear” was not the culprit.

Mismanagement, misjudgments and ignorance all made significant contributions to the Great Depression of the 1930s.

The Great Recession

The Great Recession – the one we were not supposed to have – is now seven years old and despite the best efforts of an army of professional economists, recovery remains tentative.

Unconventional monetary policy has driven interest rates down around the world. In some cases yields are negative.

The latest iteration of US growth released last week revealed the economy contracted in the first quarter. China’s central bank reported last Friday that its economy faced increased downward pressure this year as domestic levels of debt continued to rise.

China along with the U.K and emerging markets recorded weak performances in the first quarter.

The impact of this recession has spread to every corner of the globe.

Australia’s good fortune

Australia had the enormous good fortune, for six of those seven years, of being the supplier of raw materials for China’s unprecedented infrastructure/capital expenditure program.

That lucky escape appears to have nurtured a complacency gene in our national DNA. The odds on retaining this intact well into the future are very long.

Given the current finely balanced nature of the global economy along with the rapid emergence of geopolitical issues, our political leaders are experiencing a bumpy ride down the learning curve.

Balancing our relationships with out long-term ally, the United States and our relatively recent economic dependence on China’s appetite for our raw materials is a case in point.

One of the features of this recession has been its preoccupation with financial markets. As one of the root causes of the whole crisis was the mispricing of debt the concern with capital markets is understandable.

It is reinforced by the emphasis placed on monetary policy. In the US this development was adopted because congressional opposition to deploying fiscal policy was not forthcoming.

Much the same reasoning was behind the use of monetary policy in the Eurozone.

The liquidity time bomb

However, putting aside Greece, if you had to predict where the next crisis would occur on the recovery road the educated answer would probably be “market illiquidity.”

Nouriel Roubini, a New York based economist who rose to fame by his accurate calls during the early phases of the recession, describes the present situation as being a “liquidity time bomb.”

Unconventional monetary policies have created a massive overhang of liquidity.

A series of recent shocks in financial markets involving high frequency traders and sudden steep falls or “flash crashes” has raised the question as to whether these markets are deep enough to handle the investing of professional traders when they engage in herding behavior.

Roubini says: “This combination of macro liquidity and market illiquidity is a time bomb. So far it has led only to volatile flash crashes and sudden changes in bond yields and stock prices.

“But over time the longer central banks create liquidity to suppress short-run volatility, the more they will feed price bubbles in equity, bond and other asset markets. “

As more investors pile into over-valued, increasingly illiquid assets, such as bonds, the risk of a long-term crash increases.”

Roubini is not the only one to point out these risks. Major public and regulatory bodies have also done so.

High finance

Readers wanting to stay abreast of developments in the rarely reported confrontations of the world of high finance should log on to “zerohedge.com”.

The pieces are written under the name of Tyler Durden but the actual articles appear to be penned by well-informed but far from retiring bank tragics.

Yesterday, for example, the blog published a paper prepared by Deutsche Bank entitled: “The Fed Has Been Horribly Wrong” Deutsche Bank Admits, Dares to Ask if Yellen is Planning a Housing Market Crash.”

That may sound outrageous but the strategy of monetary policy has been based on employing market intervention with a view to distributing funds (including household savings) to those sectors of the economy that will spend and lift economic activity. For those who have their interest yields cut it is called financial repression. Its implementation has quite significant impacts on different sectors.

With quantitative easing we saw the Fed manipulate interest rates by actively buying government bonds.

Retail investors received lower yields than would have been the case had they been able to access a free market.

Seven years of lower than market returns for your savings can put a big hole in the so-called magic of compound interest.

Has the Fed been horribly wrong? 

If in fact the Fed has been “horribly wrong” that would make the pain of that loss even greater.

Last week Zero Hedge posted a blog headlined: “In Shocking Move, Goldman Slashes America’s Long-Run “Potential GDP” from 2.25% to 1.75%.”

That’s a reduction of more than 20 per cent in growth potential. Recently Goldman’s reduced its estimate of US long-term productivity growth to 1.5 per cent.

Actual growth is the sum of the percentage increase in the workforce and the percentage increase in productivity.

The US and UK are slowing down but yesterday we saw a study by the World Economy Institute in Hamburg that reported Germany’s birth rate had collapsed to the lowest level in the world.

Its workforce will start plunging at a faster rate than Japan’s by the early 2020’s. That is just five or six years away.

Fear can be conquered; demography can’t.

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Max Walsh

Contributor

Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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