The world economy is in serious danger of falling into another recession — and if it does, governments have few tools left at their disposal to combat it.
That’s the dire warning from HSBC chief economist Stephen King, who describes the situation as like being on an “ocean liner without lifeboats", AP reported.
With interest rates at near zero across the developed world, record levels of public debt and little room for further stimulus spending, the conventional “monetary ammunition” that has been built up following previous recessions is all but non-existent.
“In effect, the world economy is sailing across the ocean without any lifeboats to use in case of emergency,” he writes in a new report, "The world economy’s titanic problem".
That’s bad news. As the UK’s Telegraph points out, the United Nations has cut its global growth forecast for this year to 2.8 percent — only slightly above the 2.5 percent which used to be regarded as a recession.
Danger From China
The biggest danger comes from China. If the Chinese economy weakens so much that the authorities have no other choice than to let the renminbi slide, it will have severe knock-on effect.
“In this situation, [collapsing] commodity prices lead to severe weakness elsewhere in the emerging world,” King writes. “The dollar surges, but the Fed is unable to respond via interest rate cuts. The US is eventually dragged into a recession through forces beyond its control.”
And the situation in China is already worse than authorities are letting on, experts have warned.
China accounted for 85 percent of global growth in 2012, 54 percent in 2013, and 30 percent in 2014 — that figure is expected to fall to 24 percent this year.
Interest Rates
In every recession since the 1970s, the US Federal Reserve has cut interest rates by a minimum of 5 percentage points.
“That kind of traditional stimulus is now completely ruled out,” King writes. “Meanwhile, budget deficits are still uncomfortably large and debt levels uncomfortably high.”
While in the past, deep recessions have typically been followed by strong recoveries, this time around, “a deep recession has been followed by an insipid recovery: more L-shaped than V-shaped”.
“Today, inflation isn’t just low. It is, arguably, too low,” he warns. When debt levels are low, interest rates are high and budget deficits are small, dealing with recessions is relatively easy, he says. “When debt levels are high, interest rates are at zero and budget deficits are large, dealing with recessions is a lot more troublesome.”
Attempts in various global economies to “rebuild their ammunition” over the past six years have failed. The European Central Bank had “egg on its face” after trying to raise interest rates in 2011, only to be forced to drop them again.
US Recoveries Weaker
King also points out that each of the last four US recoveries have been weaker than the last, and the effectiveness of fiscal stimulus has diminished over time.
In the 1930s, it was a novel idea, but the chances of it working to boost economic activity were high given the healthy starting position and an absence of future spending commitments.
“Today, it is much more difficult to make the same argument. The best that can be said — and this certainly chimes with the Greek experience — is that pursuing aggressive fiscal austerity in the midst of a deep recession is likely to end in tears,” King says.
On the plus side, even in the event of a global downturn, Australian authorities are better placed than those in other developed economies, according to AMP Capital chief economist Dr Shane Oliver.
Our cash rate is still at 2 percent, and net public debt to GDP is at around 20 percent compared with around 100 percent in the US and Europe, and higher in Japan, he argues.
