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Global Economy Warrants a Big Dose of Caution
World Economy

Global Economy Warrants a Big Dose of Caution

The People’s Bank of China was preparing to spring a surprise while President Xi Jinping was taking a selfie with Manchester City star Sergio Aguero. On Friday, the central bank in the world’s second-biggest economy cut the cost of borrowing for the sixth time in a year.
Those investors who thought the announcement in Beijing was a big buy signal should ask themselves whether this was a sign of strength or a sign of weakness, Yahoo reported.
It is worth noting that the interest rate move came just days after China released official figures showing that the economy’s annual growth rate had slowed down in the third quarter, but only to a still healthy looking 6.9%. After all the stock market turmoil in August, that was a strong performance and it had the desired effect of reassuring markets that the authorities were in control of the planned rebalancing of the economy towards more modest but better quality growth.
The good news for the PBOC is it has plenty of scope to cut rates further from their current level of 4.35% should the economy not respond to the stimulus provided.
But it is not just in China that things are looking a bit dicey. On the day before the PBOC cut rates, the European Central Bank dropped the broadest of hints that in December it will announce new growth-boosting measures for the eurozone. Mario Draghi, the ECB’s president, has options. He could cut the ECB’s deposit rate, already -0.2%, still further and thus penalize banks that want to park money with the central bank. More likely, though, the ECB will turn to its version of quantitative easing and increase its bond-buying program from the current €60 billion ($66.1 billion) a month.

 Competitive Advantage
Japan is also poised to provide more stimulus later this week when official figures are likely to show the economy back in recession. As with the ECB, a central aim of the policy is to secure a competitive advantage by bearing down on the exchange rate. But if the yen and the euro are weakening, something else has to be strengthening, and the upshot will be that the US dollar will rise.
With the US economy showing signs of slowing, the Federal Reserve, America’s central bank, will put on ice any plans to raise interest rates, for fear that this will drive the dollar even higher.
So what’s the problem? China, Japan and the eurozone are all easing policy. The US is going to delay tightening policy. More stimulus equals stronger growth and fends off the threat of deflation. That’s got to be good, hasn’t it?
Well, only up to a point. Problem number one is that by deliberately weakening their exchange rates, countries are stealing growth from each other. Central banks insist that this does not represent a return to the competitive devaluations and protectionism of the 1930s, but it is starting to look awfully like it.
Problem number two is that the monetary stimulus is becoming less and less effective over time. There are two main channels through which QE operates. One is through the exchange rate, but the policy doesn’t work if all countries want a cheaper currency at once. Then, as the weakness of global trade testifies, it is simply robbing Peter to pay Paul.
The other channel is through long-term interest rates, which are linked to the price of bonds. When central banks buy bonds, they reduce the available supply and drive up the price. Interest rates (the yield) on bonds move in the opposite direction to the price, so a higher price means borrowing is cheaper for businesses, households and governments.
But when bond yields are already at historic lows, it is hard to drive them much lower even with large dollops of QE.
This is a time for caution. The fact that central banks feel the need to provide more stimulus more than six years into a recovery is not a reason to load up on shares or, indeed, any risky assets. Rather, it is a sign of trouble ahead. If the global economy requires a fresh growth boost, it means that an already feeble recovery is waning. If it doesn’t, it means there is a heightened risk of a new financial crash or higher inflation

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