Divergent Monetary Policies and the World Economy
World Economy

Divergent Monetary Policies and the World Economy

Global economic policymakers should approach 2016 with more than the usual degree of caution. Not only do there appear to be an unusually large number of identifiable fault lines in the global economy, but those fault lines also appear to be both interconnected and of systemic consequence.
This is all too likely to result in yet further slowing in the global economic recovery next year that would argue against any premature additional tightening in Federal Reserve interest rate policy, Washington-based AEI, reported.
Among the fault lines of most systemic importance is the marked divergence in the monetary policy stance between the world’s major economies. Whereas the Federal Reserve has long since ended its quantitative easing program and has now begun the process of normalizing interest rates, both the European Central Bank and the Bank of Japan are engaged in highly aggressive quantitative easing programs.
During the period ahead, there is every likelihood that this divergence will increase as both the ECB and the BOJ step up their unorthodox policy stances to support their anemic economic recoveries and to fend off the risk of deflation.
Ultra-Easy Policy  
Over the past year, the divergence in monetary policies between the world’s major economies contributed to more than 10% effective US dollar appreciation as well as a start to the reversal in the large US capital outflows that characterized the prolonged period of ultra-easy Federal Reserve monetary policy.
A clear and present danger for the global economy is that this trend toward a stronger US dollar and a return of capital to the United States will be exacerbated by a further divergence in relative monetary policy stances.
A further strengthening of the US dollar is likely to highly complicate China’s efforts to rebalance its distorted economy from one which relies excessively on investment and export-led growth to one that has domestic consumption play a larger role.
This is especially the case since it is occurring at a time when China’s economy is already slowing and there has been more than Singapore $800 billion in Chinese capital outflows over the past year. It is also occurring at a time when the Chinese economy is characterized by massive excessive manufacturing capacity as well as by over-investment in its property sector.
That, in turn, would raise the risk of unsettling global financial markets. It would do so by inducing China’s Asian competitors to weaken their currencies and by prompting the ECB and BOJ to further cheapen the euro and Japanese yen through even more money printing.

EM Risks Persist
Yet another considerable risk to the global economy in 2016 could very well come from the major emerging market economies, which now account for close to 40% of the world economy. A slowing in the Chinese economy will more than likely keep international commodity prices at their currently highly depressed levels, which will deal a continued body blow to major commodity exporters like Brazil, Indonesia, Russia and South Africa.
At the same time, a strengthening of the US dollar and a return of capital flows to the United States is bound to exert considerable pressure on emerging market corporates. According to the Bank for International Settlements, since 2009, those corporates have increased their US dollar-denominated borrowing by more than $3.25 trillion.
Sadly, six years after the start of European sovereign debt crisis, the European economy is still far from out of the woods. Indeed, Europe’s economic recovery remains anemic while the already disturbingly high debt levels of its peripheral countries have continued to rise.
More worrying yet, as evidenced by election results this past year in Greece, Portugal and Spain, which each saw the fall of their governments, strong winds of political change are blowing through Europe.
As a result, Europe is now suffering from both austerity and structural-reform fatigue. This makes it all too vulnerable to another round in its painful sovereign debt crisis should global liquidity conditions tighten and should the global economic recovery falter.

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