Transcript Global Tensions and Economic Security -

Global Tensions
and Economic Security
2015 CCMR Executive
Course in Decision Making
Naval Postgraduate School
October 27, 2015
Dr. Robert E. Looney
[email protected]
Outline
• The Global Economic Crisis and Aftermath
• Overview
• Patterns of Recovery
• The Current Situation
• Forecasts/Scenarios
• Key Risks
1. Emerging Market Crisis
2. Instability from Oil Price Decline
3. African Debt Problems
4. Declining Defense Expenditures in the West
• General Lessons
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The Global Crisis
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Economic Crisis and Security Threats
“The global recession is America’s primary near-term security
concern.”
Admiral Blair – Director of National Intelligence
(February 2009)
“The single biggest threat to national security is the national
debt.”
Admiral Mullen, Chairman of the Joint Chiefs of Staff
(August 2010)
“I have to confess, I paid no attention to this (economics) as a
cadet and have done nothing to increase my awareness of
economics issues between age 22 and 59. I should have
paid attention.”
General Dempsey, Chairman of the Joint Chiefs of Staff
(October 2011)
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Global Economy Overview I
The Changing Global System
• Before the 2008-09 crisis, the main feature of the global
economy was its rapid integration – has continued but at
a slower pace since the crisis
• However, economic policies largely set at the national
level to benefit domestic economy
• These policies are increasingly affecting other economies
• External effects are particularly important in the financial
sector due to potential for large and abrupt changes in:
• Capital flows
• Asset prices
• Interest rates, exchange rates, and
• Credit availability.
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Global Economy Overview II
The 2008-09 global economic crisis and its aftermath
illustrate this new reality
• Characterized by defective growth models in advanced
economies based on
• Excess monetary expansion/credit and
• Debt-driven domestic aggregate demand
• Complicated by structural flaws and limited adjustment
mechanisms especially in Europe leading to
• Instability
• An on-going crisis
• Large negative shock to the real economy
• Emerging economies were subsequently affected by
• Credit tightening (including trade finance)
• Rapid declines in exports
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Global Economy Overview III
• Post-crisis policy largely based on credit expansion and
debt reduction
• Unconventional monetary policy – United States
• Lowered cost of credit for debtors and those seeking to borrow
for business expansion
• Came at the at expense of savers – lower interest rates
• Did not work well because investment constrained by deficient
domestic demand relative to capacity
• Savers sought higher returns in emerging economies
• Causing increases in credit and causing upward pressure
on exchange rates and asset prices – responded with
• Limits on capital inflows
• Reserve accumulation and
• Measures to restrict credit and restrain asset-price inflation
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Global Economy Overview IV
• Situation changed in May 2013 when U.S. Federal reserve
indicated it might taper its purchase of long-term assets
• Asset prices shifted and in emerging economies
• Capital rushed out,
• Caused credit markets to tighten and
• Exchange rates to fall
• Causing a slowdown in short-term growth.
• The reversals may have longer term adverse effects – although
not clear at this point
• While China’s output is affected by advanced country
economic performance – financial system largely isolated
• Capital account less open, foreign currency reserves of $2.5
trillion mean exchange rate is controllable
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Global Economy Overview V
• Decentralized policy and growing externalities will result
in a partial de-globalization
• Not a good idea to run persistent current account deficits and
become dependent on (temporarily) low-cost foreign capital
• Open capital accounts may be replaced by rules-based
constraints on financial capital flows
• Lesson from crisis
• Pattern of accumulating reserves via current account surplus will
be more pronounced in order to manage exchange rates
• Public purchases of domestic assets to stabilize asset prices net
capital flows will become increasingly common.
• Successful countries will be those who learn to live with
growing policy interdependency without much policy
coordination
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Crisis Has Accelerated Changes in World GDP
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Decline of the G-8
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Patterns of Future Pubic Debt
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Debt Vulnerability
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Crisis Has Resulted in Accelerated Divergence
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Patterns of Recovery I
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Patterns of Recovery II
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Current Global Patterns I
• Today world economy is characterized by divergence
• While growth was centered in the advanced world in the
1970s, 1980s, and 1990s, more recently it has moved to
emerging economies
• According to the International Monetary Fund of the eight
countries expected to contribute most to global
economic expansion over the next five years only U.S.
and Korea are advanced economies
• The U.S. comes third contributing 10% of total world
growth after China and India – who contribute 45%
• Turkey is expected to add more growth in dollar terms to
global economy over next five years than Germany
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Current Global Patterns II
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Current Global Patterns III
• Although emerging countries are more dynamic and are
where global growth is located, they have disappointed
forecasters time after time
• Every year since 2011 forecasters have started to predict
the following year’s likely expansion only to grow more
pessimistic as time passes
• Not only have forecasts for emerging economy growth
persistently deteriorated for every year from 2012 to the
latest forecasts for 2016 economists have learnt from the
past.
• Every year they have been less optimistic than the last,
but still surprised by even weaker data
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Current Global Patterns IV
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Current Global Patterns V
Economists appear to have made four errors in forecasting:
• First they have extrapolated the rapid pre-crisis economic
growth rates of emerging economies into the present
• Not noticing that underlying productivity growth has declined
• Second they have not taken sufficient notice of a slowing
trend of employment growth in emerging markets
•
Making growth harder to achieve
• Third as with slower growth many policy weaknesses
have surfaced in many countries
• Corruption scandals in Brazil for example had been hidden by
rapid growth
• Fourth with the surprise slower growth has come a
sudden drop incommodity prices
• Particularly for those countries dependent on ore, metal and oil
exports.
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Current Global Patterns VI
• Comparing recent expctations for 2015 growth with those
three years ago highlights the significant countries with
the most disappointing economic performance –
countries which let themselves down
• Russia
• Most glaring example of unexpected weakness comes from
Russia which was thought to be set for persistent growth rates of
about 4%
• This year the economy will contract by about an equivalent value
• Hard hit by falling oil prices and economic sanactions following
its military activity in the Ukraine
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Current Global Patterns VII
• Brazil
• Country has gone from being one of the most dynamic
economies in Latin America to one regarded as having
• Weak fundamentals
• Corporate scandals and
• A Fragile policy framework
• Nigeria and South Africa
• Been among the five most disappointing large economies
compared with expectations three years ago
• Problem has been the fall in commodity prices
• China
• Commodity prices have not played a role
• Growth around 7% in 2015 -- well below 8.5% expected in 201223
Current Global Patterns VIII
Countries which exceeded expectations
• Although global growth is slower than hoped three years
ago many of the advanced economies are recovering
faster than expected at the height of the euro crisis
• Spain
• A star performer expected to expand by more than 3% in 2015
compared with the 1.5% forecast in 2012
• Germany
• Also exceeding expectations although its growth is still
anticipated as being modest in 2015 and below 2%
• India
• Performing much better than anticipated -- Helped by lower
commodity prices and better macroeconomic policy framework
• Growing at around 7.5% in 2015 abut a percent higher than
anticipated
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Current Global Patterns IX
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Current Global Patterns X
• Generally there are relatively few star performers
• Explains the gloomy economic outlook
• However the overall-situation remains too strong to be
talking yet of a global economic downturn.
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Today’s Problem
• Policy makers are in a bind in many countries
• In the Eurozone and Japan they are still trying to find ways to
stimulate demand
• In the U.S. and U.K interest rates are about to increase, but
there is widespread concern that any movement back to normal
might trigger financial turmoil
• However leaving monetary policy loose will encourage excessive
borrowing which may create bubbles and another financial crash
• In emerging markets the need is to push forward on structural
reforms to labor and product markets as well as education and
social security to enable more secure and rapid growth
• Not easy and mistakes are certain to happen.
• The economic environment in many parts of the world is
thus quite fragile with forecasts increasingly pessimistic.
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The New Normal I
• The current situation has been called “The New Normal” -It
is characterized by:
• Deficient Demand – hard to generate enough demand to
absorb potential global supply – threat of deflation
• Stagnant Productivity. In advanced countries productivity
fallen from 2% a year to less than 1%
• Fragile Finance – system may be even more fragile than
before the crisis. Assets to equity very high making banks
vulnerable
• Unstable Politics – political stresses – hostility towards
elites, foreigners, international institutions make finding
solutions difficult
• Tense Geopolitics – Russia, China, ISIS, Iran, Ukraine –
create great uncertainty
• Challenge Overload – both domestic and international.
Breakdown of global governance when problems mounting28
– maintain open global economy, climate change, peace.
The New Normal: II
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IMF Forecast 10/2015
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IMF Regional Forecasts 10/2015 I
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IMF Regional Forecasts 10/2015 II
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Possible Risks: Remaining 2015 I
• Looking ahead in 2015 – Possible Risks
• United States
• U.S. Treasury exhausts its borrowing capacity on November 5,
and some analysts place feel a government shut-down will occur
• Europe
• Greek debt relief negotiations should start soon; if protracted, the
situation could renew concerns about “Grexit.” Growing concern
that discontent in the U.K. will result in “Brexit”
• Central Banks
• The European Central Bank (ECB) and the Bank of Japan may
both consider easing measures, but new dollar strength could
create disruptive capital flows and exchange rate movements.
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Possible Risks Remaining 2015 II
“New Normal” factors at work:
• Destabilizing geopolitical events
• Geopolitical risks are very high now:
• The West’s relations with Russia are the worst they have been
since the end of the Cold War
• The stand-off in Syria makes things even more dangerous
• Tensions are rising in the South China Sea
• Oil has remained cheap at the same time – very unusual
situation – low oil prices have not provided the usual
stimulus to the global economy
• One factor – low oil prices reflect rapid buildup in supply from
U.S. shale
• Second factor – low oil prices sending a message about the
possibility of further weakness in the global economy
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Global Scenarios 2016
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Alternative Scenarios to 2020
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EIU October 2015: Major Risks I
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EIU October 2015: Major Risks II
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Geopolitical Risks Intensifying
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Assessment of Key Risks
• As noted, the current consensus forecasts and scenarios
are sensitive to a series of possible shocks/adverse
developments.
• Adverse developments in one or more areas might result
in increased instability, geopolitical tensions and/or
negative linkages leading to lower growth rates:
1. Emerging Market Crisis
2. Instability from Oil Price Decline
3. African Debt Problems
4. Declining Defense Expenditures in the West
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Key Risk: Emerging Market Crisis I
• Experts disagree about whether China faces a hard
landing, but emerging markets pose a growing risk to the
global economy
• Global markets very jittery now
• August 11, 2015, Chinese currency devaluation rattled
global markets
• Since that time Chinese yuan has weakened – then
strengthened with government support
• Currency now just 2.5% lower than in August
• Global stock markets have had much bigger changes
• Dow Jones Industrial Average down 6.5%
• Shanghai Composite Index down 22%
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Key Risk: Emerging Market Crisis II
• Crisis reflects long-standing concerns over Chinese
economy including
• Overinvestment and excess capacity in manufacturing,
• Real estate and stock market bubbles fueled by easy money and
leverage and
• An incomplete reform process that failed to place hard budget
constraints on state enterprises
• The initial policy response by government was chaotic and
opaque
• So those predicting a hard land landing have some
support for their assessment
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China: What Kind of Landing?
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Key Risk: Emerging Market Crisis III
China’s Growth Story
• IMF forecasts China’s growth rate at 6.8% (2015) and
6.3% for 2016 well below government's 7.0%
• This is well above many private forecasts
• High forecast based on several assumptions
• First, the nearly double digit growth in services and retail
sales will continue– confirming the rebalancing is
occurring
• Second, policy will be better coordinated and
communicated going forward
• Also monetary and fiscal stimulus will provide meaningful
support to activity later this year
• Third the sharp slowdown in manufacturing will not
cascade to the broader economy
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Key Risk: Emerging Market Crisis IV
• Most likely the truth in China lies somewhere between
hard landing and muddle through scenarios
• Other indicators of growth including sales, energy consumption
and international trade tell a mixed story
• Many forecasters have marked down their China
forecasts – but still room for optimism
• What happens in China will have a significant impact on
many commodity exporters
• Strong growth in Chinese services and a jobs supporting
government stimulus package will not help commodity exporters
• Slow-down already being felt in Australia, Brazil and Argentina
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Key Risk: Emerging Market Crisis V
• In countries where policies have been weak, markets
have been brutal
• In Brazil which is also experiencing a political crisis, currency
down 30% against the dollar since July
• Other countries such as South Africa and Indonesia also face
significant currency pressures
• Even greater risks come from financial contagion
• There has been a rapid buildup in corporate debt and warnings
of a banking crisis as a result of rapid credit growth in some
emerging markets.
• Nonbank corporate debt has increased 500% over past decade
to $23.7 trillion or around 90% of the GDP of these countries
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Rising EM Debt Levels
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Key Risk: Emerging Market Crisis VI
• Corporate debt defaults weigh directly on economic
growth and can damage balance sheets of banks and the
countries that stand behind the banks
• Much of this debt is linked to trade with China and
• Falling profits as well as
• Losses that could result from added currency volatility which is
likely to dramatically add to burden of servicing this debt
• Could create financial distress throughout the emerging
world
• Could lead to deflationary pressures which in turn would
depress returns on investment
• Some worried that situation is similar to the collapse of
2008
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Key Risk: Emerging Market Crisis VII
• On top of these concerns the most striking change in the
IMF’s outlook is an increased concern over the
• Sharp downward revision to the long-term growth prospects for
emerging markets
• End of the commodity super-cycle and
• A reversal of capital inflows
• Signals a period of lower investment and weaker fiscal
positions
• Results in reduced capacity to support growth
• Many cases optimism that existed following 2008-09
recession that emerging countries would rapidly see
incomes converging with advanced industrial counties is
gone.
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Key Risk: Emerging Market Crisis VIII
• For the United States fragility in emerging markets is the
critical risk
• By itself, softer Chinese growth and the 2.5% decline in the yuan
since August 11 would only reduce growth by 0.1 or 0.2%
• However if other countries depreciate their own currencies
against the dollar in response to pressures the broad based
appreciation of the dollar could be significant
• Rough rule of thumb is that a 10% move in the traded weighted
dollar reduces U.S. GDP by around 0.5% after a year
• Risks appear to have been an important factor in the
Federal Reserve September decision to delay raising
interest rates from zero
• Situation not likely to change anytime soon
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Currency Depreciation in Emerging Markets
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QE and Emerging Market Debt I
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QE and Emerging Market Debt II
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QE and Emerging Market Debt III
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QE and Emerging Market Debt IV
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EM Country Vulnearabilities
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Key Risk: Oil Price Decline I
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Key Risk: Oil Price Decline II
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Russia and Falling Oil Prices I
Facts:
• Energy is the largest single sector of Russian economy –
one quarter of total GDP, down form a third two years ago
• Energy exports account for about 68 percent of Russian
trade
• Oil and gas revenues provide half the Russian
government’s official budget and uncounted but
substantial amount of the unofficial funding that
supports the country’s power structure
• As a result of the fall in oil prices Russian economy is
predicted to decline by 3.5% this year with oil export
revenue down by $95 billion
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Russia and Falling Oil Prices II
• Immediate problem not sanctions imposed by the West
• The issue is economic
• Most of Putin’s 15 year reign has coincided with strong
energy prices and growing production of oil and gas
• Resulting revenue ha enabled Kremlin to keep most
people happy
• Businessmen, the military, the middle class of Moscow and St
Petersburg, and most of wider population
• However, little done to prepare for the current downturn
• Economy has not been diversified
• A reserve fund but amounts small and will soon be drained if low
oil prices continue
• Very limited improvement in infrastructure, particularly in the
energy sector
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Russia and Falling Oil Prices III
• Gazprom is set to produce less gas this year than at any
time since fall of the Soviet Union
• Market share expected to drop by 30% this year
• Gas-to-gas competition
• Fed by increased flows of LNG has broken the traditional link
between gas and oil prices,
• Is changing the structure of he market the Russians had taken
for granted
• In addition Gazprom’s trading activities under attack from
regulators in Brussels
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Russia and Falling Oil Prices IV
• Situation in oil no better.
• Russia exports 6m b/d – each worth 40% less than two
years ago
• Large surplus of supply over demand
• Good reason situation will continue for several years and oil
prices languish
• Sanctions and associated isolation of Russia because of
Ukraine not immediate cause of problems, but they
compound the country’s long term difficulties
• Russia needs to expand oil production into new areas but
international oil companies in not hurry to invest with
sanctions in place
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Russia and Falling Oil Prices V
• Fears about Russian economy resulting in massive
outflow of capital
• Exodus of capital since Ukraine crisis could reach $300
billion by end of 2015
• Situation dangerous because options for Russian
government are so limited
• Oil and gas markets being shaped by forces Putin can not
control
• Downward cycle could take years to play out
• Even a resolution of Ukraine crisis would not restore Gazprom’s
market share in western Europe
• Deals to sell gas from east Siberia to China and others make
sense but will not make money for another decade
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Russia and Falling Oil Prices VI
• Real risk is that economic discontent will force either
existing Russian government or its replacement into
harder political stance
• In many ways last 25 years of relatively stability are not the norm
• One of the major reasons for fall of the Soviet Union at the end
of the 1980s was the collapse in energy prices
• Russia is weaker now that at that time.
• Fear is that Russia has much to gain from higher oil
prices and that they also have the ability to destabilize
the Middle East to bring that eventuality
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Key Risk: African Debt I
Debt growing problem in Africa
• Borrowing in dollars increasingly risky and expensive
• As local currencies depreciate on softening commodity
prices, repayment costs soar
• Threatening added costs of up to 10.8 billion dollars
• March 5, 2015 Ghana announced plans for a $1 billion ten
year Eurobond to repay part of its debt maturing in 2017
• Extremely low and increasingly negative bond yields in
developed economies encouraging capital flows to Africa
• Over past two years African states have issued 22 billion
dollars in dollar denominated debt
• Almost as much as total sovereign issuance across the
region in past nine years
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Key Risk: African Debt II
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Key Risk: African Debt III
• In last several months investors becoming more cautious
• Now oil exporters would have difficulty issuing debt on
favorable terms
• In addition to possible slow oil price recovery, principle
risk in dollar bond market is threat of earlier than
expected U.S. interest rate increase
• Markets could shift very rapidly with borrowing rates
increasing sharply
• Would make it considerably more difficult for countries to
access international capital at affordable rates
• Oil exporters will be hit the hardest – suffering high
repayment costs due to currency volatility.
• The debt situation makes many African countries
vulnerable to a fiscal crisis and internal unrest.
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Key Risk: Falling Defense Expenditures I
• Military expenditures are only one gauge of military
power.
• A given financial commitment may be adequate or
inadequate depending on:
• The number and capability of a nation’s adversaries
• How well a country invests its funds and
• What it seeks to accomplish
• Nevertheless trends in military spending do reveal
something about a country’s capacity for meeting threats
• Policymakers are currently debating the appropriate level
of US military spending given:
• increasingly constrained budgets
• the winding down of involvement in Afghanistan and
• the potential threats posed by Russia and China
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Key Risk V: Falling Defense Expenditures II
• Although there are a few exceptions there is a stinking
contrast between rising defense expenditures in still
growing economies and austerity-induced cutbacks
elsewhere
• Robust growth in certain parts of the emerging world,
largely Asia, means that these countries can increasingly
afford to procure cutting edge defense technologies
• Increased military spending is a zero sum game and will
inevitably generate arms races
• Certain countries – China, India, and Russia take the view
that their economic growth should be matched by
equally impressive developments in their military
capabilities.
• U.S. and European allies risk falling behind on defense
expenditures unless they can revive growth and better
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control social expenditures.
Key Risk: Falling Defense Expenditures III
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Key Risk: Falling Defense Expenditures IV
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Key Risk: Falling Defense Expenditures V
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Key Risk: Falling Defense Expenditures VI
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Key Risk: Falling Defense Expenditures VII
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Key Risk: Falling Defense Expenditures VIII
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General Lessons
• Nobody Really Understands the World Economy – economic
outcomes hard to predict because world economy is
continually in flux – “unknown unknowns” will always be
with us.
• That Goes Double for Financial Markets – financial markets
even more volatile than real economy – Starting with the
Dutch Tulip Bubble have had 350 years of financial crashes
and panics – unlikely to stop anytime soon – each one that
comes will take most people by surprise.
• The Battle of Financial Markets is Over: The Battle of State
Finance Has Begun – Speculators will test sovereign debt
markets. Clear that governments can no longer do
whatever it takes to fix economic problems. New, large and
unpredictable risks now hang over the global economy.
• The US and its allies will face a long period of slow growth
with contracting defense budets. This will require increased
cooperation, coordination, and flexibility in adapting to a
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fundamentally altered budgetary environment
The End
• Questions?
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