Transcript State of the Global Economy, November 2016

Global Tensions
and Economic Security
2016 CCMR Executive
Course in Decision Making
Naval Postgraduate School
November 8, 2016
Dr. Robert E. Looney
[email protected]
Outline
• Part I: The Global Economic Environment
• Overview of the 2008-09 Crisis
• Patterns of Recovery
• The Current Situation – Major Economic Trends
• Forecasts
• Part II: Leading Themes/Major Risks
• Geopolitical/Security Threats
• Brexit and Anti-Globalization
• Oil Price Decline – Debt Problems, Russian Crisis, OPEC Agreement
• Emerging Market Difficulties – China Scenarios
• U.S. Long Term Budget Patterns – Declining Defense Expenditures
• Declining Western Defense Expenditures
2
Main Theme: The Security Trilemma
3
The Global Crisis, 2008-09
4
Global Financial Crisis: Initial Security Concerns
5
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 much slower pace since the crisis
• In the post- 2008-09 period:
• Economic policies largely set at the national level to benefit
domestic economy
• External effects -- these policies are increasingly affecting other
economies in an adverse way
• These effects particularly important in the
monetary/financial sector due their potential for creating
increased volatility in:
• Capital flows
• Asset prices
• Interest rates, exchange rates, and credit availability.
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Global Economy Overview II
• This instability has been compounded by growth models
in many advanced economies based on:
• Excess monetary expansion/credit, and
• Debt-driven domestic aggregate demand
• Also, structural flaws such as rigid labor markets, limited
competition and inflexible prices, especially in Europe
have led 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
• In the United States, unconventional monetary policy
• 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
• Result: increases in credit and causing upward pressure
on exchange rates and asset prices in Emerging Markets
(EMs)
• EMs 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
• Resulting in a slowdown in short-term growth.
• Volatile capital reversals may have longer term adverse effects –
although not clear at this point
• China the exception:
• 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 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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Current Global Patterns I
• Today world economy is characterized by divergence
• As the charts indicated, 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
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Current Global Patterns IV
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Current Global Patterns V
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EM/DM Growth Convergence
• However since 2009, EMs as a group are converging on
the advanced countries at a slower pace.
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Today’s Policy Environment
• Policy makers are in a bind in many countries
• In the Eurozone and Japan they are still trying to find ways to
stimulate demand and avoid deflation
• In the U.S. interest rates beginning 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
and governance 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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Current Situation Q4 2016 I
• Global Baseline:
• Situation characterized by sluggish growth, low yields, little
underlying inflation.
• Growth remains heavily reliant on the global consumer and
major central banks
• Both coming under strain
• Policy mix still off target
• Uncertainty over direction of policy continues to weigh on
investment
• Only a decisive turn toward fiscal easing or certain types of
structural reform (taxes, labor) are likely to break cycle of
stagnation
• Little sign of optimism in that regard
• Monetary tools still provide bulk of current stimulus, but
appear to have hit diminishing returns with negative
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interest rates.
Current Situation Q4 2016 II
• Fiscal policy less austere, but hardly at full throttle
• Governments have generally eased up on austerity measures
• The U.S. may join China, Canada, and Japan in moving to an
expansionary policy, but not until after the election
• The UK’s forthcoming fiscal package will be significant, but
benefits largely offset by impact of uncertainty over Brexit
negotiations with the EU
• Policy uncertainty seems to be rising with markets jittery
and investment returns low.
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Current Situation Q4 2016 III
• Policy uncertainty looms large in
• Europe
• Nationalist sentiment on the rise
• Poses a threat to economic policy and long-term investment
• Brexit uncertainty will be a drag on the UK and EU.
• China
• Policy makers continue slow pace of reforms to prop up the
economy
• Good news for global growth in the near term.
• However the government is providing credit stimulus in fits and
starts confusing the picture
• Concerns now over rising debts and weakening of bank balance
sheets
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Current Situation Q4 2016 IV
• United States
• Elections for a new president with major implications for
domestic, foreign, and energy policy
• Both candidates likely to pull back from trade and globalization –
sharp break from past policies
• Donald Trump’s tax cut proposal would increase federal debt by
$4.4 trillion over next decade
• Far more stimulus than is required to close current output gap,
potentially crowding out private investment
• Hillary Clinton’s plans would expand the debt by $1.1 trillion over
10 years but with a lift to both tax revenues and spending
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The New Abnormal I
• The current situation has been called “The New Abnormal” 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 mounting25
– maintain open global economy, climate change, peace.
The New Abnormal: II
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Slow-Down in Global Trade
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Employment Improving but Stagnant Productivity
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IMF Forecasts, October 2016
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Part II
• Leading Themes and
• Major Risks/Threats
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Geopolitical/Security Threats
• Several security trends/threats likely to have an impact
on the business operating environment and thus
economic security
• Growing anti-establishment sentiment around world -- Brexit
• China set to become more, not less assertive over territorial
claims in South China Sea following international rulings
• Threat of terrorism in Europe from extremist groups and
radicalized individuals remains genuine
• Terror attacks, combined with migrant crisis fueling rise of farright groups and pull mainstream parties toward populist fringes
• Political and economic crisis in Venezuela expected to worsen
with regime change – potentially violent a significant possibility
• Oil price drop – complicates debt servicing and government
budget decisions
• All increase uncertainty and reduce potential investment31
Brexit and Anti-Globalization I
• U.K decision to leave EU in June 2016 a shock to many
• Consequences will be long and profound
• Amplified by
• Lack of clarity surrounding it
• The mechanism through which it will occur
• Legislation governing the UK’s future relationship with Europe
and
• The impact of this new relationship; on the global economy
• Uncertainty will dampen consumer and business
sentiment in world’s fifth-largest economy
• Result – deferred investment decisions and a year of
recession in 2017
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Brexit and Anti-Globalization II
• For the Longer term, various assessments predict the UK
GDP will be lower
• From 1.3 to 5.5% per year up to 2020 and
• 1.2% to 7.5% by 2030
• Brexit will also exert geopolitical effect
• U.S. will need to build stronger relations with France and
Germany or risk diminished influence in Europe
• Both countries have strong anti-globalization groups
• Unlikely that the Transatlantic Trade and Investment Partnership
(TTIP), a US-EU trade agreement will be signed
• .
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Oil Price Decline I
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Oil Price Decline II
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Country Reserves
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Russian Crisis
• Russia – Economy in decline for years
• Falling population, brain drain, limited investment, small private
sector, over dependence on oil revenues, and very limited
reforms
• Country hit hard by oil price decline
• March 1, 2016 Russia introduced its crisis plan for the economy
• Major cutbacks in expenditures
• Defense and social spending are frequently cited as off-limit
areas for cuts so state of economy a major concern.
• Government anticipating a second year of recession, but smaller
than the 3.7% contraction in 2015
• Still many uncertainties, especially about the level of oil
prices
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Russian Crisis II
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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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African Debt II
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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.
• Question of how much assistance China willing to give. 41
OPEC Agreement I
• September 28, 2016 agreement aims at cutting oil
production from roughly 33.24 million to between 32.5
million bpd and 33 million bpd.
• Cut marginal, but first since crisis in 2008
• Also first response since price collapse in second half of
2014 – peak $110, bottomed out at $25 January 2016
• Issues to be decided before November 30 meeting:
• Who will shoulder brunt of cuts?
• How to handle rising production from Iran?
• How to reconcile differences between producers?
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Largest OPEC Producers
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OPEC Agreement II
• Overview
• Deal does not necessarily represent attempt to push up prices
• Instead, a reaction to market conditions that expect more oil
coming online soon
• With tentative deal OPEC trying to cushion impact of new
supplies – want to prevent prices from dropping below level
many OPEC countries are comfortable with
• OPEC now largely in defensive stance
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OPEC Agreement III
• Explaining the Shift
• Within OPEC Nigeria, Libya, and Iraq seeing small bumps in
production and exports
• If sustained could add more than 800,000 bpd over next couple
of months – more than entire cut OPEC is proposing
• These countries likely exempt from any production cut, although
Iraq may be subject to a freeze
• Libya and Iran have seen their production levels artificially low
because of violence and political dispute
• Nigeria militant attacks on pipelines have been repaired
• Iraq deal between Kurdish leaders and government to jointly
export 150,000 bpd from Kirkuk
45
OPEC Agreement IV
• Beyond OPEC
• Large field in Kazakhstan will start coming online in October
• U.S oil production coming back
• Between June 2015 and July 2016 production fell from 9.6m bpd to
8.45m bpd due to low oil prices
• Production stabilized
• Future estimates show a slow rise is prices stay around $50 per
barrel
• If OPEC tries to maintain a price of $60 would accelerate US
production and be self-defeating
• OPEC must
• Make sure additional production coming on stream does not
force price down, while
• not sending prices up far enough to stimulate shale production
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EM Recovery I
• Likely a slow painful recovery lies ahead
• Global growth environment remains fragile
• Commodities will rise only gradually
• U.S. monetary conditions are tightening
• Debt servicing burdens of EMs are generally high, and
• Economic reform is happening at a sluggish pace
• Positive indicators
• Capital flows into EMs are picking up
• Assets have rallied since the start of the year (particularly FX)
and
• Valuations are undoubtedly cheap
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EM Recovery II
• Hard to make the case for a sustained bull market in
either
• Equities
• Bonds
• Currencies
• However macroeconomic fundamentals will improve at a
slow pace and difficult to identify Ems without
weaknesses such as
• Large fiscal deficits
• Current account shortfalls and
• Rising debt levels
• For those currencies appreciating the gains will be
modest in comparison with heavy losses in recent years
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EM Recovery III
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EM Recovery IV
• Bright spots – upswing phase of economic cycle with
good growth prospects and macroeconomic
fundamentals
• Philippines,
• India,
• Chile
• Mexico, and
• Indonesia
• Although Romania and Poland are accelerating this is
being powered with excessively loose fiscal policy
• Commodity exporters and reform laggards still locked
into a slowdown to greater or lesser extent
• Oil exporters are suffering severely depleted government
budgets and debt issuance is being ramped up.
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EM Recovery V
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EM Problems: Lagging Reforms
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EM Rankings Under Top Challenges
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China: Scenarios I
• Baseline Case
• Leaders prefer growth and stability to reform risking further
reliance on debt and leveraging
• Reforms only post 2017 at best
• Capital outflows moderate
• Slow rebalancing away from investment as domestic
consumption is strong.
• Upside Case
• Bank of China pressured by senior leaders to adopt generalized
easing, cutting rates
• Fiscal expansion means deleveraging further delayed.
• Banks and SOEs bailed out and forced to operate more
commercially
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China: Scenarios II
• Downside Case
• Government fails to stimulate/implement reforms
• Sharp slowdown and possible crisis
• Growth slumps, credit boom turns to bust
• Non-performing loans up to 6-7% of banking assets
• Massive outflows, reserve losses, devaluation
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China: Longer-Term
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China: Policy Constraints
• Why can’t China just spend its way out of the slowdown?
• Optimists point to China’s history of responding to
economic challenges – 2008 lending surge, earlier bailout
of banking system and a restructuring of state-owned
enterprises
• Problem China’s debt burden is now much larger
• Spending now less effective –
• Private companies have been pulling back on investment
• Overall productivity of state spending is low
• Also fear of creating more bubbles in asset markets
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China’s Risky Portfolio
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U.S. Budget/Debt Constraints I
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U.S. Budget/Debt Constraints II
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U.S. Budget/Debt Constraints III
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U.S. Budget/Debt Constraints IV
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U.S. Budget/Debt Constraints V
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U.S. Budget/Debt Constraints VI
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Trends in U.S. Defense Expenditures
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Falling Western Defense Expenditures I
• 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.
Falling Western Defense Expenditures II
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Falling Western Defense Expenditures V
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Falling Western Defense Expenditures III
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Falling Western Defense Expenditures IV
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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 budgets. This will require
increased cooperation, coordination, and flexibility in
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adapting to a fundamentally altered budgetary environment
The End
• Questions?
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