The global economy is still growing but the risk of recession remains

BY Ian Stewart | tweet IanStewartEcon   /  13 January 2020

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’.

Last year the global economy grew at the slowest pace since the financial crisis. Activity slowed in developing and advanced economies, with trade tensions weighing on exports, industrial output and capital spending.

We need to put the global downturn in perspective. This has been a gradual deceleration in growth, a classic ‘soft landing’. The World Bank estimates that global GDP grew by 2.4% last year, down from 3.0% in 2018 and 3.2% in 2017. Unemployment remains low, wages are rising and consumers are still consuming. The sort of stress seen in periods of real economic weakness are notable by their absence.

So far, so good. But what of 2020?

It’s hard to get excited about global growth this year. Activity is likely to come in at roughly the same sub-trend rate as last year. But the distribution of growth around the world is likely to shift, with activity slowing in China and the rich world and picking up in emerging markets.

The negatives for growth are obvious.

Recoveries don’t last for ever and this is an old one – in the case of the US at over ten years this is the longest since records began in 1854. If the past is anything to go by (although we suggest below it may not be) the West is overdue a recession.

China’s economy, the second largest in the world, is slowing as its workforce ages and contracts. Looser Chinese monetary policy can only retard, not reverse, this structural deceleration.

The world is in the grips of a bout of protectionism which has put growth in global trade into reverse. For decades international trade has been the engine of global activity. Now protectionism, by raising prices for producers and consumers, fuelling uncertainty and disrupting activity, is slowing global growth.

Wider geopolitical uncertainties persist, and in abundance. It is by no means certain that the UK will achieve a full trade deal with the EU, creating the risk of another Brexit cliff edge at the end of this year. Events in the Middle East continue to pose a threat to Western growth, most obviously through their effect on oil prices. There are plenty more imponderables, from rising security tensions between the US and China to the possibility of a Bernie Sanders or Elizabeth Warren presidency.

With interest rates at historic lows central banks are, in the words of Mark Carney, the outgoing governor of the Bank of England, running out of the ammunition needed to combat a downturn.

Debt levels have risen globally since 2010. The ratio of debt to global GDP rose from 120% in 1970 to just over 200% in 2010 and now stands at over 230%. Previous periods of rapid debt accumulation ended in financial crises.

These all add up to serious headwinds, and risks, for the global economy. But some things are going right for growth too.

China’s central bank has been easing monetary policy since early 2018 and it continued to do so last year. One of the surprises of 2019 was that the US Federal Reserve and the European Central Bank joined in, switching from tightening to easing monetary policy. Central banks want to keep growth going and, with inflation under control, they are quick to ease when activity falters.

In the last 12 months global monetary stimulus has loosened financial conditions and boosted risk appetite. Measures of financial stress are running at low levels. Global equity markets gave investors a return of 20% last year, a better performance than in 2018 when global growth was stronger. Monetary ease reaches the financial economy first, and, with a lag, then reaches the real economy. Last year’s policy easing, with the prospect of more to come if things weaken further, offers a useful counter to the negative forces weighing on activity in 2020.

While manufacturing and exports suffered in 2019, consumers kept spending. Unemployment in the US, Japan, Germany and the UK is at multi-decade lows. Subdued inflation and oil prices are helping support consumer spending power. Agreed, consumer debt levels have risen in most countries. But this is only part of the picture; the value of assets held by households, in the form of pensions, equities and housing, have risen faster than debt. Low interest rates mean that debt servicing costs are manageable.

Even on trade there was some good news towards the end of last year. The “phase-one” trade deal struck between the US and China in December brought a respite, though certainly not an end, to the damaging trade dispute. President Donald Trump may judge that an escalation of trade tensions would hit a slowing US economy and be bad for his chances of re-election in November. Mr Trump’s underlying view of China is unlikely to shift, but he may refrain from new tariffs which make life difficult for US consumers and farmers.

What about the risk of recession? Recessions are usually triggered by one or some combination of the following: an inflationary shock which causes central banks to raise interest rates sharply, a financial crisis, or soaring oil prices. We’ll take each in turn.

Inflationary risks seem contained for now. Even today, when economies are running hot and unemployment is at low levels, there are few of the usual signs of inflationary excess. Central banks are far more worried about undershooting in terms of growth than overshooting on inflation.

A more plausible trigger for a recession today is a financial crisis. The last two US recessions were caused by financial, not inflationary, shocks; the bursting of the tech bubble triggered the 2001 recession and US real estate played a big role in the 2008 crisis. Rapid debt accumulation almost always precedes such episodes. In the West overall debt levels are roughly unchanged from the eve of the financial crisis, with private sector deleveraging offset by increased borrowing by governments. The financial system in the West is less leveraged, more tightly supervised and looks much less vulnerable than in the 2008. However, this isn’t the case across the board. In the West growth in less regulated, high-yield financial markets, such as leveraged debt and so-called ‘cov-lite’ lending, has attracted the attention of regulators in recent years. Levels of debt in emerging markets have soared in the last ten years, much of it being driven by the Chinese private sector. Slower growth could push vulnerable, highly leveraged sectors into trouble.

The final of our three recession-triggers is sharply higher oil prices. Oil price shocks, triggered by geopolitical events, were a major factor behind the recessions of the early 1970s and early 1980s. A lot has changed since then. Fracking has turned the US into the world’s leading oil producer, significantly reducing its dependence on Middle Eastern oil. As Mr Trump declared last week, “we are independent and we do not need Middle Eastern oil.” The US, and other advanced economies, have shifted away from energy-intensive manufacturing and are increasing their use of renewables. Oil is being used more efficiently, so the oil intensity of GDP has declined over time. Rising oil prices matter for Western consumers, but they matter less than in the past.

2020 is likely to be another so-so year for global growth, roughly in line with 2019. That doesn’t sound very inspiring. There’s an alternative, rosier way of looking at this. After such a long recovery, just avoiding a recession this year would constitute something of an achievement.


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