Will October remain memorable again for the wrong reasons due to mounting economic risks? | Larry Elliott
B.Ad things happen in October. This month, 13 years ago, the global banking system was on the verge of implosion. In October 1987 there was a bloodbath on the stock exchange. In October 1929, the Wall Street Crash triggered the Great Depression.
One consequence of the economic horrors of the 1930s was the establishment of the International Monetary Fund with the idea of creating a multilateral body to help countries with short-term problems and prevent the development of systemic crises.
Measured against this metric, the IMF was a success. The Great Depression did not repeat itself, even though the world was close to it in 2008. The IMF’s annual meeting this year came just weeks after the collapse of the Lehman Brothers investment bank, which cast doubt on the viability of many other financial institutions. Treasury ministers and central bank governors met in Washington to work out a rescue plan that would stem the panic.
This week it is time again for the IMF to hold its annual meetings, and while there is currently no crisis, there are many signs that one could be imminent. Economists are always on the lookout for black swans – unexpected events with massive repercussions – that can lead to a collapse in stock markets or a deep recession, but in this case it is not necessary as many major problems are clearly visible.
This is how things look. The global recovery from last year’s pandemic lockdown has started to lose momentum, and in its biannual global economic outlook, the IMF will revise its growth estimate for 2021 downwards, largely due to recent developments in the US and China.
Joe Biden’s honeymoon is over. The economy continues to expand, albeit at a slower pace, while inflationary pressures continue to mount. A dispute in Congress over how much the government can borrow, which could lead to a Washington default, has been going on for two months. The US central bank has clearly signaled its intention to remove some of the policy stimulus it provided during the pandemic.
China’s already declining economy continued to be hit by energy shortages and power outages. Evergrande, once the country’s largest real estate developer, is on the brink and there are fears that others may follow suit. The Beijing government is grappling with the difficult task of monitoring slower but more sustainable growth without causing a full-blown recession.
The rapid pace at which countries in all parts of the world have recovered from recession has created bottlenecks in the supply chain. There is a shortage of labor, raw materials and goods, and they drive up prices. Energy costs have risen sharply due to increasing demand, especially from Asia.
Meanwhile, the poorer countries of the world are still waiting for the vaccines promised them by the G7 and other rich nations earlier this year. With the Covid-19 threat still real, the West’s hoarding of cans is inexcusable. Kristalina Georgieva, the managing director of the IMF, rightly called last week on the hoarders to honor their pledges immediately.
Equity markets have recovered from the sell-off in the first few weeks of the pandemic and are ripe for a correction. TS Lombard’s Charles Dumas says the S&P 500 – the best gauge of Wall Street sentiment – is roughly 40% overrated. Another analyst, Dhaval Joshi of BCA Research, found that US tech stocks – which are responsible for much of the strong performance of the broader equity market – rise and fall in line with US Treasury bills.
Put simply, when bond prices go up, the rate of interest paid to investors – or the yield – goes down, and vice versa. Bond prices tend to fall when inflation rises, which is the case now. There is little “leeway”, says Joshi, for bonds to be sold before they bring the stock market down.
Albert Edwards of Société Générale says the current state of affairs is reminiscent of July 2008, when the European Central Bank raised interest rates when the price of oil neared $ 150 (£ 110) a barrel, just three months later with the to be confronted with the deflationary consequences of the Lehman debacle.
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Central banks in Norway, New Zealand and Poland have already hiked rates while the Bank of England and the Fed prepare to tighten monetary policy. So, says Edwards, shouldn’t we be talking about the R-word?
It’s a fair question. Every sharp rise in energy prices since the early 1970s has been followed by a recession, and this can be no exception. Rising oil and gas prices are inflationary in the short term, but deflationary in the longer term because they increase business costs and reduce consumer purchasing power. This pattern was established during the first oil shock in 1973 (another event in October) when a surge in inflation was followed by rising unemployment as companies went bust.
Politicians do not seem to be aware of this danger. At last week’s Conservative Congress, for example, there was not the slightest hint that the recent economic slowdown could be followed by a harsh winter. Energy intensive companies really suffer.
Financial markets seem to assume that the pandemic is all but over, the economic recovery will resume quickly, and inflationary pressures will be temporary and relatively painless. If they’re right on all counts, this won’t be one of October that is remembered for the wrong reasons. But stock prices rebounded last week after Vladimir Putin said he could provide Europe with more Russian gas. Some might see this as a sign of trouble ahead.