What can we expect in the next months?
In the coming months, the world economy will go through a period of gusty weather. A key indicator of global financial well-being is the movement of the Dow Jones Industrial Average, an index which tracks thirty major stocks traded in the New York stock exchange and NASDAQ. Since last August, when China decided to devalue its currency, yuan, the Dow has not only been declining after reaching a peak on May 27 at 18,400, there has been an increased level of volatility in its daily prices. Like the canary in a coal mine, this volatility in the Dow might be pointing to some serious downturn, or uncertainty at best, in the world economy going forward. There is a growing consensus that the next quarter will not be as robust as originally expected, and the mood among economists is not upbeat, if anything.
So what changed? First of all, in August the Dow plummeted almost 5 percent in a single day over bad news coming from Europe: Greek debt crisis, lukewarm European economic growth, and a weakening euro pushed down by sluggish exports. The Dow has since then gone down to below 16,000 from a high of 18,400 reached on May 27, 2015. Adding to the uncertainty is the role unwittingly being played by the US Federal Reserve. Since January 2015, financial markets have been expecting, as well as speculating, that the Fed would raise the short term interest rate, known as the Fed Funds Rate. But the condition that Fed has set to raise the rate -- higher inflation and strong labour market -- has not materialised yet. Now we have reached the end of the year, and the Fed has one more meeting of its Open Market Committee (OMO), the group that sets interest rate policy, in December. We know from the minutes of the past Fed OMO meetings that it is still debating whether to raise short-term rate this year since a) growth rate of jobs is still weak in the US economy, and b) the outlook for economic growth in Europe and Asia is not very bright. Also, China's recent devaluation of its currency and its potential impact has added to the general feeling of nervousness in the global financial markets.
Some may ask, is the US economy really hurting and what is the role of US monetary policy in global economic recovery? Let me address the first question with some numbers. The September employment numbers published by the government were bad. Only 142,000 new jobs were created and the third quarter numbers were revised downward. Economists traditionally keep an eye on unemployment rate, but nowadays they also closely follow the labour force participation rate. The participation rate is a key indicator of the strength of the economy as well as of how the growing wealth is being spread around among the labour force. In September, the labour force participation rate fell to 62.4 percent, the lowest since 1977 when Jimmy Carter was the President of the USA. It is reported that 350,000 Americans left the labour force, and most of them did so involuntarily since jobs are so hard to find that they stopped looking for work. Some of this can be attributed to falling oil prices which has led to layoffs in the oil exploration and drilling industries. Another indicator of US weakness is lacklustre wage growth. Wages grew by 2.2 percent last year, and barely kept pace with inflation.
Turning to the second question raised above, since USA is the world's largest economy, with ties to all countries in the world, US demand for imports and its interest rate have ripple effects on the global economy. As can sometimes happen, recent US financial market dynamics have had a negative impact on capital market in emerging countries. According to one estimate, "Capital flight from the 19 largest emerging market economies has reached almost one trillion dollars in the past 13 months". Most of this money moved to the USA. While global funds inflow into the USA has kept the exchange rate high, hurting its exports, it had other ramifications too. Coupled with slow growth in China, which hurt exports from Brazil to Turkey, from South Africa to Indonesia, the value of the currency of these countries is tumbling, and foreign investors are fleeing. Add to this, the uncertainty regarding the budget fight in Congress and nervousness about its readiness to raise the debt ceiling, one can see what keeps Wall Street and financial markets worldwide on edge.
Europe had a slow recovery in GDP and a downward spiral in exports. The EU economy advanced just 1.5 percent in the second quarter, with only Spain hitting a record 3.1 percent growth. This compares with Germany's 1.6 percent, France's 1.0 percent and the United Kingdom's 2.6 percent. And now comes the turmoil fuelled by the migrant crisis and the recent Volkswagen scandal; these might or might not hit the economy as much as create uncertainty in some countries.
Finally, there is trouble in China, Japan, India and the other emerging markets of Asia. Performance of China's GDP, its commitment to liberalise its economy and open up its financial markets to foreign investors, and its ability to keep the yuan exchange rate to be determined by market forces, are all open to speculation. While the People's Bank of China, its central bank, is assuring investors that the Communist government is committed to preventing its currency from depreciating too much, its ability to do so depend on the availability of foreign exchange reserves to prop it up. China currently has a huge trade surplus and may not hesitate to use it to shore up its currency. But it has a good reason to let the yuan go down further from the 6.3447 per US dollar on October 9 (down from 6.2104 on August 10 before it was devalued). Its reserves are not endless. Foreign exchange reserves in China decreased to 3.5 USD trillion in September from 3.6 USD trillion in August of 2015. The reserve a year ago was 3.9 USD trillion in October 2014. But US Treasure Secretary Jack Lew advised countries against engaging in a currency war and from pursuing a "beggar-thy-neighbour" policy to boost exports. In addition, China is hoping to get the yuan recognised as an international reserve currency and currency manipulation will dash its dreams. Regardless of the course of action it adopts, there will be a global impact since it is "the second largest economy and the second largest importer of both goods and commercial services".
To sum it up, there might be more bad news down the pike for countries as far flung as Australia, Brazil and Venezuela. Price of oil, copper, iron ore, and aluminium and many other commodities (except for gold) that these countries export have gone down adding to a "globally disinflationary environment". Both IMF and OECD are now worried that the global economy will grow by less than 3 percent this year. IMF estimates that emerging markets and developing economies will only post a combined 4.5 percent growth in 2016, a 0.2 percentage point drop from what was stated in its earlier World Economic Outlook report, published in April and warns of "uncertainty in the global economy". IMF Managing Director Christine Lagarde said last week that the world could get stuck in a muddle of mediocre growth unless policymakers take economic reforms more seriously. "The latest snapshot of the global economy looks uneasily familiar: a brittle, uneven recovery, with slower-than-expected growth and increasing downside risks," Lagarde said.
The writer is an economist who focuses on public policy issues.
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