The International Monetary Fund’s scaled-back global growth forecasts remain overly optimistic. A rapid economic slowdown is set to lower world growth, possibly to a 3% pace by the end next year.
In January, the IMF projected world growth of 3.9% in 2018 and 2019. The world economy, the IMF wrote, was experiencing “the broadest synchronized global growth upsurge since 2010.” Managing director Christine Lagarde proclaimed that “all signs point to a continuous strengthening” of the global economy.
The IMF's outgoing chief economist, Maurice Obstfeld, now concedes those forecasts were “over-optimistic.” But the message still is that modestly scaled-down but steady growth will continue at 3.7% this year and the next.
What the IMF keeps missing
The IMF seems fated to return to its pattern of Groundhog Day forecasting that followed the global growth surge in 2010. From mid-2011 onward, the IMF kept extrapolating from that brief euphoria. The projections acquired a déjà vu quality: each time growth proved disappointing, the IMF found a reason why growth had temporarily slowed—the Tōhoku earthquake and tsunami in Japan, uncertainty about America’s exit from expansionary monetary policy, a “one-time” repricing of risk, and severe weather in the United States. These disruptions would pass, and all would soon be well, the IMF insisted.
The IMF kept getting its forecasts wrong because it failed to recognize the endemic weaknesses in the world economy. Northwestern economist Robert Gordon has tirelessly documented that, despite signs of gee-whiz innovation, long-term productivity growth in advanced nations had been declining for decades. Moreover, after the disruption due to the global financial crisis between 2007 and 2009 and the prolonged eurozone crisis that followed, global economic and financial systems did not recover the resilience to maintain sustained growth.
These endemic weaknesses have persisted. Consider the U.S. economy. The tax cuts passed in December have injected huge stimulus, the growth spurt from which even the IMF recognizes will soon begin to wear off.
Most commentators, however, miss a more important reason why U.S. economic momentum is likely to fade faster than their forecasts suggest. As a Deutsche Bank analysis highlights, U.S. companies used almost $1 trillion of liquid deposits held abroad to buy back their stocks, pushing up stock prices to ever-new highs. With stocks overvalued by many conventional measures, insurance companies, which were overweight in equities, moved some of their investments into bonds. Hence, bond yields also remained low. The combination of high stock prices and low bond yields, the Deutsche Bank concludes, was a “supercharged” version of the Fed’s bond purchases.
Now the repatriation of profits is virtually over, and the recent rise in bond yields and slump in stock prices could continue.
Déjà vu in China
The global déjà vu story of repeated overly optimistic forecasts, however, centers on China, the world’s second-largest economy. Following the global financial crisis, Chinese authorities injected huge fiscal and credit stimulus starting in late 2009. As the domestic economy raced forward, China’s voracious appetite for imports boosted commodity prices and the volume of global trade. All countries benefited, and the world economy experienced “synchronized growth.” But then, fearful of growing domestic credit bubbles, Chinese authorities pulled back on their domestic stimulus in 2011. Chinese growth and, hence, world growth fell.
Read: Ed Yardeni says Trump’s tariffs take direct aim at Chinese stocks
Much the same has happened recently. In 2017, Chinese authorities again used fiscal and credit measures to rev up flagging domestic growth. Predictably, world trade growth, which had been languishing at around 3% a year in 2015 and 2016, jumped to reach a 5.5% pace in the second half of 2017. Virtually all nations participated in the growth acceleration.
But again, rising property Chinese prices and debt burdens raised financial vulnerability well above dangerous thresholds. The Chinese authorities, as before, pulled back on the stimulus, and the domestic economy slowed. By mid-2018, world trade growth decelerated to around 4%, dampening the prospects of world GDP growth.
The IMF has substantially reduced its projection of world trade growth, but even that lower forecast at 4 percent in 2019 is overly optimistic. With the Chinese growth slowdown to 6.2% next year from 6.6% this year, as the IMF projects, world trade growth could easily slow down to the 3%-3.5% range, as in 2015 and 2016. The tariffs on Chinese goods imposed by the Trump administration and tough talk on further increases heighten the prospect of further trade deceleration.
Read: Trump’s tariffs against China are hurting U.S. tech companies instead
Adding to the global headwinds are rising interest rates as the U.S. Federal Reserve boosts its policy rate and the European Central Bank winds down its bond purchases. Emerging markets are already dealing with the consequences of higher interest rates. In Argentina and Turkey, but also in India, depreciating currencies have increased the burden of repayment of dollar-denominated debts. While an emerging-market crisis is unlikely, the adjustment to the global headwinds will decelerate emerging markets’ economic growth at faster pace than the IMF estimates. The trivial revision for India, to 7.4% from 7.5%, misses the deep stresses in the financial system and the country’s loss of competitiveness.
Watch Europe
Slowing trade and rising rates will have their biggest impact on European nations. These nations depend heavily on trade and require the crutch of low interest rates to compensate for their low long-term growth rates. Along with world trade deceleration since the start of the year, industrial production growth has sharply slowed in the large European countries—Germany, France, and Italy. With continued global trade deceleration, the IMF’s projection of 1.9% euro-area growth in 2019 appears highly unrealistic. Meanwhile, the ECB, constrained by political limits, will be unable to do much to revive growth. Italy could move from a barely sustainable equilibrium to a runaway crisis.
Read: Here’s why investors remain uneasy about Italy’s banks and the ‘doom loop’
The core problem today, as in 2010-11, is that the world economic growth depends so heavily on policy stimulus and to an alarmingly high degree on the performance of the Chinese economy. Hence, as the temporary factors that lifted growth in 2017 fade, global GDP growth could well decelerate to 3%, the benchmark for a global recession.
When global GDP growth is 3%, several countries are in a technical recession, measured as two consecutive quarters of negative growth. Such an outcome would further spook global financial markets. The stresses from the last financial crisis, though well below their peaks, remain elevated. The monetary and fiscal space for responding to new turbulence is limited.
Brace yourself.
Ashoka Mody is the Charles and Marie Robertson Visiting Professor in International Economic Policy at Princeton University and previously was a deputy director of the International Monetary Fund’s European Department. He is the author of “EuroTragedy: A Drama in Nine Acts.”
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