Many policymakers believe the worst is over, but is this just ‘groupthink’? And which warnings might the IMF miss this time?
The global economy seemed to be on the mend when the International Monetary Fund met for its spring meeting in Washington 10 years ago. Alan Greenspan had cut official interest rates in the US to 1% after the collapse of the dotcom boom and the world’s biggest economy had responded to the treatment. Gordon Brown was chancellor of the exchequer and the UK was in its 12th year of uninterrupted growth.
Companies in the west were flocking to China now that it was part of the World Trade Organisation. The talk was of offshoring, just-in-time global supply chains and integrated capital markets. The expectation was that the good times would last for ever. No serious thought was given to the notion that total system failure was just around the corner. Faith in the self-correcting properties of open markets was absolute.
When the crash duly came, a self-flagellating IMF confessed that it had been guilty of groupthink. It had either ignored the signs of trouble or played down their significance when it did spot them. The fund has learned some hard lessons from this experience. Downside risks to the forecasts in its half-yearly World Economic Outlook (WEO) are now exhaustively catalogued.
The world of 2014 is not dissimilar to that of 2004. The boost provided by cheap money has got the global economy moving. Inflation as measured by the cost of goods and services is low but asset prices are starting to hum. Financial markets have got their mojo back. Deals are being done, big bonuses paid. The received wisdom is that the worst is over and that the prospects for the global economy will strengthen as the remaining problems are ironed out.
Some analysts believe that the Great Moderation – the period of low inflation and continual expansion – has returned after the hiatus caused by the crash.
The optimists could be right. Recessions tend to be the exception rather than the norm and countries eventually revert to a trend rate of growth. In the UK it is 2% or so; in the US it is a bit higher; in the eurozone a bit lower. This could be the start of a long global upswing built on technological change and the advent of middle-class spending power in fast-growing emerging market economies.
Or it could be another case of groupthink.
Imagine, therefore, that in five years’ time the IMF is doing its postmortem on another period of global turbulence. What will it say were the warning signs missed during 2014? Here are five to be going on with.
The first will doubtless feature in the WEO due to be published on Tuesday: the global economy’s dependency on exceptionally low interest rates. Since peaking in the 1970s, the trough in interest rates has been lower in each subsequent cycle and they are now barely above zero. Countries such as Britain and the US have only been able to revert to their trend rate of growth through periods of looser and looser monetary policy. As Adair Turner noted in his lecture to the Cass Business School in February, this has averted the threat of secular stagnation – but at a price. The recovery engineered by Greenspan was a case of “the hair of the dog”, and the same applies in spades to the one since the Great Recession of 2008-09.
The second threat is a bond market crash as the world’s central banks try to return monetary policy to a more normal setting. Central banks are adopting a cautious approach to this process, with the Federal Reserve gradually reducing the amount of bonds it buys under the quantitative easing programme and the Bank of England using forward guidance to reassure borrowers that any increase in official interest rates will be modest and gradual.
It is assumed that central banks can pull off the normalisation of monetary policy relatively painlessly. But that was the received wisdom a decade ago when Greenspan finally started to edge up borrowing costs. The Fed had failed to spot the colossal bubble building up in the housing market and the vulnerability of sub-prime borrowers to the falling real estate prices caused by tighter policy.
The reason bond markets need to be watched is simple. By buying large numbers of bonds, central banks have increased their price. The yield (interest rate) on a bond moves inversely to its price, so as bond prices go up the yield goes down. When the time comes to sell the bonds back to the market, the opposite should happen. The greater supply of bonds will depress bond prices and raise their yield. If there were to be a rush to the exit, the increase in bond yields would be swift and painful.
In some respects, crashing bond markets are a too-obvious threat. A real black-swan event contains the element of surprise, so it is worth looking around to see if there is a bubble out there that everybody is missing, something so obvious it is staring us in the face. How about fracking? The assumption is that the solution to the world’s energy needs lies in shale oil and gas, which is why investment has been piling into the sector. Yet the Oil & Gas Journal reported last month that 15 major companies have written off $35bn in investment since the boom began. Getting oil and gas out of the ground is proving costlier and less profitable than expected. So the third threat is that fracking proves to be the new sub-prime.
An oil field over the Monterey shale formation in California: is fracking really the solution to the world’s energy needs? Photograph: David McNew/Getty Images
Finally, there are two slow-burn problems that the world ignores at its peril. In an interview with the Guardian last week, Jim Yong Kim, the president of the World Bank, warned of the risk of resource conflicts within the next five to 10 years unless the international community gets serious about dealing with global warming. The catalogue of extreme weather events – from floods in the UK to droughts in Australia – is growing. The inaction of policymakers on climate change is the same as Greenspan’s on asset-price bubbles: deal with the problem if it arises. We all know how that ended.
Kim also says that action needs to be taken against rising inequality. So does the IMF’s managing director, Christine Lagarde. For the first three decades after the second world war, the global economy was by and large the story of a rising tide lifting all boats. That is no longer the case, with a tiny elite now grabbing the lion’s share of global growth. At the bottom, and increasingly for those in the middle as well, it is a case of wage squeezes, high unemployment, debt, austerity and poverty. The 85 richest people on the planet own the same wealth as half the world’s population but seem oblivious to the risk of widespread social unrest. So, of course, were the Bourbons and the Romanovs.