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A ‘Groundhog Day’ Global Economy In 2016?

Dr. Harry G. Broadman

(Forbes) – As 2015 closes and we begin the latter half of the 21st century’s second decade, much of the global economy one year on has changed only modestly and still moving in slow motion.  2016 will surely hold some significant economic surprises.  These will likely include re-runs, yet punctuated with new twists, turns and sharper edges.  Will the world’s marketplace in 2016 be a shadow of its former self?

Here’s a list of some—but by no means all—of the key factors that will shape our near-term (and perhaps, long-term) economic future.  I also point to potential policy changes to keep an eye out for.

‘Honey, Who Shrunk OPEC?’

Remember the villainous oil cartel of the 1970s that embargoed petroleum sales and quadrupled the price of crude?  Forty years later, oil prices are close to historical lows.  While not dead, OPEC is certainly limping, and with oil prices unlikely to rise significantly anytime soon, it could enter the ICU, especially if structural factors—rather than transitory or one-off policy changes or unexpected disturbances—continue to further soften demand while not appreciably curtailing supply (in the short run). What’s going on here?

Global demand for oil is not expected to grow much due to an increasingly hobbled Chinese economy, a Japan that remains in the economic doldrums, and a slowly growing Europe.  Accompanying this could be a movement (albeit incremental) away from consumption of fossil fuels, especially in automobiles—if technological breakthroughs continue, heightened congestion in urban areas entice more commuters to rely on mass transit, and there is a greater shift by employers in permitting their employees to work remotely.

At the same time do not discount the heightened anxiety about global warming in playing a larger role in curbing the world’s appetite for oil. The significant press attention given to this month’s Paris Agreement sensitized the public to the accumulating evidence and the risks.  And this has only been exacerbated by the record-setting warm temperatures so far during this year’s winter in the US.

On the supply side, the Saudis—despite the kingdom’s recent acknowledgment of a significant budget deficit—will try to stick to their high level of output.  They are boxed-in by a twin strategy to maintain their market share in the oil-consuming advanced countries and to discipline their oil-producing foes in the Middle East, especially Iran and Iraq—not to mention Mr. Putin, whose economy, twenty years after the ‘nominal’ break-up of the Soviet Union, remains as concentrated on oil as ever.

Yet, if anything, Iran and Iraq are likely to expand production, especially if their geo-political fortunes improve.  At the same time, the UAE has signaled its willingness to maintain production, if for no other reason than for Abu Dhabi to provide a backstop for Dubai, should the finance-centric, non-oil producing emirate fall victim to disturbances in international capital markets as it did in 2008.

Then there is of course the historic, meteoric rejuvenation of the North American oil patch, especially in the US and Canada.  Along with Mexico, they will keep chugging away as very sizeable global suppliers, although the smaller, higher cost, marginal producers will continue to drop off as long as prices remain where they have been.  The recent overturning of the woefully obsolete 40-year old US ban on crude oil exports, however, has infused more oxygen into US production.

And let’s not forget about the ‘wild cards’ on the supply-side.  These include Venezuela, where recent parliamentary elections have raised the prospects for an ending of the Chavez era of economic mismanagement, and Libya, where the future political economy roadmap remains as uncertain as it was a year ago.

What To Watch For.  Although highly unlikely—largely because it makes such good sense—there may be a movement in the US—at least—to adopt a ‘inter-generational insurance premium’, which would be charged for each unit of fossil fuel consumed.

Not only would this create an institutionalized incentive to systematically wean ourselves off of an energy source whose current continued use poses substantial prospective risks to generations that follow us, but also generate revenue to be directly invested through public-private partnerships in the repair, maintenance, or modernization of urban mass transport infrastructure as well as in new infrastructure for the production and distribution of non-fossil fuel energy sources.

Why now? With oil prices extraordinarily low, this is precisely the time to ease in such a policy.  And the charge could be structured in a graduated fashion to take into account any future oil price increases or decreases.

The concept is similar to proposals made in the 1980s to impose a surcharge on oil imports to lessen our exposure to energy security risks and help finance the Strategic Petroleum Reserve.

Is The Fed’s Hibernation From Raising Interest Rates Really Over?

You hardly need to be an economist to have believed that following a decade of US monetary policy characterized by nominal interest rates of zero percent the Federal Reserve would not have moved on December 16th to raise the short-term rates they set.  After all, as the US economy shows continuing, though not always consistent, signs of recovery the central bank took great pains since last quarter to pre-announce publicly such a change would likely be in the offing at the December meeting of the Federal Open Market Committee (FOMC).

And also as widely expected, the rate increase was de minimis: ¼ of 1 percent.   However, in this particular case ‘does size matter’?   Not really.  The central goal for the Fed was to signal to the markets—not just in the US but around the world—that the days of zero interest rates are finally over.

In truth, the underlying data were—and still are—mixed.  Most important, there is scant evidence of inflationary pressure. While the expansionary effects of the Fed’s Quantitative Easing (QE) program have yet to run their course—and in time may well generate excess demand and thus induce inflation in the US—the prevailing worry throughout much of the rest of the world is deflation.

But in many respects the Fed had largely tied its own hands.  By telegraphing way ahead of the FOMC December meeting that the odds of taking such action were essentially a foregone conclusion, the Committee’s vote (which was unanimous) turned into a public referendum on whether the Fed had regained confidence in the strength of the US economy.  So much so that the conventional wisdom was that if the Fed did not raise rates, that decision would send the rest of the global economy into an utter tailspin.

This may be a dangerous game.  Why?  Because more than anything else, central banks need to be seen—and, in fact, act—as if they are above the political fray; that is, to assert their policy independence.  Back in September 2015 both the IMF and the World Bank publicly and strongly criticized the Fed for even contemplating a rate increase during that month’s FOMC meeting.  In the end, the Fed made no change in September in its rate policy.  Then, by the time the October FOMC meeting rolled around, newly-released data portrayed unexpected weakness in the US economy.  While this took the wind out of the sails for raising rates at that juncture, more importantly the data helped rationalize the position the Fed had taken in September.  However, some damage to the Fed’s independence had already taken place.

To this end, there is an argument that the Fed might well have paused on the December rate rise until the next meeting of the FOMC in late January—only just a few weeks away.  If this had been the case, in the public statement that always accompanies an FOMC decision—which, although qualitative, isthe document that markets actually focus on rather than simply quantitative changes in rates—the Fed could have employed much of the same text it had actually issued in December. The statement would still have signaled the FOMC’s renewed faith in the US economy but that for the sake of a few weeks it wants to obtain a better read on any potential inflationary pressures in the system.

What To Watch For.  Through 2016 the Fed is unlikely to raise rates on a regular, monthly timetable, and the magnitude of any rate changes will not be uniform.  In fact, barring wholly unforeseen economic shocks—especially those that are externally generated—it is quite conceivable that the Fed will change rates far more gingerly than currently held by the conventional wisdom.  The FOMC’s mid-December public statement took pains to spell out that the Fed’s policy posture at this juncture is to be ‘accommodative’; that is, to tilt towards ensuring growth is sustainable.  This suggests a Fed that is just as concerned about deflation as it is about inflation.

Will China’s ‘One Belt, One Road’ Become ‘A Bridge To Nowhere’?

As it has for much of 2015, China’s soft economic underbelly will remain a core concern for the growth of the global marketplace.  Indeed, the odds are that China’s economic troubles will only get worse in 2016.  This is because Beijing has painted itself into a corner and the various policy levers it is trying to press are producing contradictory outcomes.  And all of this is coming to a head just as China, with much fanfare, has established both the Asian Infrastructure Investment Bank (AIIB), a regionally focused entity, and its ‘One Belt One Road’ (OBOR) trade and investment network, which is designed to help China up its geo-economic game globally in the spirit of further recreating a modern version of the ancient Silk Road. The timing for launching these initiatives may prove to be unfortunate.

Much of the press focus on China is on so-called ‘headline’ statistics and their monthly changes—a myopic, short-term perspective that is hardly unique to watchers of China.  Nonetheless, these data add up to a picture that is anything but rosy. But the truly worrisome story about China’s economy lies below the monthly headlines; it actually has been in the making for decades.

Despite Beijing’s recent significant monetary easing (interest rates have been cut six times since 2014 along with relaxation of bank reserve requirements) as well as approval for a massive (even by Chinese standards) number of new infrastructure investments, industrial output remains tepid, growing at 5-6 percent.  The steel industry has been particularly hard-hit—not surprising in light of the dissipation of demand for construction within China, a sector that is reeling because of the huge overhang of supply in real estate. (One cannot escape being visually struck by the sheer number of empty buildings in virtually any Chinese city.)

Yet even in the areas that have been the focus of the government’s infrastructure stimulus program, for example, water, agriculture and social-housing projects, it was recently revealed by China’s National Audit Office that 14.2 billion yuan (about US$2.23 billion) of committed funds still have not utilized—a sure sign of constraints on the absorptive capacity of such investments.

In contrast, retail sales growth is booming at 10-11 percent.  In many countries that would be a good development. But China, notwithstanding long-standing pronouncements to the contrary, has in factnot appreciably moved away from being an economy whose growth is heavily reliant on the industrial sector rather than on consumption (the opposite from the US, for example).  To paraphrase former US defense chief Donald Rumsfeld, in the short run ‘Beijing has little choice but to spur growth with the economy it has, not the one it wishes it had’.

Meanwhile China’s factories are operating with significant excess capacity, trade flows are declining, and deflation is becoming widespread.  Moreover, debt among domestic non-financial firms keeps growing rapidly and is currently very high (though unlike in other large emerging markets whose corporates’ debts have ballooned, the liabilities of Chinese firms are rarely denominated in foreign currency.)  This is due to the fact that the country’s traditional economic backbone, the lumbering state-owned enterprises SOEs—still championed by the Communist Party—not only have been induced to become larger (at the expense of the non-state, “private” sector, whose growth has actually been faster) but the resources they “borrow” from the four state-owned banks are rarely repaid to any meaningful degree.  Indeed, China’s fixed asset investment is still growing at greater than 10 percent.

Beijing has also resorted to targeted tax incentives as a way to pump up the economy.  To reinvigorate the country’s export-led growth—a goal the Chinese leadership actually has argued goes against their stated goal of transforming the country into a consumption-oriented market—Chinese firms whose goods or services are sold overseas are now eligible for tax cuts.  Beyond blunting the drive to stimulate consumption at home, this policy is tantamount to China’s exportation of its excess capacity to the rest of the world.

In addition, the government recently announced a ten percent tax reduction on domestic purchases of compact automobiles.  Not surprisingly, this has helped boost car sales. However, it also results in enlarging, rather than diminishing, one of the major sources of pollution in China’s large urban areas, a problem that has grown so large that the government has instituted rationing when the use of automobiles is permitted—not to mention issuing health emergency notices so people do not even leave their homes and go to work.

What to Watch For. Beijing’s policies will continue to expose China’s endemic barriers to sustained high levels of growth, which stem from the contradictions inherent in the Party’s “social market economy” model. Unfortunately, the current slowdown—at this juncture probably attributable as much to natural business cycle forces as to secular shifts—is coming precisely at the time when structural reforms are most urgent.  Yet ‘the ask’ of the Chinese citizenry for ‘buy-in’ to such significant changes is likely to be too tall an order if Beijing continues to want to have its cake and eat it too.   Something will have to give.

What’s likely to happen in 2016? The (real) rate of growth will continue to slide below Beijing’s announced targets, labor unrest will rise in the state sector, the stock “market” will remain volatile, moves toward corporate bankruptcies will strain the legal system, and the RMB will significantly depreciate.  The AIIB and OBOR initiatives may well move to a slow track.

Will The Eurozone Finally Go On A Diet?

If 2015 was the year the Eurozone was able to skirt a breakdown, occasioned by the (seemingly transitory) balking by Greece’s leadership to continue to live within the Eurozone’s policy straight-jacket, which was inherently misconceived at its inception years ago, 2016 may well be the year that finally brings things to a head.  And in some respects hopefully it will.

Recent forecasts for 2016 for the Eurozone’s 19 member economies place expected average GDP growth to be somewhere just above 1.5 percent, with Germany (Europe’s greatest economic power) projected to grow slightly above the average.   In contrast, Greece’s economy, which will be dealing with its near-miss bankruptcy and close-to-insolvent banks for years to come, will likely see its GDP continue to shrink by more than 1% in 2016 (as it did in 2015).

Greece will also run a budget deficit above the 3%-of-GDP ceiling “mandated” by European Union (EU) rules—that is, the rules that govern not only the single currency Eurozone countries but also the other 9 members of the EU.  Greece is not alone here:  other Eurozone countries—notably Italy, Spain and even France—are also currently registering deficits larger 3% of GDP.  Of course what really separates the Greeks from the rest of the group is the magnitude of national debt relative to the size of the economy.  At the end of 2015 Greece’s debt-to-GDP ratio was just shy of 200%.

As 2016 commences, the latest data suggest that for the forecasts to turn out accurate over the course of the year, a significant amount of positive change will need to occur—and do so on many fronts.  For example, unemployment for the Eurozone as a whole barely improved in November 2015, dropping from 10.6% to 10.5%.  While Germany’s unemployment rate stood at 4.5%, Italy’s rate was 11%, and for Spain and Greece, the rates exceeded 20%.

Symptomatic of the weakness in market demand that these data reflect, the rate of inflation for the region is barely positive:  the latest monthly figures show headline inflation at 0.2%, which is little different from the recent trend.  This is why the worry in Europe is still squarely on deflation, not inflation.

The latest data on retail trade also illustrate a region still mired under economic pressure.  In November 2015, retail sales declined from the previous month by 0.3%.  But these figures only pertain to the 19 Eurozone countries.  When measured across all of the 28 EU countries, however, retail sales actually rose by 0.2%.  There may be a bit of a message here about economic performance among countries tied to a single currency compared to those who are not.

For the moment, monetary easing by the European Central Bank, coupled with low oil prices, is providing a life-line for Europe.  But time is running short.  And, the strain on the EU economies emanating from the huge flows of refuges and migrants from the East will only exacerbate thestatus quo.

In the absence of fundamental structural reforms taking place or a change in the EU’s ‘rules of the game’ being accepted, the prospects for the present day Eurozone staying intact are, in fact, dim.

What to Watch For.  All eyes should remain on Greece for the Eurozone’s inevitable shrinkage.   The headlines focus on whether Prime Minister Tsipris is able to move forward with the structural reforms he agreed to with Greece’s creditors, including the IMF, this past summer in order to receive successive tranches of bail-out funds.

But let’s be honest:  the political and economic outlook coloring relations between the creditors and the Greek citizenry is, at its fundamentals, as bleak as it was a year ago.  For all sides, it is a waste of time, money and energy to think, let alone act, otherwise.

Indeed, there will likely be hidden costs that emerge only later from poor policy decisions being undertaken by Greece now.  For example, the upcoming sale of the nation’s largest shipping port at Piraeus, being made as part of Greece’s program of privatization (not a bad policy in and of itself), is slated to not actually go to a buyer in the private sector but rather to anothergovernmental entity, COSCO, the Chinese state-owned shipping entity.

As detailed earlier, there are fundamental problems with the structure of the Eurozone.  The real issue on the table, therefore, should be not what (yet again) “new” conditions should the Greeks sign on to with the creditors in 2016 (surely on the upcoming agenda).  Rather, all resources should now be focused on the steps Greece should take to proactively withdraw from the Eurozone.

The fact is that the economic fallout within the rest of the EU will be far more limited than it would have been a year ago in light of restructuring initiatives already made by EU banks and corporates in the meantime.  And for Greece there’s simply no way to escape the pain either way it turns.

But it is far better to make such a move while not in the throes of a heated crisis.  In short, shouldn’t we just cut to the chase?  Doesn’t it simply make much more sense for the Greeks—for better or worse—to proceed in a way that they re-gain control of, and be responsible for, the kind of economy and lifestyle they choose to want?

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