Many are overly excited about the renewed growth of the world economy. For example, Chief Economist of the IMF, Maurice Obstfeld, wrote in his recent blog entry that “Recent data point to the broadest synchronized upswing the world economy has experienced in the last decade”. All looks nice, but what if it was a mirage, a growth pulse driven by unsustainable policies and actions?
In this blog-entry, I will argue that the recent spurt in global growth is exactly that. It is driven by a false belief that the long-awaited global recovery is finally here. However, a deeper look into the sources of growth paints a cruelling picture of manipulated world markets and on labile foundations of global growth. This entry is based on the recent business cycle forecast by GnS Economics.
Who has driven global growth?
This question can also be formalized by asking, where has the growth in private credit and capital come from? Figure 1 presents the development of global private non-financial debt. It shows that one country is responsible for all of increase in private debt since 2008: China. Figure 2, presenting the capital formation of major industrialized nations, tell a similar story. Without China, capital formation would have reached the level of 2008 only in the end of 2015.
The message of these figures can be summarized by saying that without China, the world economy would have achieved only dismal growth since 2008.
The trouble with China
The main problem of China is that its debt share to GDP runs very high. The private debt of the financial sector of China is around 23 trillion dollars, or around 210 % of GDP. In addition, the latest reports put the size of non-bank financial, or the shadow banking sector of China to a massive 37 trillion dollars. The rapid increase in the assets of the shadow banks occurred during 2016, when China launched the latest patch of its major stimulus program. This more than doubles the level of private debt in the Chinese economy, thus raising its GDP-share to over 500 %. It is obvious that this is not sustainable, by any means.
This money has been used to a growing volume of unproductive investments. Figure 3 shows the share of fixed asset investments in China. Last year, they totaled to over 80 % of the GDP, a preposterous number. For a fast-growing developing economy, a reasonable investment share would be between 20 and 40 %. It thus seems evident that the majority of the investments made in China will not be profitable, implying that the majority of the loans used for the investments will also never be paid back. China’s banking sector will thus face crippling losses from unprofitable loans, when the investment boom turns sour.
China has kept its economy afloat using large array measures, including capital controls, government stimulus and credit stimulus since last year. The question is, if China’s economy is doing so fine, why are these crisis fighting measures needed?
Central bankers’ road to ruin
I have dealt with the problems caused by the unorthodox monetary policies of central banks several times (see, e.g., here and here). Their problems can be summarized by stating that central banks have effectively created a “zombie economy”, where unprofitable firms have been kept in operation with cheap credit and asset prices have been inflated by the asset buying programs.
Recent reports also tell a story of central banks buying the stock market dips (for example, see here, here and here), giving a troubling picture of how manipulated the capital market currently is. When the inflated and manipulated asset markets finally turn a corner, it will likely to be both swift and brutal.
The world economy is on the brink
World economy is like over-inflated balloon. Ready to go and just looking for a needle sharp enough. Still, if you look around, bulls are a bound. They act like the excessive debt growth would not be a problem, market risk would have been all but eviscerated by central banks’ asset buying and as if China would have invented a perpetual motion machine of economic growth. But, the Stein’s law, “If something cannot go on forever, it will eventually stop”, still holds.
To cover the excess of China, major global economies would have to go on an unimaginable investment spree. Although major economies have been improving, there is no signs of such an investment boom. Quite the contrary. QE programs have inflated asset prices across the globe and QT (quantitative tightening) currently considered by the major central banks will work the other way. Eventually, indebted households and firms will also need to face higher interest costs, after nearly of a decade of near or below zero rates. This unlikely to work well with their bloated balance sheets.
We are closing to the point where the normal market order will be restored, one way or another. Current late-cycle economic boom is nothing more than a mirage created by unsustainable growth of debt in China and equally unsustainable monetary stimulus by the global central banks. The thing with this central planning is that it only efficient until suddenly it is not. Thus, all we can basically do is to wait for the twilight to hit the global economy. But, when it does, expect the ensuing crisis to be just one thing: epic.