The world’s major stock price averages have registered robust double-digit gains, since early-summer, to within touching distance of multi-year highs, a somewhat puzzling development given that virtually all of the most recent data confirms that global economic growth has slowed to the most sluggish pace since the ‘Great Recession’ came to an end three years ago.
A troubling slowdown in economic activity is detectable almost everywhere, with stagnation or outright contraction evident across much of the developed world, while several emerging market economies have struck a nasty speed-bump. The deterioration in the global economic outlook is beyond dispute, and reflected in rising unemployment, falling investment rates, as well as the volume of world trade, which has slowed to a standstill.
Hope continues to trump reason however, as investors continue to demonstrate blind faith in policymakers’ ability to deliver stimulus measures that will lift the global economy from its current soft patch. It is staggering to observe that many seasoned market players persist with such a belief, given that all the evidence suggests that the various growth models responsible for the robust expansion in economic activity, in the years that preceded the global financial crisis, are now exhausted.
The debt-driven model that underpinned economic growth throughout most of the Western world, for at least the past two decades, is undoubtedly beyond rescue at this juncture. The rate of increase in non-financial private sector debt outpaced GDP growth by more than three percentage points a year on average through the 1990s, and the gap widened to almost six percentage points a year in the early years of the new millennium, which inevitably pushed debt ratios to dangerous levels.
The unsustainable private sector borrowing spree duly came to an end once the ‘Great Recession’ struck in 2008, and the resulting plunge in economic activity required fiscal and monetary stimulus on an unprecedented scale to prevent a worldwide depression. The unthinkable did not happen of course, but policymakers’ efforts to promote a self-sustaining economic expansion have been less than impressive.
The U.S. economy for example, is experiencing the weakest recovery in post-war history, with annualized economic growth, quarter-on-quarter, averaging little more than two per cent since the downturn ended, or less than half the pace recorded over a comparable time period, following the previous ten recessions. Additionally, although real output has reached new highs, not one of the four indicators that the National Bureau of Economic Research employs to date business cycles, has exceeded their pre-recession peaks.
Meanwhile, European economic performance has been even less inspiring, with activity failing to recover its pre-recession peak in both the euro-zone and the U.K., such that GDP-per-capita is still roughly two per cent below its 2007 level in the former, and six per cent below in the latter. Further, the post-recession experience in both economic regions trails the Japanese record following the deflation of its twin property and stock market bubbles more than two decades ago.
Three years have passed since the advanced economies of the Western world reached their nadir, and economic growth continues to disappoint, while aggregate debt ratios remain close to record levels, as the deleveraging of private sector balance sheets has been offset by the deterioration in public finances. Further, persistently elevated unemployment rates, alongside relatively subdued investment in the productive capital stock, threatens to lower potential growth rates that are already pressured by an unfavorable demographic picture.
The debt-driven model apparent in most of the developed world is bankrupt, but troubling, the growth models applied in emerging market economies can no longer be relied upon to drive the global economy forward. This is true not only in India, where persistently large fiscal deficits, a deteriorating external position, and stubbornly high inflation have undermined the sub-continent’s status as emerging-market darling, but also in China, where an unprecedented investment boom has limited the central government’s scope to offset the sharp slowdown in economic growth via a fiscal stimulus package centered on infrastructure spending.
The Middle Kingdom’s economy is already in desperate need of rebalancing towards household consumption, which at less than 35 per cent of GDP is well below that of countries at a similar level of in income. Additional infrastructure spending at this juncture may well ease cyclical pressures, but would undoubtedly result in greater economic turbulence later.
China’s policy response to the global financial crisis precipitated a nine percentage point increase in the investment share of GDP to close to 50 per cent between 2007 and 2011. However, the investment boom has been accompanied by an increase in the incremental capital/output ratio – the quantity of new capital required to generate an additional unit of growth – to levels comparable to its East Asian neighbors just before crisis struck in 1997.
Further, central government and corporate debt ratios are not far removed from Japanese levels just before its economic miracle came to an end in 1989. Rebalancing, and not fiscal stimulus, is what the Chinese economy requires, and simple arithmetic suggests that this is not possible without a significant drop in the economy’s long-term growth rate.
Investors continue to push stock prices higher on hopes that stimulus measures will return the world economy to a more familiar growth trajectory. Cyclical solutions cannot solve structural problems however, and it is troubling to note that there are no growth engines available to push the world economy forward.