Change is coming. get ready. !!!
A new macroeconomic era is emerging. What will it look like?
For months There has been turmoil in the financial markets and mounting evidence of stress in the global economy. You might think that these are just normal signs of an upcoming bear market and recession. But, as our special report this week makes clear, they also point to the painful emergence of a new order in the global economy – a shift that may be the result of the rise of Keynesianism after World War II, and the axis toward free markets and globalization in the 1990s. This new era holds promise that the rich world may escape the low-growth trap of the 2000s and tackle big problems like aging and climate change. But it also brings acute risks, from financial chaos to collapsing central banks and out-of-control public spending.
The turmoil in the markets of a magnitude not seen in a generation. Global inflation is in the double digits for the first time in nearly 40 years. Slow to respond, the Federal Reserve is now raising interest rates at the fastest pace since the 1980s, while the dollar has remained at its strongest in two decades, wreaking havoc outside America. If you have an investment portfolio or a pension, this year has been awful. Global stocks are down 25% in dollar terms, their worst year since at least the 1980s, and government bonds are on track for their worst year since 1949. Along with about $40 trillion in losses, there is a turbulent feeling that the global order is being turned upside down On the upside with globalization approaching decline and the collapse of the energy system after the Russian invasion of Ukraine.
All this marks the definitive end of the era of economic calm in 2010. After the global financial crisis in 2007-2009, the performance of rich economies took a poor pattern. Investment by private companies has been weak, even in those with huge profits, while governments have not taken the slack: public capital has actually shrunk around the world, as a share of Gross domestic productIn the decade following the collapse of Lehman Brothers. Economic growth was slow and inflation was low. With the private and public sectors doing little to stimulate more activity, central banks have become the only game in town. They kept interest rates at very low levels and bought huge amounts of bonds at any sign of trouble, expanding their reach into the economy more than ever before. On the eve of the pandemic of central banks in America, Europe and Japan owned up to $15 trillion in financial assets.
The extraordinary challenge of the pandemic has led to extraordinary measures that helped unleash today’s inflation: runaway government stimulus and bailouts, temporarily skewed patterns of consumer demand and supply chain entanglements caused by the shutdown. Since then, this inflationary impulse has exacerbated the energy crisis, as Russia, one of the largest exporters of fossil fuels along with Saudi Arabia, has isolated itself from its markets in the West. Facing a serious inflation problem, the Fed has already raised interest rates from a maximum of 0.25% to 3.25% and is expected to raise them to 4.5% by early 2023. Globally, most monetary authorities are also tightening restrictions.
What on earth comes next?
One immediate concern is an explosion, as a financial system accustomed to low rates wakes up to the rising cost of borrowing. Although one medium-sized lender, Credit Suisse, is under pressure, banks are unlikely to become a major problem: most have larger buffers of safety than in the past. Instead, the risks lie elsewhere, in a new-look financial system that relies less on banks and more on volatile markets and technology. The good news is that your deposits are not about to go up in smoke. The bad news is that this system of corporate and consumer finance is opaque and overly sensitive to losses.
You can already see this in the credit markets. As companies that buy debt are risk-averse, the interest rate on junk mortgages and bonds is rising. The market for “leveraged loans” used to fund corporate buyouts has stalled — if Elon Musk buys Twitter, the resulting debt could become a major problem. Meanwhile, investment funds, including pension schemes, are facing losses in the illiquid asset portfolios they have accumulated. Parts of the plumbing may stop working. The Treasury market has become more turbulent (see Pattonwood) as European energy companies have faced huge collateral demands on their hedges. The UK bond market has been thrown into disarray by obscure derivative bets made by pension funds.
If markets stop running smoothly, impede the flow of credit or threaten contagion, central banks may step in: the Bank of England has already yoRetreat and start buying bonds again, while reducing their simultaneous commitment to raising interest rates. The associated belief that central banks will not have the resolve to follow through with their tough talk is behind the other big fear: that the world will go back to the 1970s, with rampant inflation. On the one hand, this is alarming and on top of that. Most forecasters believe that inflation in America will fall from the current 8% to 4% in 2023 with rising tidal energy prices and rising rates. However, while the odds of inflation reaching 20% are slim, there is a stark question as to whether governments and central banks will bring it down to 2%.
moving target
To understand why, look beyond the nonsense to the long-term basics. In a significant shift from the 2000s, there is a structural increase in government spending and investment. Elderly citizens will need more health care. Europe and Japan will spend more on defense to counter threats from Russia and China. Climate change and the pursuit of security will boost the country’s investment in energy, from renewable infrastructure to gas stations. Geopolitical tensions are also driving governments to spend more on industrial policy. However, even with increased investment, demography will have a greater impact on wealthy economies. As people get older, they save more, and this excess savings will continue to lower the basic real interest rate.
As a result, the primary trends in the 1920s and 1930s are for larger government but real interest rates are still low. For central banks, this creates an acute dilemma. In order to bring inflation down to their targets of about 2%, they may have to narrow enough to cause a recession. This will have a high human cost in the form of job losses and lead to a political backlash. Moreover, if the economy shrinks and ends up in the trap of low growth and low rates in the 2000s, central banks may once again lack sufficient stimulus tools. The temptation now is to find another way out: get rid of the 2% inflation targets of recent decades and modestly raise them to, say, 4%. It will likely be on the list when the Fed begins reviewing its next strategy in 2024.
This brave new world of somewhat higher government spending and somewhat higher inflation would have advantages. In the short term, that will mean a less severe recession or no recession at all. In the long run, it will mean that central banks have more room to cut interest rates in a deflationary period, reducing the need for bond-buying and bailouts whenever anything goes wrong, causing an increasing distortion of the economy.
However, it also comes with significant risks. The credibility of central banks will be damaged: if the goal posts are moved once, why not again? Millions of contracts and investments written based on the promise of 2% inflation will be disrupted, while moderately high inflation will redistribute wealth from creditors to debtors. Meanwhile, the promise of a moderately larger government could easily spiral out of control, if populist politicians make reckless spending pledges or if state investments in energy and industrial policy are poorly implemented and morphed into bloated vanity projects that lower productivity.
These opportunities and dangers are daunting. But it’s time to start assessing its implications for citizens and businesses. The biggest mistake in economics is the failure of the imagination that reflects the assumption that today’s system will last forever. It never does.
Change is coming. get ready.!!!
A new macroeconomic era is emerging. What will it look like?
A great rebalancing between governments and central banks is under way
www.economist.com
The challenge of the age | Nov 5th 2022 | The Economist
The challenge of the age. Special report from The Economist. You've seen the news, now discover the story.
www.economist.com
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