The FINANCIAL — Lower oil prices may seem like manna from heaven, and if they solely represent increased supply – higher US production and Libya’s return to oil exporting – the impact on the global economy is unambiguously positive. However, if falling oil prices reflect broader deflationary patterns, there is reason for concern. Deflationary pressures were well-established long before oil and other commodity prices fell, suggesting the global economy remains in poor shape.
In the developed world, deleveraging has not reduced overall debt levels. At best – as in the US – lower private borrowing has been offset by higher public debt. Despite interest rates at zero and years of central banks pursuing unconventional easing, there are very few signs of renewed credit growth. It is increasingly difficult to ignore the echoes from Japan.
Meanwhile, falling oil and commodity prices have increased strains within the emerging world. Continuous quantitative easing has tempted many companies there to swap the proceeds of hard-currency debt issues into local currency bank deposits to gain a generous interest-rate spread. However, emerging nations were struggling with poor returns on investment, deteriorating competitiveness and an unhealthy dependency on raw-material exports.
Now the chickens are coming home to roost. Weakening export revenues alongside higher corporate hard-currency debt have created an unstable outcome: as emerging-market currencies soften, companies rush to convert their local currency deposits to match their hard-currency liabilities. This leads to further currency weakness and reduced funds for local banks to support credit expansion. The inevitable result is a sharp slowdown in domestic demand alongside sustained currency sell-offs.
Despite the apparent good news in the US, the American recovery is vulnerable to weakening global demand and a potentially much stronger dollar. There is a case for a global accord designed not only to safeguard the US recovery but also to deal with fundamental global imbalances – most obviously, the savings glut.
The US would reprise its role as consumer of last resort, agreeing to offset a stronger dollar with domestic monetary and fiscal stimulus, including keeping interest rates lower for longer. China would tackle its excessively high domestic household savings by opening up capital markets and boosting consumer demand. Germany would raise its retirement age considerably to encourage lower saving and reduce its current-account surplus.
These measures would support near-term demand while reducing global savings. However, political realities make such an accord unlikely, suggesting the world economy remains highly unstable.
Our latest forecasts reflect these fault lines. US growth in 2015 is raised from 2.6 per cent to 2.8 per cent but Japan’s is cut from 1.0 per cent to 0.6 per cent and the UK’s reduced from 2.6 per cent to 2.4 per cent with eurozone growth trimmed to 0.9 per cent.
Of the major emerging-world economies, Brazil is expected to contract by 0.5 per cent in 2015 and Russia by 3.0 per cent. Our growth forecast for China is reduced from 7.7 per cent to 7.3 per cent with lower expectations for the rest of Asia.
This emerging-market weakness will likely put further upward pressure on the US dollar and, for all the talk of monetary-policy normalisation, we suspect central banks will struggle to build the case for higher rates in 2015. Ambitions will be thwarted by a persistently awkward economic reality.
Discussion about this post