Will October be memorable again for the wrong reasons as the economic risks mount? | Larry Elliott
Bad things happen in October. It was during this month, 13 years ago, that the global banking system nearly imploded. There was a stock market bloodbath in October 1987. And it was in October 1929 that the Wall Street crash triggered the Great Depression.
One of the consequences of the economic horrors of the 1930s was the creation of the International Monetary Fund, with the idea of creating a multilateral body that would help countries solve short-term problems and prevent the development of systemic crises.
Judging by this metric, the IMF has been a success. There was no repeat of the Great Depression, although in 2008 the world approached it. The IMF’s annual meeting that year came just weeks after the collapse of investment bank Lehman Brothers raised doubts about the viability of many other financial institutions. Finance ministers and central bank governors met in Washington to craft a bailout that ended the panic.
This week, it is again time for the IMF to hold its annual meetings, and while there is no current crisis, there are many signs that one could be imminent. Economists are always on the lookout for black swans – unexpected events that have a massive impact – that can lead to a stock market meltdown or deep recession, but in this case it’s not necessary as there is a lot of big problems clearly visible.
Here is what it looks like. The global recovery from last year’s pandemic-induced lockdowns has started to falter, and in its half-year global economic outlook, the IMF will downgrade its growth estimate for 2021, mainly due to recent developments in the region. United States and China.
Joe Biden’s honeymoon is over. The US economy is still expanding but at a slower pace, as inflationary pressures continue to intensify. A dispute in Congress over how much the government can borrow, which could lead to Washington defaulting on its debt, has been on hold for two months. The US central bank has made it clear that it intends to remove some of the stimulus it provided during the pandemic.
China’s already sluggish economy has been hit even harder by energy shortages and blackouts. Evergrande, once the country’s largest real estate developer, is on the brink and there are fears that more will follow. The Beijing government is grappling with the delicate task of overseeing slower but more sustainable growth without causing a full-blown recession.
The rapid pace at which countries in all regions of the world have recovered from the recession has created bottlenecks in the supply chain. There are shortages of labor, raw materials and goods, and they drive up prices. The cost of energy has risen sharply due to a recovery in demand, especially from Asia.
Meanwhile, the world’s poorest countries are still waiting for the vaccines promised by the G7 and other rich countries earlier this year. With the threat of Covid-19 still real, the West’s hoarding of doses is inexcusable. IMF Managing Director Kristalina Georgieva rightly called last week on hoarders to honor their commitments without delay.
Stock markets have recovered from the selloff they experienced in the first few weeks of the pandemic and are ripe for a correction. TS Lombard’s Charles Dumas says the S&P 500 – Wall Street’s best mood indicator – is roughly 40% overvalued. Another analyst, Dhaval Joshi of BCA Research, noted how US tech stocks – responsible for much of the strong performance of the broader stock market – rise and fall against US Treasuries.
Simply put, when bond prices rise, the interest rate – or yield – paid to investors falls, and vice versa. Bond prices tend to fall when inflation rises, which is currently the case. There is, Joshi says, little “wiggle room” for bonds to sell before they knock the stock market down with them.
Albert Edwards of Société Générale says the current state of affairs echoes July 2008, when the European Central Bank raised interest rates as oil prices approached $ 150 (£ 110) a barrel , only to be confronted three months later with the deflationary consequences of the Lehman debacle.
Central banks in Norway, New Zealand and Poland have already raised interest rates, while the Bank of England and the Federal Reserve are preparing to tighten policies. So, said Edwards, shouldn’t we be talking about the R word?
This is a reasonable question. Every sharp increase in energy prices since the early 1970s has been followed by a recession and this is perhaps no exception. In the short run, rising oil and gas prices are inflationary, but in the longer run, they are deflationary because they increase business costs and reduce the purchasing power of consumers. This pattern was established during the first oil shock of 1973 (another October event), where a surge in inflation was followed by an increase in unemployment as companies went bankrupt.
Politicians seem oblivious to this risk. At last week’s Conservative Party conference, for example, there was not the slightest hint that the recent economic downturn could be followed by a harsh winter. Energy-intensive businesses are really hurting.
Financial markets seem to assume that the pandemic is all but over, that the economic recovery will continue at a steady pace, and that inflationary pressures are transient and relatively painless. If they are right on all counts, then this won’t be one of those October that is remembered for the wrong reasons. But last week, stock prices rallied after Vladimir Putin said he could supply Europe with more Russian gas. Some may see this as a sign of trouble ahead.