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New year rings in more volatility

Global economy showing signs of increased vulnerability
/ 04:59 AM January 07, 2019

Investors around the world felt tremors from gaping faults in the global economy. On Christmas Eve 2018, American stocks had their worst December performance since 1931 at the time of the Great Depression. The US stock market has thus entered bear territory, when stocks have fallen 20 percent or more from a recent high.

It seems the US stock market will gyrate with much volatility in the new year. According to Goldman Sachs and CNBC, it takes stocks an average of 22 months to recover from a bear market.

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Joining the United States with the bears are the major bourses of Germany, China and Japan.

And according to a CNN report, almost half of US chief financial officers surveyed fear a recession in 2019.

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The immediate trigger is the new regime of rising interest rates. The Federal Reserve, or Fed or the US central bank, hiked the benchmark rates four times in 2018. That’s nine increases since December 2015. Two more are due in 2019.

The Fed’s intent is to prevent overheating of the US economy, and to normalize interest rates from the lows of the past years, for the Fed had set the rates near zero in response to the Great Recession of 2008-2009.

Add to that, yields on the 10-year Treasury bonds have risen to their highest levels in seven years. This is likely due to fears of inflation.

All these rate hikes will curb spending. Families will be less willing to borrow as higher rates hit auto loans and adjustable mortgages. Firms will be investing less, and interest payments will eat into their profit margins.

The stock market is volatile, too, as investors shift from stocks to bonds—the latter have become more attractive due to their higher yields.

The regime of higher interest rates will be burdensome for the global economy because of the mess in debt.

For the world as a whole, the total household, corporate and government debt is $247.2 trillion in the first quarter of 2018.

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That equals 318 percent of global gross domestic product, or GDP, says the Institute of International Finance. The sum is way over the $177.8 trillion in the first quarter of 2008, before the Great Recession struck.

The United States, the largest economy on earth, is highly indebted, and this covers consumers, firms, the federal government and state governments. Household debt alone in the United States is around $15 trillion.

Then there is the debt trouble of Argentina, Pakistan, Turkey and Venezuela. They all have large debts denominated in US dollars. Higher interest rates in the United States lead to a stronger dollar (i.e., weaker local currencies). Hence, their dollar debts have become more expensive.

China deserves special attention because it is the world’s second-largest economy. According to Pantheon Macroeconomics, Chinese debt of all kinds amounts to 320 percent of its GDP. This was fueled by the state’s policy to provide cheap loans to its agencies and select industries. And it has a large shadow banking industry. China’s debt is now much larger than it was 10 years ago.

China’s growth has been slowing. Its growth of 6.5 percent in the third quarter, while high by international standards, was below expectations.

Its stock market is shaken. Both the Shanghai Composite index and that of Shenzhen have sunk to bear levels: they have fallen at least 20 percent from their latest peaks.

The Asian giant is also hit by the trade war unleashed by US President Donald Trump.

The United States has slapped tariffs on $250 billion in Chinese goods, while China has hit back with tariffs on $110 billion of American goods. Higher tariffs make imports cost more and stoke inflation.

China’s slump is affecting the world as the nation is the second-largest economy on earth. It imports much in crude oil, metals and various raw materials. Because of sliding demand, prices of high-grade copper, which is used for buildings and electronics, have been falling in five of the past six months. Automotive build rates are depressed significantly as well.

If a big global recession hits, countries will likely reply by lowering interest rates or ramping up government spending. The problem is, they are running out of ammunition.

Despite the interest hikes in the United States, rates are still low. The benchmark rate is only 2.5 percent and won’t likely reach 3 percent until the close of 2019. That’s way below the 5.25 percent before the previous crisis struck. The European Central Bank has not yet raised its rates. And Japan’s rates are negative. So lowering interest rates will not work for rates already low.

Meanwhile, boosting government spending will also be hard due to the grave debt burden. When the Great Recession hit, the US Treasury pumped $440 billion of capital into troubled financial institutions. Then Congress passed the American Recovery and Reinvestment Act, which injected another $800 billion into the economy.

Where will the US government find such huge funding now that it grapples with such heavy debt? —CONTRIBUTED

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