Orthodox Downgrades Traced To Mid-2015's 'Dollar' Intensification

by: Jeffrey Snider

If the US consumers and attendant "demand" had been relatively weak entering 2015 producing even at that point questionable conditions that are now admitted as a manufacturing recession, it is increasingly clear that "something" changed around the middle of the year. Obviously, market turmoil that had been largely focused overseas suddenly swung internally to capture US markets once though invulnerable, but even in the economic accounts the mid-year inflection stands out - industrial production being perhaps the most important indication (so far).

Whether or not this leads the NBER to consider a recession dating is beside the point right now; what is relevant is what IP renders in especially the wider historical context about past recession and how that relates to our current circumstances. It suggests, with very little room for argument, that the US economy is already in truly dire condition and increasingly so at the same time as market indications suggest and price the very same.

After it has become clear about these kinds of dangers, now the economists are adding their lagging analysis. The World Bank, as per usual, reduced its growth estimates in January for everything from global GDP to US GDP to world trade. In January 2013, with all the secondary "stimulus" (QE3 & 4 in the US, Mario Draghi's promise and what would be the last of China's bubble-ism) still rather fresh in the economic models, the World Bank predicted global trade would expand by a healthy 6.7% in 2014 and then 7.0% in 2015. While 2014 never lived up to those expectations, finishing at 3.6%, last year's final estimate did not either also estimated 3.6%. These are contractionary numbers not appreciably different than the trade levels of 2012 and 2013, nor 2008.

ABOOK Feb 2016 World Bank Global Trade

Most concerning was the scale of the downgrade from the World Bank's last estimates in June. Since mid-year, the expectation for trade growth (2015) fell from 4.4% to again 3.6% as of January; 2016 trade estimates were slashed from 4.9% at mid-year to now just 3.8% and already back within the same challenging range as all prior years. This is a major problem but as far as the World Bank is concerned (despite the stark changes in behavior) it is largely limited to EM's or "developing" economies.

Over the last quarter century, trade flows of goods and services have increased rapidly (Figure 4.1.1). The value of world trade has more than quintupled, from $8.7 trillion in 1990, to more than $46 trillion in 2014. The relative importance of trade has increased too, from 39 percent of world GDP in 1990, to 60 percent in 2014. That said, global trade growth has slowed to about 4 percent per year since the crisis from about 7 percent, on average, during 1990-07. This slowdown in world trade reflects weak global investment growth, maturing global supply chains, and slowing momentum in trade liberalization.

It is a fundamental misreading of the global economy, searching for answers where the obvious doesn't fit the convention. From 1990 to 2007, the eurodollar standard was an unbelievable monetary tailwind to not just global trade but that global trade baseline for global growth. It was all (or mostly) financed by bank balance sheet expansion, a co-dependency in the truest sense.

ABOOK Feb 2016 TIC Overall 6m

Even when this inflection in 2007 is incorporated into analysis it often misplaces cause and effect; lower US trade in this view accounts for less dollars being recycled through what is usually referred to as the "petrodollar" system. Thus, trade supposedly leads to dollar effects. That contention, however, is a fundamental distortion of what the eurodollar is, which we can easily observe in EM corporate debt (among many other assets and liabilities). In the Great Recession it was the panic in eurodollars that sunk the global economy, not the other way around, a trend which unevenly continues.

Because of this fundamental rearrangement, the World Bank sees the effects upon global trade without figuring the cause, and thus is not as alarmed by the turmoil since last summer as far as "developed" economies and their role.

Emerging market economies have been an engine of global growth during the 2000s, especially after the 2007-08 global financial crisis. However, times are changing. Growth rates in several emerging market economies have been declining since 2010. The global economy will need to adapt to a new period of more modest growth in large emerging markets, characterized by lower commodity prices and diminished flows of trade and capital.

Looking ahead, global growth is poised to recover modestly, by 2.9 percent in 2016, after (once again) falling short of expectations at 2.4 percent in 2015, held back by weak capital flows to emerging and developing countries, weak trade and low commodity prices. Under the baseline scenario, it is expected that China will steer its economy to a more consumption and services-led growth and the monetary policy tightening cycle in the United States will proceed without undue turbulence; as a consequence, global growth will see a modest upturn.

That was written last month. In other words, despite being completely wrong about EM's last year and how they would contribute to the more robust upturn expected in 2015, the World Bank now admits EM's are mostly out of the equation but the upturn still somehow stands without their contribution or factoring the cause of the miss. It is convenient compartmentalization inconsistent with the eurodollar but certainly more so with recent accounts in both EM and developed economies.

The OECD, by contrast, an organization made up of "developed" nations, has instead registered the differences over the past seven or eight months and has become worried. So much so that they even declared "urgent" policy needs.

Global GDP growth in 2016 is projected to be no higher than in 2015, itself the slowest pace in the past five years. Forecasts have again been revised down in light of disappointing recent data. Growth is slowing in many emerging economies with a very modest recovery in advanced economies and low prices depressing commodity exporters. Trade and investment remain weak. Sluggish demand is leading to low inflation and inadequate wage and employment growth.

Financial instability risks are substantial. Financial markets globally have been reassessing growth prospects, leading to falls in equity prices and higher market volatility. Some emerging markets are particularly vulnerable to sharp exchange rate movements and the effects of high domestic debt.

The idea that "global economies have flat-lined" is again very different from their view from last March:

Growth prospects in the major economies look slightly better than at the time of the OECD November 2014 Economic Outlook, but the near-term outlook is still one of moderate, rather than rapid, world growth…

The favourable tailwinds create an opportunity for the euro area and Japan to get back to somewhat stronger growth rates, and on balance the most recent indications are encouraging. In the United States, a cyclical recovery continues, although one-offs like the severe winter weather in the Northeast may disrupt the quarterly profile of growth.

In other words, the OECD only ten months ago was sure that monetary policy worked and would continue to work everywhere if only moderately well (even, ridiculously, in Japan). After a summer of turbulence and sharp second derivative collapses, it seems to have dawned on the economists there, if not yet the World Bank, the severe "weather" in the US economy was not winter at all but rather "dollar." That is the storm continuing to disrupt trade and economics all over. For the OECD, importantly, "transitory" was just declared dead and monetary policy significantly demoted.

In other words, the OECD's message is exactly the same as US industrial production as noted at the outset. The global economy may or may not be in recession at the moment, a classification that is admittedly debatable, but in many ways that doesn't matter - the economy here and globally is at the very least close, and certainly in danger of fully participating. At the forefront of that shift (from last year's mild concerns and relatively upbeat if historically subdued forecasts to this year's "urgent" warnings) is global trade and the leverage and financialism that used to support it all that no longer does.

The OECD even goes so far as to highlight 2015 trade in comparison with the past two recessions. That doesn't suggest anything good for 2016 as it still follows the "dollar", which has still not yet arrived at whatever stable state awaits the end of the transition.

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