Citi thinks China will drag the world down next year
By Buttonwood
IT IS rare for economists, particularly those at an investment bank, to forecast a recession. For a start, it is difficult to get it right; a recession is by definition a change in trend and economists tend to extrapolate from past ones. But secondly, it is a career risk. One economist once told Buttonwood that, “I never forecast a recession. If I’m right, no-one will thank me; if I’m wrong, I’ll be fired.”
Perhaps it is no surprise that the forthright Willem Buiter, once a member of the Bank of England’s monetary policy committee and now the chief global economist of Citigroup, a bank, has been willing to go out on a limb. He once called gold a “6000-year old bubble” and back in 2012 predicted that there was a 90% chance of Greece leaving the euro area. He now says a global recession is the “most likely” outcome with a 55% probability. But it is worth noting that he defines a global recession, not as a period of falling output, but as:
...a period during which the actual unemployment rate is above the natural unemployment rate or NAIRU [non-accelerating inflation rate of unemployment, the lowest level of unemployment obtainable without causing inflation due to the economy overheating], or during which there is a negative output gap; the level of actual GDP is below the level of potential GDP. To avoid excessive attention to mini-recessions, this period of excess capacity should have a duration of a year or longer.
Translating this definition of a moderate recession into GDP growth rates for the next few years, a moderate global recession starting in the second half of 2016 means global real GDP growth at market exchange rates declining from its likely current rate of 4% or slightly less, to 2.5% or less by the middle of 2016 and staying at or below 2.5% for a year or more.
So what is driving his view? He cites:
...the very weak—indeed negative—world trade growth in the first half of 2015, the continued weakening of (real) commodity prices, the weakness of the global inflation rate, the recent decline in global stock prices, plus indications that corporate earnings growth is slowing down in most countries, and the unprecedented decline in nominal interest rates.
The problem stems from the emerging markets and, in particular, China. No emerging market is outperforming Citigroup’s forecasts for 2015. China’s official numbers may look fine but Mr Buiter reckons the real rate of GDP growth is currently 4% and may drop to 2.5% by the middle of next year. In Chinese terms, that is a recession.
Investment in China has been, on average, woefully inefficient—especially since 2008. Most of it continues to be allocated to infrastructure, construction and traditional industrial and extractive activities.
A reduction in the share of fixed investment in GDP by 10% is overdue... the question is whether this reduction in investment can be achieved without aggregate demand damage.
He thinks that is unlikely. This will have significant knock-on effects in the developed world. China’s share of world GDP in 2014 was 13.3% and 14.3% of global trade. Even countries that don’t directly trade that much with China will be affected, since they sell to countries that do export to China. The developed economies are unlikely to respond with fiscal stimulus. So Mr Buiter concludes that:
...the monetary authorities once again will have to do the heavy lifting. If the Federal Reserve and the Bank of England raise rates this year or early next year they may, if the global recession scenario materialises, be cutting rates again during the second half of 2016.
