Markets are realising that the five-and-a-half year recovery since the financial crisis may already be over, says Ambrose Evans-Pritchard
Combined tightening by the United States and China has done its worst. Global liquidity is evaporating.
What looked liked a gentle tap on the brakes by the two monetary superpowers has proved too much for a fragile world economy, still locked in “secular stagnation”. The latest investor survey by Bank of America shows that fund managers no longer believe the European Central Bank will step into the breach with quantitative easing of its own, at least on a worthwhile scale.
Markets are suddenly prey to the disturbing thought that the five-and-a-half year expansion since the Lehman crisis may already be over, before Europe has regained its prior level of output. That is the chief reason why the price of Brent crude has crashed by 25pc since June. It is why yields on 10-year US Treasuries have fallen to 1.96pc, and why German Bunds are pricing in perma-slump at historic lows of 0.81pc this week.
We will find out soon whether or not this a replay of 1937 when the authorities drained stimulus too early, and set off the second leg of the Great Depression.
If this growth scare presages the end of the cycle, the consequences will be hideous for France, Italy, Spain, Holland, Portugal, Greece, Bulgaria, and others already in deflation, or close to it. The higher their debt ratios, the worse the damage.
Forward-looking credit swaps already suggest that the US Federal Reserve will not be able to raise interest rates next year, or the year after, or ever, one might say. It is starting to look as if the withdrawal of $85bn of bond purchases each month is already tantamount to a normal cycle of rate rises, enough in itself to trigger a downturn. Put another way, it is possible that the world economy is so damaged that it needs permanent QE just to keep the show on the road.
Traders are taking bets on capitulation by the Fed as it tries to find new excuses to delay rate rises, this time by talking down the dollar. “Talk of ‘QE4’ and renewed bond buying is doing the rounds,” said Kit Juckes from Societe Generale.
Crashes are another story. They signal global stress, doubly dangerous today because the whole industrial world is one shock away from a deflation trap, a psychological threshold where we batten down the hatches and wait for cheaper prices. That is the Ninth Circle of Hell in economics.
The world is also more stretched. Morgan Stanley calculates that gross global leverage has risen from $105 trillion to $150 trillion since 2007. Debt has risen to 275pc of GDP in the rich world, and to 175pc in emerging markets. Both are up 20 percentage points since 2007, and both are historic records. The Bank for Settlements warns that the world is on a hair-trigger. The slightest loss of liquidity can have “violent” effects.
Saudi Arabia has clearly shifted strategy, aiming to force high-cost producers out of business across the globe, rather than defend OPEC cartel prices by slashing its own output to offset rises in Libyan supply. Bank of America thinks the Saudis are targeting $85 a barrel, partly in order to squeeze three enemies, Iran, Russia, and the Caliphate.
Full article: World economy so damaged it may need permanent QE (The Telegraph)