OECD – “Disconnects” & “Financial Vulnerabilities”
The OECD yesterday released their latest global economic health check titled "Will risks derail the modest recovery? Financial vulnerabilities and policy risks"
So first, by modest recovery they have retained their estimates of world GDP growth with 2017 at 3.3% and 2018 at 3.6%. With China at 6.5% and India at 7.3% the ‘rest’ are all in the 2’s and 1’s. Hence ‘modest’…
But the crux of the report is that even this modest growth is highly susceptible to market shocks that could derail it entirely. Their list is extensive but is summarised as "disconnect between financial markets and fundamentals, potential market volatility, financial vulnerabilities and policy uncertainties could derail the modest recovery."
The reference to disconnect was principally targeted at a market that is supported by central bank stimulus through record low interest rates and QE money printing, which whilst the latter is halted in the US, it is still full steam ahead in the EU, Japan and China. On this:
“Significant financial vulnerabilities arise from the overreliance on monetary policy in recent years, which has led to an extended period of exceptionally low interest rates, rising debt levels in some countries, elevated asset prices and a search for yield. In advanced economies, some countries have experienced rapid house price increases in recent years, including Australia, Canada, Sweden and the United Kingdom. As past experience has shown, a rapid rise of house prices can be a precursor of an economic downturn. House price-to-rent ratios are at record highs in several countries and above long-term averages in many others. Although there has been a slower accumulation of household debt in recent years, mortgage-debt-to-income ratios remain high in many countries.”
Yes, Australia gets a first place mention for our property market, but its not property alone. Vern Gowdie of the Daily Reckoning pointed out on Friday our GDP growth is being fuelled off debt on these record low interest rates:
“We’re told our $1.6 trillion economy ‘grew’ by 2.4% over the past 12 months…give or take, that amounts to an increase of $40 billion in economic activity.
Australia’s total debt — public, private and corporate — at the start of 2016 was near $6 trillion.
Currently, our total debt is estimated to be $6.2 trillion…an increase of $200 billion in 12 months.
Going a further $200 billion into the red ‘bought’ us $40 billion in economic activity. It’s now taking $5 of debt to produce $1 of GDP ‘growth’.”
That is pretty straight forward maths. But back to the OECD. They also highlight the dangers in currency volatility given we are seeing the disconnect of a US Fed tightening whilst the aforementioned are still full on easing. We’ve written before of the elephant in the room of how China responds to a Fed hike induced USD surge (a must read). As the OECD says:
“The recent interest rate rises have been associated with sizeable exchange rate movements, with the US dollar appreciating rapidly against the euro and yen, and a number of emerging market currencies have faced market pressures. Financial market expectations imply that a large divergence in short-term interest rates between the major advanced economies will open up in the coming years. This raises the risk of financial market tensions and volatility, notably in exchange rates, which could lead to wider financial instability.”
They are also particularly concerned about Emerging Market fragility off the sheer amount of non performing loans and loans vulnerable to those currency volatilities:
“The rapid growth of private sector credit and the relatively high level of indebtedness by historic norms is a key risk in some countries, notably China, fuelled by favourable financial conditions amid low global interest rates. These high debt burdens, particularly of non-financial companies, leave economies more exposed to a rapid rise in interest rates or unfavourable demand developments. At the same time, a turning of the credit cycle is leading to a rise in non-performing loans, particularly for India and Russia, potentially exposing a misallocation of capital during the upswing and creating pressures on the banking system. In China, the high share of non-performing and “special-mention” loans reflects to a large extent borrowing by state-owned enterprises.”
Finally, as we are seeing here in Australia time and again, and in reference to the anti globalisation / anti establishment disenchantment factor, governments are too afraid to make the hard choices to address all this:
“Uncertainties in many countries about future policy actions and the direction of politics are high. News-based measures indicate global policy uncertainty increased significantly in 2016, rising particularly sharply in some countries. Many countries have new governments, face elections this year, or rely on coalition or minority governments. More generally, falling trust in national governments and lower confidence by voters in the political systems of many countries can make it more difficult for governments to pursue and sustain the policy agenda required to achieve strong and inclusive growth. Rising inequality and growing concern about the fairness of society may also help to undermine trust and confidence in governments. These tensions lead to less predictable outcomes, including on progress in implementing policy reforms.”
The take away is that yes growth could continue to stumble along and everything could be ok. But sharemarkets are currently priced at ‘awesome’ growth levels, and there are a number of unintended but seemingly inevitable consequences to unwinding the very stimulus that got us there and that could come home to roost at any moment. So play the stimulus game, but make sure you have your hedge or insurance safe haven in play for when it goes wrong….