Slowing, a Bit

Regular readers of this blog will know that globalization has been one of my favourite topics. I recently received a new blog from the International Monetary Fund (IMF) in which the process, defined by the Fund as the change in the sum of exports and imports of all economies relative to global gross domestic product, is tracked over the last century and a half, the period for which robust data are available. The Fund calls this the “trade openness metric”. I found both the blog’s text and chart to be such a comprehensive, yet brief, depiction of globalization, that I decided to simply reproduce it here for readers:

https://www.imf.org/en/Blogs/Articles/2023/02/08/charting-globalizations-turn-to-slowbalization-after-global-financial-crisis

Here are some insights from the data:

1. Globalization, often thought of as a relatively recent phenomenon, was well underway during the industrialization period from 1870 to roughly the start of World War One.

2. Trade protectionist policies proliferated through the Great Depression years and World War Two, and not surprisingly, globalization slowed dramatically.

3. Post-World-War-Two, the process began a multi-decades acceleration, especially after 1980 as China and other developing economies liberalized trade policies, and after 1995 when the World Trade Organization became the arbiter of trade agreements and disputes, and capital flows surged.

4. The Fund describes a period of “slowbalization” following the global financial crisis of 2008, during which political support for freer trade has steadily declined and the pace of trade reform has slowed. As shown in the blog’s chart, however, the slowing has been relatively minor, at least to the end of 2021, when set against the historical trend.

Hats off to the IMF authors, Shekhar Aiyar and Anna Ilyina, for such s succinct description, and data depiction via a chart, of globalization.

Round 4

It is now fair to ask when patience will be exhausted. Four times within six years, the Egyptian government has sought a bail-out from the International Monetary Fund (IMF).

A long time in the making, the decline of the Egyptian economy is accelerating. Its currency, the Egyptian pound, has, officially, lost nearly half its value over the past year, and 200 per cent since 2012. Yet, in a thriving currency black market, pounds trade well below even the drastically lower official rate. The current account in the balance of payments has recorded large deficits for more than a decade. The federal government’s estimated budget deficit for 2022, at 7.8 per cent of GDP, is among the highest in the world. Nearly half of its revenue is required just to service accumulated debt, which amounts to 90 per cent of GDP, and a large portion of what’s left has been spent on infrastructure megaprojects - some of dubious value, such as the building of a new capital city - that have been a hallmark, and likely the folly, of President Sisi’s rule. The private sector is moribund, as reflected in the decline of the purchasing managers’ index for 75 of the last 84 months. The official measurement of inflation is 21 per cent, though it is almost certainly much higher, especially for food. As this economic deterioration has dragged on, daily life for the majority of the 100m Egyptians has become increasingly miserable: the World Bank estimates that a third of them live on less than $2 a day, and another third are close to that threshold.

The IMF has once again stepped forward. As with the 2016 $12 billion bail-out, the most recent deal with the Fund struck in December 2022 ($3 billion over 46 months) comes with conditions. A “flexible” exchange rate regime is to be implemented, and the government is to sell its positions in many state-owned firms, including army-controlled companies like Wataniya, which operates gasoline stations, and Safi, a bottled-water company. (Similar promises in 2016 went unfulfilled.) Bread subsidies are to remain constrained, despite a huge jump in the price of imported wheat related to the war in Ukraine, the principal source of this critical foodstuff. In such a repressive country, anger is widespread amongst the populace, if still below the surface, and with these new IMF conditions (assuming they are implemented), it will only worsen.

The Fund expects the December program to “catalyze additional financing from Egypt’s international and regional partners”. A decade ago, when Sisi seized power in a coup, Gulf states provided $25 billion in aid, in the hope that it would prevent further violence and economic collapse. This level of assistance seems unlikely this time, and, indeed, frustrated Gulf states are instead picking off cheap Egyptian assets; there is even talk they may be eyeing the purchase of the Suez canal.

Egypt is a key Western ally in a politically volatile region. As such, the IMF would appear to have an unspoken mandate to do all required to avoid an implosion. But it should insist that its financing conditions - particularly those pertaining to structural changes in the economy - be finally implemented. Continuing to support a regime that refuses to reform meaningfully will only deepen the crisis, in Egypt and the region.

Inflation Focus

JP Morgan weighed in yesterday morning (December 12) on the likely trend in inflation. Their note listed the following scenarios for the US consumer price index released this morning:

5% probability — CPI 7.8% or higher — S&P 500 down 4% to 5%

25% probability — CPI 7.5% - 7.7% — S&P 500 down 2.5% to 3.5%

50% probability — CPI 7.2% - 7.4%. — S&P 500 up 2% to 3%

15% probability — CPI 7.0% - 7.2% — “A bullish outcome that could pull terminal rate lower.” — S&P 500 up 4% to 5%

5% probability — CPI 6.9% or lower — “A print here could be the technical end of the bear market...This would give increasing confidence in projections of headline inflation falling [to] 3% in 2023. Further, if inflation is at 3%, irrespective of the labor market conditions, it seems unlikely that the Fed would hold the terminal rate at 5%. Any Fed pivot will rip equities.” — S&P 500 up 8% to 10%

It’s that last scenario that turned heads, even with just a 5% probability assigned.

Turns out, the 15%, 7-7.2% scenario is what has been reported this morning, indicating a further deceleration in inflation. Not surprisingly, European stocks have rallied, the UK pound has hit a 6-month high viz the US dollar, the Canadian dollar has similarly jumped, and stock and bond markets in the US have opened on a tear. For financial markets everywhere, it seems the inflation trend, and hence the size of further interest rate increases, remains the primary focus.

Too Much in Either Direction, aka, the Friedman Loop

On CNBC’s website this past Friday, a caption of a lead article read“ September job gains affirm the Fed has a long way to go in inflation fight”. The article noted that while the increase of 263,000 in non-farm payrolls reported that morning was the smallest gain in nearly a year and a half, an unexpected drop in the unemployment rate and another jump in workers’ wages “sent a clear message to markets that more giant interest rate hikes are on the way”. Right on cue, the stock markets sold off significantly through the day, adding to the negative sentiment in markets evident for most of this year.

A rapid acceleration in US inflation since March 2021 - the consumer price index was up 8.3% year-over-year in August 2022, compared to annual rates in the range of 1-3.5% through the first two decades of this century - dominates the focus of officials at America’s central bank, the Federal Reserve System. Their concern is that inflationary expectations become embedded in the economy, making a return to the Fed’s inflation target of 2% increasingly difficult. Accordingly, they are raising the Fed Funds rate at a furious pace to dampen demand, five times since March of this year, to 3.25%. Futures pricing indicates another 0.75-point move in November, and further smaller increases in December and February.

Much of the current discussion in financial markets revolves around the question of whether the Fed, and most other world central banks, can engineer a so-called “soft-landing”, that is, whether their interest rate increases will be sufficient to tame inflation without leading to economic recession.

One of Canada’s leading economists, David Rosenberg, weighed in on the issue this past week in an opinion article in Toronto’s Globe and Mail newspaper titled, “Central bankers are in fantasy-land and we’re all going to pay the price”. In his usual provocative way, Mr. Rosenberg argues that central banks have already overtightened, to the point where “you have inverted the yield curve by nearly 70 basis points on the spread between two-year and ten-year bonds”. (Note to reader - inverted bond-yield curves frequently predict recessions.) He goes on to note that central bankers are essentially looking in the rear-view mirror in discerning the direction of future policy moves. He asks, “what on earth (are central bankers) looking at, the twelve-month trailing trend in the consumer price index? Talk about chasing your tail - it is among the most lagging of the lagging indicators”. And he adds, “in the meantime, real-time data show that rents and home prices are now deflating - not merely slowing” - (as are material prices), and the labour market clearly is not as tight as the Fed and everyone else in business TV says. This Fed is focused on job vacancies, which have absolutely no correlation with wage inflation or price inflation - none”. And, according to Rosenberg, not only has the Fed got future policy direction wrong, it also was off course when it kept easing monetary policy into massive fiscal stimulus during the pandemic and reopening of the economy. (Note to reader - as recently as the first quarter of 2022, the Fed was holding its Fed Funds Rate near zero and continuing to buy billions of dollars of bonds.) In short, the easing of monetary policy was too much, and too long; so now is the tightening.

The too much, in either direction, criticism of monetary policy would have been old news to the Nobel Prize-winning economist, Milton Friedman (his seminal work was A Monetary History of the United States, 1867-1960, co-authored with Anna Schwartz) . He argued for years that monetary authorities seemed always to be reacting to historical data, and thus exacerbated rather than stabilized current and future trends in the economy. Cycles of economic boom and bust were thus chronic, a pattern described as the Friedman loop. (One of his particular assertions in A Monetary History was that too-tight monetary policy following the 1920’s boom was at the core of the persistent Great Depression of the 1930s.) Rosenberg clearly agrees that at least with respect to the current monetary authorities, their actions have been, and are likely to continue to be, de-stabilizing. Or, in Rosenberg terms, “this is the weakest set of FOMC members I can recall in my near-forty years in the business….Mr.Powell and his crew are just cleaning up their own mess, and are now in the process of over-tightening as they over-eased”. To which Mr. Friedman might have added, deja-vu.

Stranded Assets

World leaders (apparently absent Xi Jinping and Vladimir Putin) will gather in Glasgow next week pledging a course for reaching net zero global carbon emissions within thirty years. As an unfortunate backdrop to COP26, as the annual summit is called, energy markets are suddenly showing signs of extreme dysfunction - the first of what could be several green-era energy crises. There are power cuts in China, coal shortages in India, surging electricity prices in Europe, and gasoline prices well above $3 per gallon in North America. Oil prices, at over $80 a barrel, are at their highest level since 2014. Spot prices for Asian natural gas have jumped nearly 1,000% over the past year. Vladimir Putin, not one to miss an opportunity for leverage, has just reminded Europe that their continued supply of natural gas is dependent on Russian goodwill.

The appearance almost overnight of these shortages seems remarkable. Recall that as recently as 2020, global energy demand fell by an unprecedented 5% as the spread of Covid -19 shut down economies everywhere. The Covid shock triggered an immediate investment cut-back in the energy industry - perhaps prematurely and inappropriately, as it turns out, as some $10.4 trillion of global policy stimulus has led to a world economy cranking back up far more quickly than most thought. The result has been dangerously low stockpiles and spiking prices. The Economist estimates that oil inventories are only 94% of normal, European gas storage 86%, and Chinese and Indian coal below 50%. The price of a basket of oil, gas and coal has jumped 95% since May.

In the past, producers of fossil fuels would have typically responded to such price signals by rapidly increasing output and investment. But not now. Climate change has changed that. Producers and investors are under intensifying pressure to move away from fossil fuels. As just one example, Shell Oil recently said it plans to actually reduce oil production by 1-2% a year until 2030. When asked what the energy price jump means for investment, Wael Sawan, Shell’s chief of oil and gas production, said, “From my perspective, it means nothing”. Here’s a second example: Dutch pension fund ABP, one of the world’s largest, has just announced it will divest some $21 billion of investments in fossil fuel producers by 2023, a marked turnaround from its position as recently as June.

At the COP26 summit, we are about to hear much more about the urgent need for green alternatives to fossil fuels. Mark Carney, the United Nations’ special envoy on climate action and finance, has noted that as the energy industry shifts its investment focus, fossil fuel assets are likely to be rendered worthless by 2030, if not sooner. Carney, when Governor of the Bank of England, first warned about the “potentially huge” risk to investors from so-called stranded assets in 2015, commenting that vast reserves of coal, oil and gas could become “literally unburnable”. This view is supported by the International Energy Agency (IEA) which earlier this year concluded, in a stunning analysis, that there should be no new oil, gas or coal development if the world is to reach net-zero fossil fuel by 2050.

Let us hope that the leaders at COP26 move beyond pledges and begin devising specific policies. Essential aspects will include strengthening support for Article 6 of the Paris Agreement calling for an international carbon market, close public/private sector collaboration, and a re-emphasis from rich countries to help finance poor countries’ existing climate strategies. Your writer’s best guess is that progress at COP26 will be at best incremental, not negligible, but not a “big leap” of the sort John Kerry, America’s climate envoy, is expecting. I hope I’m wrong, but history (all 25 of the previous COPs) says I’m not.

View fullsize

\reuters 2015

annie's christmas 2015 text block do not edit.  leave as is.   

---

\in part 2 of our series on afghan men....