Expectations were low heading into the G20 Meetings in Shanghai last week. After years of meagre growth and repeated attempts to use central bank levers to kick-start struggling economies, it’s no wonder why world leaders weren’t able to come to terms on the best way forward. Instead, they called for “structural reforms,” perhaps echoing their frustration that central banks have shouldered an unequal share of the burden in the fallout of the 2008 financial crisis.[1]
While there were several themes identified throughout the two-day meetings of the world’s most powerful finance ministers and central bankers, the common thread was that the actions of central banks alone are not enough to achieve balanced growth. In fact, it appears that central banks are running out of effective policy levers to achieve the lofty mandates of economic growth and price stability amid greater instability.
“The global recovery continues, but it remains uneven and falls short of our ambition for strong, sustainable and balanced growth,” G20 leaders said in a communique following the two-day meetings on February 27. “Monetary policies will continue to support economic activity and ensure price stability, consistent with central banks’ mandates, but monetary policy alone cannot lead to balanced growth.”[2]
The communique highlighted volatile capital flows, plunging commodity prices and geopolitical tensions as the main downside risks to global growth. Adding to this volatile cocktail is the potential of a UK exit from the European Union, which according to the large majority of economists could unleash chaos on the region. The UK will vote on whether to quit the EU, dubbed ‘Brexit’ by the masses, on June 23. Latest polls indicate a narrow lead for the Stay camp, although both sides were virtually tied just a few weeks ago.[3]
Monetary Policy Not Working
Most observers of the global economy realize that central banks have a necessary but insufficient role to play in promoting economic growth and price stability. Skeptics are quick to remind us of the trillions of dollars in stimulus that have been spent over the past eight years trying to keep economies above water. After years of expansionary policies and rock-bottom interest rates, global economies remain in a precarious state. On the one hand, nations have proved inflexible in responding to external shocks, such as the fallout from the oil price collapse that began in summer 2014. On the other hand, they are desperately trying to undo a legacy of slow growth without addressing the root cause of the issue. With real wages stagnating or declining in many parts of the advanced industrialized world,[4] no amount of stimulus or “quantitative easing” is going to magically promote inflation. Europe and Japan are learning this lesson the hard way.
You Cannot Rely Solely on the US
The US recovery since the subprime mortgage crisis has been viewed by some commentators as an outcome of effective central bank policy. Many will argue against this point (after all, the Federal Reserve added trillions of dollars to its balance sheet between 2009 and 2014[5]), claiming that cheap money created a false recovery and an overvalued stock market. Whatever side of the fence you’re on, it’s tough to dispute that the world is looking to the United States for stability. After all, the world’s largest economy led all other advanced countries in growth in 2015 and is expected to do the same in 2016.[6]
However, US Treasury Secretary Jacob L. Lew warned about the dangers of holding the US recovery to unreasonably high expectations.
“You can’t count on the United States providing all the demand for the world. You can’t be the consumer of first and last resort,” he told Bloomberg News in the lead-up to the G20 Meetings.[7]
China’s Low Growth Conundrum
China is no stranger to using policy levers to respond to economic downturns and market collapses. In late February it lowered its reserve requirement by half a percentage point, effectively lowering the amount of reserves lenders have to hold to support the economy. It was the fifth such adjustment by the People’s Bank of China since last February.[8]
China’s conundrum is that its economy has been slowing for some time and is expected to continue for many years as the country transitions away from exports and investments toward consumption. China’s trade freefall in 2015 gave policymakers few options but to weaken their exchange rate, provoking images of an all-out currency war. After all, the European Central Bank, Switzerland[9] and to a lesser extent Canada are all seeking a weaker currency to drive up exports and boost competitiveness. Somehow these points weren’t reflected in the communique.
While Chinese Premier Li Keqiang attempted to restore policy unity at the G20 meetings, he wasn’t able to lure Germany. US Treasury Secretary Lew also said that there was no need for a crisis response because the world is in a “non-crisis environment.”[10]
What It All Means for Investors
China’s recent efforts to lower the reserve ratio did little to curb investor sentiment. After all, the markets have grown numb to the PBOC’s stimulus over the past 12 months. Investors are becoming skeptical that the PBOC is unwilling or perhaps unable to stabilize its market. This outlook is unlikely to change anytime soon. And while Chinese and global equities appear to be correcting upward at the moment, volatility will inevitably make its return. That’s because the global economic picture hasn’t changed very much over the past two months. While the markets were oversold during parts of January and February, it’s difficult to classify the present environment as anything but bearish.
The same holds true for oil prices. Crude has surged more than 30% since its February lows, boosting confidence that the worst is over. However, long-term, it’s difficult to imagine any scenario where oil prices are anywhere near their pre-crisis highs. That’s because the oil market is still abundantly oversupplied. According to some industry insiders, the next great oil crisis may occur earlier than we think, given how quickly the market for electric cars is expected to grow over the next decade.[11]
For currencies, the US dollar is still the favourite, despite fumbling out of the gate in 2016. Although the Fed isn’t expected to raise interest rates before June, it’s the only central bank tightening monetary policy. The outlook on commodity currencies, the British pound and euro remain weak as the combination of low oil prices, Brexit and ECB stimulus dampen their appeal.
[1] Alejandro Reyes (February 29, 2016). “At China Meeting, G20 Calls For Structural Reforms—But Will Countries Follow Through?” Forbes.
[2] G20 Information Centre. G2O Communique.
[3] The Telegraph UK. EU referendum poll tracker and odds.
[4] The Economist (September 6, 2014). “The big freeze.”
[5] Greg Robb (October 29, 2014). “Fed ends QE3 and sends upbeat signals on economy.” Market Watch.
[6] International Monetary Fund (January 2016). Subdued Demand, Diminished Prospects. World Economic Outlook (WEO) Update.
[7] Jonathan Chew (February 24, 2016). “The G20 Will Not Take a ‘Crisis Response’ to Jumpstart World Economy.” Fortune.
[8] Imperial Options (March 1, 2016). Global Stocks Struggle For Gains Amid New Round of China Stimulus.
[9] Balazs Koranyi and Leika Kihara (February 28, 2016). “Central banks near policy limits but back G20.” Reuters.
[10] Gernot Heller and Brenda Goh (February 26, 2016). “China talks up growth agenda at G20 amid lack of wider policy unity.” Reuters.
[11] Tom Randall (February 25, 2016). “Here’s How Electric Cars Will Cause the Next Oil Crisis.” Bloomberg Business.
