‘An Unexpected Shock Could Bring The Global Economy To Its Knees’: One Bank Says Secular Stagnation Now ‘Good Case’ Scenario

Each passing week brings new evidence to support the contention that the damage from the epochal shift towards protectionism and away from globalization and multilateralism is already done. It’s now just a question of whether it gets worse.

The IMF and the OECD have slashed their outlook for the global economy repeatedly, warning time and again that without an end to the trade conflicts, fiscal stimulus or, ideally, both, the situation will become increasingly dire.

“The global economy is facing serious headwinds and slow growth is becoming worryingly entrenched”, OECD Chief Economist Laurence Boone said last month. “The uncertainty provoked by the continuing trade tensions has been long-lasting, reducing activity worldwide and jeopardizing our economic future”.

In other words: This is not a drill. The ongoing backslide into protectionism and nationalism at the expense of globalized markets and inclusive politics has chipped away at the very foundation on which the modern system of trade and commerce is built. That foundation hasn’t crumbled yet, but it’s getting shakier by the month.

Underscoring all of this is BofA’s Athanasios Vamvakidis, who delivers a strikingly blunt assessment in a note dated October 21.

“Secular stagnation has now become our baseline”, Vamvakidis writes, adding that “growth is slowing in almost all major economies, in some cases from already low levels”. Here’s a bit more:

Trade deals are only likely to avoid further tariff increases, at least for now, while keeping the tariffs of the last two years in place. Political uncertainty in the US is likely to increase ahead of the elections next year. We see increasing evidence that monetary policy has become ineffective, accumulating negative side effects. Fiscal policy is not coming to the rescue, and in any case, very few major economies could afford it. Structural reforms remain a theoretical and unpopular concept for most governments. Having to fight increasing populism, mainstream governments have often become reluctant to push for much needed reforms. Tight labor markets, in any case, suggest capacity constraints. Increasing wages without inflation also point to risks for profits. 

If you’re getting the impression that policymakers and centrist politicians are hemmed in on all sides by populism, you would be correct. Reforms aimed at restoring what, on textbook definitions, would count as “healthy” economic dynamics conducive to long-term stability and sustainable growth, simply aren’t palatable in the current economic environment.

Of course, populist politics raises the odds of fiscal stimulus being enacted, but as Vamvakidis notes, there isn’t much scope for that, unless you simply scrap the playbook in favor of unorthodox policies (e.g., variants of MMT).

Meanwhile, the break down of traditional models linking labor market slack to inflation combined with the threat of lackluster growth and input price pressures from tariffs, point to crimped corporate profits going forward.

And then there’s monetary policy operating at the limits, with central banks forced to question what’s possible in terms of negative rates and balance sheet expansion – and whether any benefits from plunging further down the rabbit hole will be more than offset by deleterious side effects, both known and unknown.

Hilariously – or not – BofA goes on to write that the above is actually the best case scenario. To wit:

And this is the good case scenario, as we are concerned that an unexpected shock could bring the global economy to its knees. Monetary policy has almost no room to respond in most cases. Government debt levels are much higher almost everywhere compared with before the last global crisis. International policy coordination is in the worst state in recent decades. Populism could get another boost, making the appropriate policy response even more difficult.

Happy trails.

Read more:

OECD Calls For ‘Urgent’ Action As Growth Outlook Slashed To Weakest Since Crisis

‘Insidious’ Trade War Has ‘Destroyed Growth In International Trade’, OECD Chief Economist Fumes

IMF Issues Quarterly Doom And Gloom Report — Cuts Growth Outlook Again

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2 thoughts on “‘An Unexpected Shock Could Bring The Global Economy To Its Knees’: One Bank Says Secular Stagnation Now ‘Good Case’ Scenario

  1. Raise taxes on wealthier taxpayers and corporations and follow up with a tax cut to low to moderate incomes for a modest overall tax cut. Raise the minimum wage substantially on a regular basis over the next decade. Enact infrastructure bank legislation and increase spending on education. Cut tarriffs or increase free trade zones such as TPP, USMCA etc. Embrace research and development on climate change solutions. Consider implementing a VAT with provisions to make the VAT progressive or income neutral in order to pay for universal health care and lower payroll taxes on employment for medicare and social security. Lower the age for medicare to 50 and offer medicare to children under 18, and offer a public option for health care plans so as to reduce overall spending on health care. Cut defense spending as a % of GDP in the US. All these initiatives will help the economy grow by making it more efficient and fairer.

  2. Really nice report here, worth reading — just another perspective on reform with lots of good info:

    (OCTOBER 2019)

    After the 2008 financial crisis, the global non-financial
    corporate sector has significantly stepped up its bor-
    rowing activity, boosting the outstanding amount of
    debt to $72.6 trillion (or 91.4 percent of world GDP) as
    of the first quarter of 2019, according to the Institute
    of International Finance. This level of debt well exceeds
    that of the government sector’s $67 trillion (or 87.2 per-
    cent of GDP), reflecting rising leverage by the corpo-
    rate sector–whose debt-to-EBITDA (earnings before
    interest, tax, depreciation, and amortization) ratio has
    increased to 4.8 times at the end of 2018, compared
    with four times in 2011, according to Standard & Poor’s
    (S&P) Global.8

    Of particular note is the shift from bank lending to cap-
    ital-market financing, with the volume of annual corpo-
    rate bond issuance having doubled from the average
    of $860 billion before the 2008 crisis.

    At the same time, the quality of the corporate bond
    market has deteriorated steadily, despite the fact
    that large international corporations have been prof-
    itable. According to the Organisation for Economic
    Cooperation and Development (OECD), the share of
    BBB-rated bonds–just one grade above high-yield
    (HY) or junk status–is now about 54 percent of the
    global investment-grade (IG) corporate bond market
    (or about $7 trillion out of $13 trillion).9 Specifically for
    the United States, BBB bonds amount to $3.2 trillion, or
    about 53 percent of the US IG corporate bond market.
    Historically, the rate of migration from BBB to HY bond
    status (BB or lower) averages 4 percent within a one-
    year time horizon, with a maximum rate of 10 percent.
    10In 2009, during the latest recession, the migration
    rate rose to 7.5 percent. If this were to happen again
    in the next recession, there could be a potential supply
    of up to $525 billion of newly downgraded junk bonds
    within one year. This would have a significant “cliff ef-
    fect” on the corporate bond market.

    Basically, authorities are being pushed out of their
    comfort zone (of regulating banks) to reconcile the
    economy’s reliance on monetary accommodation with
    the ensuing imbalances and distortions posing risks to
    financial stability, and to develop lender-of-last-resort
    facilities for banks outside the United States with huge
    USD liability, as well as buyer-of-last-resort facilities for
    various weak segments of the corporate debt markets,
    including for non-US borrowers.


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