Professor Rogoff : 2019 will be Very “Nervous”

“This year and next, the most serious economic risks will arise.”

These risks include a recession of economic growth in China, an increase in world long-term real interest rates, as well as a crescendo of populist economic policies that undermine confidence in the independence of central banks, which will lead to an increase in interest rates on “reliable” government bonds of developed countries.

As Harvard University professor Kenneth Rogoff writes in his article on Project Syndicate, a significant slowdown in China has probably already begun. Although the trade war waged by US President Donald Trump does undermine business confidence, it has only become an additional push down for the economy, which is already slowing down as it is in the process of transitioning from growth through exports and investment to more sustainable growth. due to domestic consumption.

How much the Chinese economy will slow down is an open question, but since there is an inevitable contradiction between the rigid centralization of the political system under the leadership of the party and the need to increase decentralization in the economic system where consumers play the main role, long-term growth rates may fall quite significantly.

Unfortunately, the idea of ​​avoiding the transition to growth at the expense of consumption and continuing to stimulate exports and investment in real estate is also not particularly attractive. China is already the dominant global exporter, and there is not enough market space in the world, nor enough political patience to allow it to maintain its previous export growth rates. Stimulating economic growth through investment, especially in residential real estate (it accounts for the lion’s share of Chinese construction), is also increasingly problematic.

The downward pressure on prices, especially outside the cities of the first level, seriously complicates the attraction of additional investments at the expense of the savings of Chinese families in housing. Yes, China, probably much better than any Western country, positioned for the socialization of losses in the banking sector, however, to cope with a sharp decline in prices for housing and construction projects will most likely be extremely difficult.

Any significant recession of economic growth in China will hit hard in other Asian countries, as well as in developing countries that export raw materials. The countries of Europe, and especially Germany, will not stand aside either. The United States is less dependent on China, but due to injuries inflicted on financial markets and the export of politically significant products, the slowdown in China can be much more painful for the United States than the country’s leadership believes.

Another, less likely, but even more painful external risk may materialize if the long-term trend of reducing global long-term interest rates changes and they increase significantly. I’m not just talking about a significant tightening of the monetary policy of the US Federal Reserve in 2019. This will create problems, but mainly affect the short-term real interest rates and, in principle, can be canceled over time. Much more serious risk is associated with shock for very long-term real interest rates, which are now at the lowest level in all of modern history (with the exception of the period of financial repression after World War II, when markets were much less developed than they are today).

Sustained growth in long-term real interest rates is a low probability event, but it cannot be considered completely impossible. There are many explanations for the tendency to reduce long-term rates, but some of these factors may turn out to be temporary, and it is very difficult to determine empirically the scale of the influence of various probable factors.

One of the positive factors that could lead to an increase in global rates: a sharp rise in productivity, for example, if the so-called fourth industrial revolution starts to affect the growth rate of the economy much faster than is now expected. Naturally, this will be good for the global economy as a whole, although it can create significant problems for lagging regions and population groups. However, upward pressure on global interest rates may also come from a less positive factor: the trend of a sharp decline in economic growth in Asia (for example, due to the long-term slowdown in China), which will lead to the disappearance of the usual external surplus of the countries of the region and the emergence of a deficit.

But, probably, the most probable cause of the increase in global real rates will be an explosion of populism in many countries of the world. Populists can cancel the markets-friendly economic policies of the last decades, thereby sowing in global markets doubts about how really reliable the debt of developed countries is. This may lead to an increase in risk premiums and interest rates. If governments are slow in adapting to this new situation, the budget deficit will start to grow, markets will begin to doubt even more about government commitments, and events will turn into a vicious circle.

Most economists agree that current low long-term interest rates allow developed countries to borrow more than they could otherwise. But the idea that such a build-up of public debt is a gift is nonsense. Failure to respond severely to a financial crisis, cyber attack, pandemic, or trade war greatly increases the risk of a long-term stagnation. This is a very important explanation of the reason why most serious scientific studies conclude that a very high level of debt is accompanied by a slowdown in the long-term growth rate of the economy.

When the authorities overly rely on debts (rather than increasing taxes on the rich) to pursue a progressive income redistribution policy, it is easy to imagine that markets will begin to doubt the ability of these countries to grow at a sufficient rate to get rid of high debt levels. Investor skepticism may well push up interest rates to uncomfortable levels.

Of course, there are many other risks to the growth of the global economy, including the growing political chaos in the United States, indiscriminate Brexit, swinging banks in Italy, and an increase in geopolitical tensions.

But because of all these external risks, the growth prospects of the global economy are not inevitably bleak. In the US, the baseline scenario is still strong economic growth. Growth rates in Europe can also be above the trend, as the continent continues a long and slow economic recovery after the debt crisis at the beginning of the decade. The Chinese economy has been proving for many years that those who doubt it are wrong.

So, 2019 may well be another year of solid global growth. Unfortunately, this year will probably also be very nervous.

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