January 25, 2016
Dean Baker
The Hankyoreh, January 25, 2016
View article at original source.
The business press is understandably obsessed with the turmoil in financial markets in recent weeks. Stock markets around the world have tumbled, the interest rates on many corporate bonds have soared, and the price of oil and other commodities has plunged to levels not seen in this century. This provides cause for concern. ?
At such times, it is important to remember that the stock market is not the economy. Most major stock markets were priced quite well relative to corporate earnings. Although price to earnings ratios had not reached the peaks of the 1990s bubble, they were well above historic averages. For this reason, it should not have surprised anyone that prices could drop by 5–10 percent fairly quickly. The peaks in 2015 reflected an optimistic picture for profits and also the continuation of historically low interest rates. ?
But the declines we have seen in the market to date will not have a major impact on the world economy. Unlike the 1990s, we did not have a situation in which large amounts of investment were being directly financed by stock issuance. The drop in stock prices will dampen consumption through the wealth effect (people‘s consumption spending falls when their stock wealth decreases), but this is not likely to be large enough to have a major impact on consumer demand in most countries. ?
It is best to step back from the market turmoil and see the risks to growth in the world economy. Here the main story is the slowing of growth in China. Unfortunately it is not easy to come to any firm conclusions about China’s growth prospects. ?
The one point on which nearly all experts agree is that its economic data cannot be trusted. While over the long-term the country has undoubtedly experienced extraordinary improvements in living standards that would be consistent with its GDP growth data, its short-term data is influenced by the political concerns of the leadership. As a result, it doesn‘t provide a clear basis for assessing its economic prospects. ?
Clearly the days of China’s double-digit growth are over. But a slowdown can mean anything from an actual recession, where China‘s economy contracts in 2016, to growth in a 5.0–7.0 percent range. The latter would be slow for China, but quite rapid for almost anyone else. Given China’s extraordinary track record over the last thirty five years, it is probably reasonable to assume that growth will still be positive in 2016, even in a bad scenario. ?
This means that China will not be a rapidly growing export market, but it will not be plunging either. While particular industries may be hit, countries like Japan and Korea that are major exporters to China, can probably still count on a healthy level of exports next year. ?
There is a worse story for commodity exporters. There is a worldwide glut of many commodities, most notably oil. The growth slowdown in China is a factor in this glut, but far from the only cause. The high prices of recent years, together with technological improvements both in the extraction of oil and gas and in the development of clean energy, has created a huge imbalance of supply and demand. Furthermore, we appear to be in a perverse situation where lower prices may lead to increased supply from many producers, as some oil exporting countries have no other way to make up for lost revenue. Similarly, increased production may be the only way that many heavily indebted companies can escape bankruptcy. ?
This commodity glut is probably the biggest cause for concern in the world economy at present, as it is likely to mean major hardship for the more heavily populated oil exporting countries, and inevitably it will lead to many corporate bankruptcies and debt write-downs. But the pain in the oil sector offers benefits for everyone else. The savings should offer the opportunity for increased spending elsewhere, and if the private sector is not prepared to do it, governments should be. ?
This is a tremendous opportunity to repair and improve infrastructure, shift resources to education and health care, and accelerate the switch to wind and solar energy, as well as conservation measures. There is little need to worry about budget deficits in a context of plunging commodity prices and historically low interest rates, but the obvious answer for those who have deficit concerns is to impose large carbon taxes that will offset much of the impact of falling energy prices. It would be possible to raise a vast amount of revenue and still leave consumers paying less for energy with the tax than they had paid in the recent past without the tax. ?
It is unfortunate that myths and superstitions about government deficits are preventing the sort of fiscal response we need to move the world economy back towards its potential. The current problems afflicting China are a real setback on the road to recovery. This is not a story of another financial collapse or recession, but we will see a world economy that is weaker in 2016 than the already weak 2015 economy.
