2019 Headwinds Are Getting Stronger

Daily Reckoning

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In 2017, every prominent economic forecasting entity was shouting from the rooftops about “synchronized global growth.” This was a reference to the fact that not only were certain economies growing, but they were all growing at the same time.

Chinese GDP growth had come down but was still substantial at 6.85%. U.S. GDP growth was posting solid gains of 3.0% in the second quarter of 2017 and 2.8% in the third quarter. Japan and Europe were not growing as quickly as the U.S. and China, but growth was still accelerating from a low level.

Synchronization was a big part of the story. Growth was not isolated and episodic. Growth was fueling more growth in what seemed to be a sustainable way. The world economy was firing on all cylinders.

Then in 2018 the global growth story came screeching to a halt. Japanese growth went negative in the third quarter of 2018. Germany also went negative. Chinese growth continued its drop (6.5% in the third quarter) instead of stabilizing.

The U.K slowed partly because of confusion around Brexit. French growth slid amid riots triggered by a proposed carbon emissions tax. Australian home prices declined precipitously because export orders from China dried up and Chinese flight capital slowed to a trickle due to Chinese capital controls.

The U.S. economy held up fairly well in 2018, with 4.2% growth in the second quarter and 3.5% growth in the third quarter. But much of that growth was inventory accumulation from foreign suppliers in advance of proposed tariffs.

That inventory growth will likely dry up once the tariffs are either imposed or abandoned early this year. Fourth-quarter growth in the U.S. is currently projected at 3.0%, continuing the downtrend from the second quarter.

What happened?

Much of the global slowdown has to do with the high degree of interconnectedness of the global economy and the extent of global supply chains. The flip side of synchronized growth is a synchronized slowdown. Just as growth in one economy can lead to increased exports for trading partners, a slowdown leads to reduced exports.

Still, why has growth slowed down at all?

The answer has to do with debt, Fed policy, political developments, as well as trade wars. Specifically, the U.S. and China, the world’s two largest economies, are discovering the limits of debt-fueled growth.

The U.S. debt-to-GDP ratio is now 106%, the highest since the end of the Second World War. The Chinese debt-to-GDP ratio is a more reasonable 48%, but that figure is misleading because it does not include the debts and guarantees of provinces, state-owned enterprises, banks, wealth management products and numerous other entities that the government in Beijing is directly or indirectly obligated to support.

When that additional debt is taken into account, the real debt-to-GDP ratio is over 250%, about the same as Japan’s.

Debt-to-GDP ratios below 60% are considered sustainable; ratios between 60% and 90% are considered unsustainable and need to be reversed; and ratios in excess of 90% are in …read more

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