by Michael Roberts
This week, the US Federal Reserve raised its benchmark interest
rate from 0.5% to 0.75% for just the second time since the financial
crisis of 2008, arguing that the American economy was expanding “at a healthy pace”.
The Fed’s monetary committee also indicated that it planned to hike its
policy rate at least three times in 2017 on the grounds that economic
growth, employment and inflation were picking up and President-elect
Trump’s proposed policies of cutting corporate taxes and boosting
infrastructure spending could accelerate US economic recovery. “My colleagues and I are recognizing the considerable progress the economy has made,” says Janet Yellen, the Fed’s chairwoman, “We expect the economy will continue to perform well.”
There is a certain irony in Yellen’s statement given that this time
last year, in hiking the policy rate for the first time in nine years,
she made a similar declaration of confidence in the economy and then
economic growth slowed to a trickle and the Fed postponed any further
The US economy has expanded on average by only 2% a year since the
end of the Great Recession in 2009. The unemployment rate has dropped
to more or less the same level as before global financial crash, but
investment and productivity growth has been very weak.
Back last December, I raised the question
that, given weak business investment, hiking interest rates might push a
layer of US companies into difficulty and trigger a new recession or
slump. Indeed, that was why the Fed held off further hikes during this
So are things that much better that this risk of rising interest
rates triggering a recession is now over? Well, Yellen described the
rate increase as “a vote of confidence in the economy.” And
the justification for this comes from somewhat improved figures of real
GDP growth in the third quarter of this year, at a 3.2% annual rate.
However, the pick-up was all in housing and inventories (building up
stocks not sold), while business investment stayed flat. And on a
year-on-year basis, US real GDP was higher by only 1.6%, while business
investment contracted by 1.4%.
However, after falling in Q2, corporate profits rose in Q3, up 6.6%
compared to Q2 and higher by 2.8% from Q3 2015. So it could be argued
that the US economy is doing better in the second half of 2016 than in
the first half, which was dire. House prices have surpassed their
pre-recession peak and consumer confidence is at a new high.
Globally, corporate profits also picked up in the third quarter of
2016. A weighted average of five key economies, US, China, Japan,
Germany and the UK) saw profits rise by over 5% yoy. Along with rising
business activity indicators in the US and Europe, it seems that the
major economies have staged a bit of a recovery in third quarter. But
global business investment growth remains weak.
There are two risks that could undermine Yellen’s confident forecast
(for the second time. The first is that rising interest rates will lead
to increased costs of servicing corporate and household debt that
cannot be funded through extra profits or real incomes in households.
So default rates on debt obligations will rise.
There has been no real reduction in the build-up of private-sector
debt in the major economies that took place in the early 2000s and
culminated in the global credit crunch of 2007. That accumulated debt
took place against a backdrop of favourable borrowing conditions—low
interest rates and easy credit. Between 2000 and 2007, the ratio of
global private-sector debt to GDP surged from about 140% to 163%,
according to the IMF.
Public sector debt mushroomed after the global financial crash to
bail out the banks and fund spending on unemployment and other benefits.
The average level of public debt to GDP rose from 34% pts to roughly
90% – a post-1945 record. Combined with private-sector debt, the level
of total nonfinancial borrowing to GDP in the advanced capitalist
economies is actually higher today than it was in 2007.
In the emerging economies, after the Great Recession the increase in
private sector debt has been massive. China is in a league of its own,
with a 96%-pt increase in its ratio to 205% of GDP. Even excluding
China, the figures are still big, up 25% pts and at 92% of GDP for
emerging economies. Indeed, the increase in the private debt to GDP
ratio in the emerging economies outside China now exceeds what took
place in the DM in the 2000s expansion.
Most of this extra debt is the result of corporations in these
countries borrowing more to increase investment, but often in
unproductive areas like property and finance. And much of this extra
borrowing was done in dollars. So the Fed’s move to raise the cost of
borrowing dollars will feed through these corporate debts.
Moody’s, the US credit monitoring agency, reckons that there is now
$7trn of global government debt that will face downgrades for risk of
default because of rising costs of financing if the US dollar stays
strong and global interest rates start rising during 2017. That’s 16%
of total global public debt. In 2016 anyway, there were 35 credit
downgrades for country debt.
Nevertheless, stock markets in the major economies head towards new
highs on the expectation that the major economies are on the road to
sustained recovery and that Trump’s policies will stimulate spending and
boost corporate profits next year.
I have already put huge question marks against
the likelihood that Trump can achieve fast and sustained economic
growth in the US with his policies. And I am not the only doubter. I
have already referred to the views of Deutsche Bank and JP Morgan on likely economic recovery in the US in 2017.
Now huge private equity fund, Bridgwater Associates, is also doubtful about the expected economic recovery. Its founder, Ray Dalio, reckons that “This
is not a normal business cycle; monetary policy will be a lot less
effective in the future; investment returns will be very low.” Echoing the view presented, ad nauseam, on this blog, Dalio identifies a “short-term
debt cycle, or business cycle, running every five to ten years but also
a “long-term debt cycle, over 50 to 75 years.” He comments “Most
people don’t adequately understand the long-term debt cycle because it
comes along so infrequently. But this is the most important force behind
what is happening now.” Dalio reckons that debt growth has
outstripped the income growth in the form of profits and interest
necessary to service the current levels of debt. Easy money and low
central bank rates cannot counteract the rising costs of debt servicing
Now in 2017, it seems that the floor of interest rates globally, set
by the Fed’s policy rate, is set to rise, if the Fed sticks to its plan
to hike three more times and again in 2018. At the same time, oil
prices are set to rise, assuming the OPEC oil producers stick to their
plan to cut production. That will increase fuel prices and cut into
corporate profits. And if the dollar stays strong against other major
currencies, the servicing of dollar debt globally will jump, putting
many corporations into difficulty.
So the relative recovery in global corporate profits and economic activity in the last part of 2016 may not last in 2017.
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