Global downturn is sharp, but not permanent
"If the world as a whole was to move now into any kind of prolonged downturn, it would be quite a surprise. The normal precipitating forces for a recession are not around"
Monday 12 June 1995
Clearly, the world economy has slowed down very abruptly since the strong surge in growth in the middle of last year. At that stage, gross domestic product in the major economies was growing at a rate of 3.6 per cent (quarter on previous quarter annualised), with each of the major blocs - the US, Japan and Europe - expanding at very similar rates. Industrial production was even more robust, rising at an annualised rate of 7.2% in the middle of last year.
By the end of the year, though, the annualised GDP growth rate in the major economies had roughly halved to around 2%, with Japan and Europe slowing particularly sharply. So far in 1995, there has also been a marked drop in US growth, which fell to 2.7 per cent in the first quarter, but the situation elsewhere is very hard to read. There has been no GDP data yet in Japan or Germany, and in the latter case there may be no sensible activity figures for many months because of a botched change in the method of collecting statistics from January onwards. Furthermore, in the UK, the wide discrepancy between official government statistics and business survey data has created great uncertainty.
Economists cannot afford to wait until the official statisticians around the world get their act together and produce reliable GDP figures for the first half of 1995. If we wait that long, the world may have emerged from a recession long before the statisticians announce that we were in one to start with. Instead, we need to make the most of what evidence we can get from business surveys, leading indicator models and the like.
The graph shows the results of an exercise just conducted by Philippe Gudin de Vallerin, my colleague at Goldman Sachs. It attempts to make the best possible statistical guesstimate of recent changes in manufacturing production in the major economies, using past relationships between business survey data, other leading indicators and the level of output in each case. The following conclusions can be drawn from this analysis.
First, there has undoubtedly been a very sharp slowdown in the global growth rate in the first half of this year. In fact, for the major five economies taken together, manufacturing growth in the second quarter seems to have turned negative, and it is quite possible that real GDP will also prove negative for the quarter. Second, the slowdown has been most pronounced in Japan and the US, both of which could end up with zero or negative growth in the current quarter. Third, there seems to have been much less of a slowdown in Europe, with Germany and the UK apparently remaining fairly robust. Among the major European economies, France seems to have slowed the most, while anecdotal evidence suggests the devaluing countries on the fringes of Europe have hardly slowed at all. Thus while there is some contrast between the core and periphery in Europe, and while the entire continent may have slowed a little, the situation in Europe is not yet too bad.
Nevertheless, a negative quarter for GDP in the bloc of major developed economies cannot be dismissed lightly. This does not often happen in the midst of a recovery phase in activity, so it demands an explanation. Two events, I believe, explain what has happened.
The first is the currency "shock" of 1995, which actually has been more of a yen shock than anything else. (Measured by trade-weighted exchange rate indices, the dollar is down by 7.4 per cent this year, the mark is up by 3.2 per cent and the yen is up by a massive 14.2 per cent.) Because Japanese exporters have absorbed the main impact of the yen shock in their profit margins without making large changes in the foreign currency export prices, the net effect on activity has been adverse in Japan, but not very beneficial elsewhere. Exchange rate changes normally do nothing more than redistribute output around the world. However, because Japan is currently acting as a "sink" for world activity, the net effect of the yen shock for the world as a whole has been negative. This shock will continue to reverberate around the Japanese economy for quite a while, but will shortly begin to be offset by the monetary and fiscal easing that is now under way. The second quarter should therefore be the low point for Japanese activity.
Elsewhere, and especially in the US, activity has been hit by last year's monetary tightening, and by the rise in bond yields, which has hit the housing sector, and may have had negative "wealth" effects on consumption in some economies. But these effects should soon be wearing off. Short rates in the major economies have been eased, notably in Japan and Germany. Furthermore, bond yields are down by an average of 1.5 per cent around the world. Overall, global monetary conditions certainly cannot be classified as "tight". Monetary "tightness" measures have not yet returned even to mid-cycle readings, and in the next few months, the recent declines in short and long rates should boost world activity.
If the world as a whole was to move now into any kind of prolonged downturn, it would be quite a surprise. The normal precipitating forces for a recession are not around - a sharp monetary tightening to head off rising inflation pressure, and/or a downturn in the investment cycle. With the exception of Japan, company balance sheets are extremely strong, as evidenced by the recent extraordinary boom in corporate merger activity, which has been mostly internally financed by the companies themselves. Consumer activity is still quite subdued, not least in Europe, but it should gain from reduced fiscal tightening next year. Consumers, like companies, have little financial reason suddenly to retrench further.
There are already a few straws in the wind that activity may be passing the worst - better consumer activity in the US, the stronger than expected "Tankan" business survey in Japan, huge upgrades to UK export data, gains in consumer confidence in France, etc. Although there will be plenty of bad activity data to come as the second quarter is fully revealed to the world by statisticians, global activity should in fact be improving by the time this official news belatedly hits the tapes.
Overall, then, there has been more of a dent to the world upswing than the politicians seem ready to concede, but this should certainly not be as deep, nor last as long, as the bond markets currently imply.
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