December 1, 2017
Last week, the OECD published
its latest World
Economic Outlook. WARNING GRAPHICS OVERLOAD AHEAD!
The OECD’s economists reckon
that “The global economy is now growing at its fastest pace since 2010, with
the upturn becoming increasingly synchronised across countries. This
long-awaited lift to global growth, supported by policy stimulus, is being
accompanied by solid employment gains, a moderate upturn in investment and a
pick-up in trade growth.”
While world economic growth is
accelerating a bit, the OECD reckons that “on a per capita basis, growth will
fall short of pre-crisis norms in the majority of OECD and non-OECD economies.”
So the world economy is still not yet out of the Long Depression that started
in 2009.
The OECD went on: “Whilst
the near-term cyclical improvement is welcome, it remains modest compared with
the standards of past recoveries. Moreover, the prospects for continuing the
global growth up-tick through 2019 and securing the foundations for higher potential
output and more resilient and inclusive growth do not yet appear to be in
place. The lingering effects of prolonged sub-par growth after the financial
crisis are still present in investment, trade, productivity and wage
developments. Some improvement is projected in 2018 and 2019, with firms making
new investments to upgrade their capital stock, but this will not suffice to
fully offset past shortfalls, and thus productivity gains will remain limited.”
The OECD also thinks that much
of the recent pick-up is fictitious, being centred on financial assets and
property. “Financial risks are also rising in advanced economies, with the
extended period of low interest rates encouraging greater risk-taking and
further increases in asset valuations, including in housing markets. Productive
investments that would generate the wherewithal to repay the associated
financial obligations (as well as make good on other commitments to citizens)
appear insufficient.” Indeed, on average, investment spending in 2018-19 is
projected to be around 15% below the level required to ensure the productive
net capital stock rises at the same average annual pace as over 1990-2007.
The OECD concludes that, while
global economic growth will be faster in 2017 and 2018, this will be the
peak. After that, world economic growth will fade and stay well below the
pre-Great Recession average. That’s because global productivity growth
(output per person employed) remains low and the growth in employment is set to
peak. That’s a ‘slow burn’ of slowing economic growth.
But even more worrying for
global capitalism is the prospect of a new economic slump, now that we are some
nine years since the last one. In a chapter
of the World Economic Outlook, the OECD’s economists raise the issue of the
very high levels of debt (both private and public sector) that linger on since
2009. “Despite some deleveraging in recent years, the indebtedness
of households and nonfinancial businesses remains at historically high levels
in many countries, and continues to increase in some.” The debt of
non-financial firms (NFC) rose relative to GDP during the mid-2000s, generally
peaking at the onset of the global financial crisis and remaining stable
thereafter.
After a limited downward
adjustment during the post-crisis period, NFC debt-to-GDP ratios have increased
again since.
Household debt-to-income
ratios also rose significantly up to 2007 and stabilised thereafter at
historically high levels in most advanced economies. The rise in the
debt-to-income ratio was driven by the acceleration in debt accumulation prior
to the crisis, with subdued household income growth impeding deleveraging
thereafter.
And as I have reported before
in previous posts, non-financial companies (NFC) in the so-called emerging
economies have sharply increased their debt burdens over the last nine years,
so that now, ‘rolling over’ this debt as it matures for repayment amounts to
about half of the gross issuance of international debt securities in
2016. In other words, debt is being issued to repay earlier debt at an
increasing rate.
The OECD points out that there
is empirical evidence that high indebtedness increases the risk of severe
recessions. Also, if the prices of ‘fictitious’ assets like property or stocks
get well out of line with the value of productive assets (ie capital
investment), that is another indicator of a coming recession. Currently, there
is no OECD economy in recession (defined as two consecutive quarters of a fall
in GDP), but the global house price index is reaching a peak level over the
trend average that has signalled recessions in the past.
Credit is necessary to
capitalism to overcome the ‘lumpiness’ in capital investment and smooth over
cash liquidity. But as Marx argued, ‘excessive’ credit expansion is a
sign that the profitability of productive investment is falling. As the
OECD puts it: “If borrowing is well used, higher indebtedness contributes to
economic growth by raising productive capacity or augmenting productivity.
However, in many advanced economies, the post-crisis build-up of corporate debt
has not translated into a rise in corporate capital expenditure.”
So the OECD concludes that the
post-crisis combination of rising corporate debt and historically high share
buybacks may suggest that, rather than financing investment, firms took on debt
to return funds to shareholders. This reflects “pessimism about future demand
and economic growth, leading corporations to defer capital spending and return
cash to their shareholders for want of attractive investment opportunities.”
Moreover, firms with a persistently high level of indebtedness and low
profits can become chronically unable to grow and become “zombie” firms. And
zombie “congestion” may thus
reduce potential output growth by hampering the productivity-enhancing
reallocation of resources towards more dynamic higher productivity firms.
So the OECD story is that
world economic growth is picking up and there is little sign of any slump in
production in the immediate future, even if growth may stay well below the
pre-crisis average. But there are risks ahead because the still very high
levels of debt and speculation in financial assets that could come a cropper if
profitability and growth should falter.
This is much the same story
that the IMF told in latest
IMF report on Global Financial Stability that I referred to in
a recent post. As the IMF put it: “Private sector debt service
burdens have increased in several major economies as leverage has risen,
despite declining borrowing costs. Debt servicing pressure could mount further
if leverage continues to grow and could lead to greater credit risk in the
financial system.”
The IMF comments: “While
debt accumulation is not necessarily a problem, one lesson from the global
financial crisis is that excessive debt that creates debt servicing problems
can lead to financial strains. Another lesson is that gross liabilities matter.
In a period of stress, it is unlikely that the whole stock of financial assets
can be sold at current market values— and some assets may be unsellable in illiquid
conditions.” So “if there are adverse shocks, a feedback loop could
develop, which would tighten financial conditions and increase the probability
of default, as happened during the global financial crisis.”
The IMF sums up the
risk. “A continuing build-up in debt loads and overstretched asset
valuations could have global economic repercussions. … a repricing of risks
could lead to a rise in credit spreads and a fall in capital market and housing
prices, derailing the economic recovery and undermining financial stability.”
The IMF posed an even nastier
scenario for the world economy than the OECD by 2020. Yes, the current
‘boom’ phase can carry on. Equity and housing prices can continue to
climb. But this leads to investors to drift beyond their traditional risk
limits as the search for yield intensifies despite increases in policy rates by
central banks. Then there is a ‘Minsky moment’.
There is a bust, with declines
of up to 15 and 9 percent in stock market and house prices, respectively,
starting at the beginning of 2020. Interest rates rise and debt servicing
pressures are revealed as high debt-to-income ratios make borrowers more
vulnerable to shocks. “Underlying vulnerabilities are exposed and the
global recovery is interrupted.” The IMF estimates that the global economy
could have a slump equivalent to about one-third as severe as the global
financial crisis of 2008-9 with global output falling by 1.7 percent from 2020
to 2022, relative to trend growth.
Will the high debt in the
corporate sector globally eventually bring down the house of cards that is
built on fictitious capital and engender a new global slump? When is
credit excessive and financial asset prices a bubble?
The key for me, as
readers of this blog know, is what is happening to the profitability of
capital in the major economies. If profitability is rising, then
corporate investment and economic growth will follow – but also vice
versa. But if profitability and profits are falling, debt accumulated
will become a major burden. Eventually the zombies will start to go
bankrupt, spreading across sectors and a slump will ensue. Financial
prices will quickly collapse toward the real value of their underlying
productive assets.
Indeed, according to Goldman
Sachs economists, the prices of financial assets (bonds and stocks) are
currently at their highest against actual earnings since 1900!
What the OECD and IMF reports
show is that if there is a downturn in profitability, the next slump will be
severe, given that private debt (both corporate and household) has not been
‘deleveraged’ in the last nine years – indeed on the contrary. As I
said, in my
paper on debt back in 2012: “Capitalism is now left with a huge debt burden
in both the private and public sector that will take years to deleverage in
order to restore profitability. So, contrary to the some of the
conclusions of mainstream economics, debt (particularly private sector debt) does
matter.”
For now, the world economy is
making a modest recovery from the stagnation that appeared to be setting in
from the end of 2014 to mid-2016. The Eurozone economic area is seeing an
acceleration of growth to its highest rate since the end of the Great
Recession.
Japan too is picking up, based
on a weak currency that is enabling exports to be sold. And the latest
figures for the US show an annualised rise of 3.3% in third quarter of 2017,
putting year on year growth at 2.3%, still below the rates achieved in 2014 but
much better than in 2016 (1.6%). And the forecast for this current
quarter is for similar.
As for corporate profits and
investment, the latest data show that US corporate profits were rising at over
5-7% yoy before tax, although stripping out the mainly fictitious profits of
the financial sector reveals that the mass of profit is still well below the
peak of end-2014.
And as I showed in a recent
post, profitability has fallen since 2014.
IMAGE 11
There is a high
correlation and causality between the movement of profits and productive
investment.
And that is confirmed in the
latest data for the US. As corporate profits have recovered from the
slump of 2015-16, so business investment has made a modest improvement.
As for global corporate
profits, we don’t have all the data for Q3 2017, but it looks as though it will
continue to be on the up.
So overall, global economic
growth has improved in 2017 and, so far, looks likely to do so in 2018 too.
Corporate profits are rising and that should help corporate
investment. But
profitability of capital remains weak and near post-war lows and
corporate debt has never been higher.
Any sharp upswing in interest
rate costs (and the
US Fed continues to hike) will increase the debt servicing burden. So
if corporate profits should peak and falter in the next year or so, a major
recession will be on the agenda.
