Global economy: weakest since 2008, but it should be booming

Posted: August 6, 2015 in Global Economy, Oil
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file9961251406222Oil has fallen again in recent weeks. This week, West Texas Intermediate oil has been hovering at just a dollar or two above the year low. Meanwhile, a report from the National Institute of Economics and Social Research (NIESR) has predicted that 2015 will be the worst year for the global economy since 2008. It shouldn’t be like that. With oil as cheap as it is, the economy should be booming.  So this all begs the question, “why?” Is there some rather worrying underlying reason for the weakness in the global economy?

At the time of writing (6 August 2015, 6.45 am) West Texas Intermediate oil is trading at $45.17. To put that in context, just over a year ago it was trading at $104. Brent crude oil is just shy of $50. One day, black gold will probably go back over $100. Maybe, one day it will even pass the 2008 peak, when it went close to $150, but this day is not likely to be any time soon.   The oil cycle moves slowly. Investment in oil has dropped drastically, new projects have been shelved. It will be several years before these developments show up in rising oil prices, though.

There are winners and losers from cheaper oil. Apologies if this sounds like a lesson from the University of the Bleeding Obvious, but cheaper oil benefits its consumers and hits its producers. So in theory the effect of falling oil prices on the global economy should be neutral. It is just that on the whole, oil consumers have a much lower savings ratio that oil producers. A fall in the oil price distributes income from high savers to high spenders. Given that we are in a time when there is a chronic shortage of demand worldwide, this should be good news.

As an aside, there is another not commonly understood potential side effect of cheaper oil. Ask yourself this question, why are interest rates so low? That is to say, what is the real reason? Forget central bankers, they move with the tide. The main reason why rates are so low is because worldwide there is a shortage of demand and a savings glut.  Back in the noughties this savings glut funded consumer spending in the West, creating a bubble which burst in 2008. Since then it has been funding surging government debt, and maybe sharp rises in debt in emerging markets.  McKinsey has said that global debt has risen by $57 trillion since 2007. The savings glut made this possible. There are many reason for this, and many of these reasons have not gone away. But at least one driver of low interest rates, the rise in savings coming out of oil producers, has gone into reverse.  

Returning to the global economy in 2015, earlier this week NIESR projected that “The world economy will grow by 3 per cent in 2015 – the slowest rate since the crisis – and 3.5 per cent in 2016.” So that is odd. The price of oil has fallen by a half, and the global economy is weak. Something is wrong.

There are two ways looking at this. You can look at individual countries, one at a time, or you can look for some deeper underlying cause.

The US has a bad start to the year because of an exceptionally cold winter in the north east of the country. This had a knock-on effect worldwide. The UK, it appears, got caught up in it all with falling exports to the US dragging down on growth.  

By its standards, the Eurozone had a good first half of this year, this despite Greek woe. But then again, this is the Eurozone, and the key phrase here is “by its standards.”  The only other region in the world that puts in such a continuously poor performance is Japan.

The world’s second largest economy, China, has slowed fast. There is more than one reason. For one thing, China sits on a mounting debt pile, with local government especially badly exposed.  This is beginning to hurt. For another thing, the Chinese government is trying to re-engineer the shape of the Chinese economy, shifting it from investment and savings led, to consumption led. This is a good thing, but the transformation is hurting

Russia’s problem are well documented. It is clear that it has lost out big time to the falling oil price. Brazil has suffered from a wider fall in commodity prices, but like Russia, there were deep structural problems with the economy anyway.

So pick it apart, there is a reason for the slow growth. Even so, I can’t help but feel that the overall performance of the global economy, given how weak oil and other commodity prices are, is very disappointing. You could respond by saying that I have mixed up cause and effect. You could say that oil has fallen in price because global demand is low. But I would respond to that by saying at least part of the reason for the fall in the oil price has been the revolution in fracking and previous surges in oil investment. The rise of renewables are taking a toll, too.  I don’t accept that I have got things the wrong way round.

So what are the possible underlying drivers at work? There are to theories to explain what is happening, there is the Robert Gordon ‘innovation is slowing’ theory, and the Larry Summers Secular Stagnation theory. I will look at these theories in more depth in a few days.

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