[SCMP Column] Off Life Support

December 21, 2015

Whether the Fed’s decision last week to lift interest rates for the first time since 2006 was premature or a mistake, it was without question a watershed moment.

The global economy has been semi-comatose in the intensive care unit for more than seven years, kept alive by zero interest rates and massive and continuous transfusions of cash from Central Banks, and at last we have a move that cautiously signals that the economy may soon come off life support.

Personally, I am not surprised that it has taken so long to test the life support. Once we recognized the awesome scale of the crash in 2008, we were always going to face a lost economic decade. It still now astonishes me that there were professional economists talking as early as spring 2009 about the appearance of “green shoots”. These were obviously people with profoundly clouded judgment, or such huge vested interests in recovery that they did not mind testing our credulity. Since the US and the UK alone have lost more than 1 million financial sector jobs since 2008, then one has to hope these people are among those who have lost their jobs – no doubt subsisting on the illusory green shoots they detected back in 2009.

I know this is Christmas week, and so I should not be gloomy, but I still remain anxious that we are set to lose even more than a decade to the “Great Recession”. If it has taken us seven years to take this first tentative step towards normality, how much longer before we get interest rates back up to “normal” levels, or before the huge debts accumulated by governments across the globe through the many “QE” programmes have been eased down either by government spending cuts, or tax increases, or strategic currency devaluations?

Janet Yellen has made much of the improving employment and inflation numbers to justify her Fed rate increase. These are indeed encouraging “green shoots” – but that is exactly what they are. Retail spending is rising – up 30% from 2008. Property prices across the US are back to 90% of 2007 levels. Gross unemployment has halved to 5%, but that glosses over the many people who have stopped looking for work, and over how many of these jobs are part time. Export numbers continue to disappoint. A recent survey by the US National Association of Manufacturers shows 55% of company respondents believe that the economy was not yet strong enough to cope with higher interest rates.

But outside the US, trepidation remains widespread. Most of Europe’s economies are still wrestling with socially calamitous unemployment levels. “Belt tightening” policies that are creating real pain in the real economy are putting many political careers at risk. EU growth is a tepid 1.5%.

In Asia, China’s slow-down has of course caused heart burn in many economies. Its decision to focus on domestically-driven growth has punctured regional trade, and its move out of export-driven manufacturing growth has had catastrophic consequences for the world’s commodity exporters. Exports from the liberalizing Pacific Alliance economies – Peru, Chile, Colombia and Mexico – are expected to fall by 13% this year in value terms as end-demand from China for commodities like iron ore and copper has tumbled. In other major emerging markets like South Africa, Brazil, Indonesia and Russia, the commodity price slump has also had serious consequences – with no signs of early improvement.

In one respect, the collapse in commodity prices has been a blessing. Lower oil and gas prices have brought down petrol costs, and taken pressure off air ticket prices. Inflationary pressures have been kept at bay by manufacturers’ lower input costs.

When you put all these factors together, our economies still look very fragile for several years to come. And then there is the challenge of living with higher interest rates – both for companies and for mortgaged house owners. From a horrible peak around 1980 when interest rates reached 20%, national interest rates have over the last four decades averaged around 5-7%, and we must expect to revert over time to such average levels. But worldwide QE policies have brought company borrowing costs down to record low levels, and house-owners’ mortgage rates down to 3% or less. Even though the prevailing view is that the Fed will raise interest rates by just 1 percentage point next year and a further percentage point in 2017, the expectation is that Fed rates will reach 3.5% by 2019 or 2020 - still below the global average of the past 40 years.

The good news here is that the process of adjusting to higher interest rates will be gradual, hopefully leaving ample time to adjust. The bad news is that mortgage and bank loan costs are going to rise steadily, and at some stages quite sharply, for most of the coming decade. If mortgage costs are a squeeze today, they are only going to get worse. Much worse.

This of course suggests another piece of inevitable bad news: house prices, inflated by these record low interest rates, will fall, and perhaps significantly. For Hong Kong, that is perhaps on balance good news - not for existing house owners, but for that half of the population denied the possibility of home ownership by the strangling cost of entry.

So as we edge into the Year of the Monkey, and drink toasts to the future, the main message is that several years of austerity and belt-tightening still lay ahead, even though we can more credibly today talk about “green shoots”. Patience and risk aversion may still be well advised. We are more than half way through our “lost decade”. And while China’s domestic restructuring is at present causing us all heartburn, on balance we remain lucky to live on China’s doorstep. As the global economy begins to rally back towards boisterous good health, there will be nowhere more exciting to be than in China, where a seismic digital revolution is taking place – but I think that is a story for another day.
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