The world economy is defying gravity. That cannot last

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The world economy is defying gravity. That cannot last

The Economist | November 2, 2023

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Even as wars rage and the geopolitical climate darkens, the world economy has been an irrepressible source of cheer. Only a year ago everyone agreed that high interest rates would soon bring about a recession. Now even the optimists have been confounded. America’s economy roared in the third quarter, growing at a stunning annualised pace of 4.9%. Around the world, inflation is falling, unemployment has mostly stayed low and the big central banks may have stopped their monetary tightening. China, stricken by a property crisis, looks likely to benefit from a modest stimulus. Unfortunately, however, this good cheer cannot last. The foundations for today’s growth look unstable. Peer ahead, and threats abound.

The irrepressible economy has encouraged bets that interest rates, though no longer rising rapidly, will not fall by much.   Some people, including Janet Yellen, America’s treasury secretary, say these higher interest rates are a good thing—a reflection of a world economy in the rudest of health. In fact, they are a source of danger. Because higher rates are likely to persist, today’s economic policies will fail and so will the growth they have fostered.

To see why today’s benign conditions cannot continue, consider one reason why America’s economy in particular has fared better than expected. Its consumers have been spending the cash they accumulated during the pandemic from handouts and staying at home. Those excess savings were expected to have been depleted by now. When those excess savings buffers have been run down, high interest rates will start to bite, forcing consumers to spend less freely. And trouble will start to emerge across the world economy if rates stay higher for longer. In Europe and America business bankruptcies are already rising; even companies that locked in low rates by issuing long-term debt will in time have to face higher financing costs. House prices will fall, at least in inflation-adjusted terms, as they respond to dearer mortgages. And banks holding long-term securities—which have been supported by short-term loans, including from the Fed—will have to raise capital or merge to plug the holes blown in their balance-sheets by higher rates.

When interest rates were low, even towering debts were manageable. Now that rates have risen, interest bills are draining budgets. Higher-for-longer therefore threatens to pit governments against inflation-targeting central bankers. Some governments would go on to tighten their belts as a result. But doing so may bring economic pain.

These strains make it hard to see how the world economy could possibly accomplish the many things that markets currently expect of it: a dodged recession, low inflation, mighty debts and high interest rates all at the same time. It is more likely that the higher-for-longer era kills itself off, by bringing about economic weakness that lets central bankers cut rates without inflation soaring.

A more hopeful possibility is that productivity growth soars, perhaps thanks to generative artificial intelligence (ai). The resulting boost to incomes and revenues would make higher rates bearable. 

2 key takeaways from the article

1. Even as wars rage and the geopolitical climate darkens, the world economy has been an irrepressible source of cheer. Only a year ago everyone agreed that high interest rates would soon bring about a recession. Now even the optimists have been confounded.  Around the world, inflation is falling, unemployment has mostly stayed low and the big central banks may have stopped their monetary tightening. Unfortunately, however, this good cheer cannot last. The foundations for today’s growth look unstable. Peer ahead, and threats abound.
2. The irrepressible economy has encouraged bets that interest rates, though no longer rising rapidly, will not fall by much.  Some people say these higher interest rates are a good thing—a reflection of a world economy in the rudest of health. In fact, they are a source of danger. Because higher rates are likely to persist, today’s economic policies will fail and so will the growth they have fostered.

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Topics:  Globally Economy, Inflation, Interest Rate