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Governance crisis and economic risk

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Bruno Cavalier
Chief Economist at ODDO BHF

The world is experiencing a governance crisis whose latest developments have markedly increased the risk of an economic crisis. The US and the UK, two countries that have done so much for political and economic freedom, are headed today by narcissistic clowns whose sole guiding principle is to break up a global or European order claimed to be the source of all evil, regardless of the cost. Confidence, an essential ingredient for societies to function properly, has been eroded. Economic uncertainty is attaining new heights, and this could slow investment and growth still further.

  • The world economy entered the 11th year of its expansion phase this summer following the worst financial crisis in modern history. This expansion has been far from uniform. Growth slowed very sharply in 2011-2012 (euro crisis), and then in 2015-2016 (oil crisis). There has been a fresh slowdown over the past 18 months against the backdrop of trade strains. During the first two cold snaps, the pace of world growth fell to around 2.5%, not far above a recessionary zone. Each time, this risk failed to materialise because of a positive confidence shock. In 2012, Mario Draghi was able to use all the ECB’s political capital to reassure the markets about the euro’s integrity. In 2016, China and the US stimulated their economies in unison. Today, annualised world growth is running a shade above 3%, down from 4% at the start of 2018. It is not yet in a critical zone, but the confidence shock taking shape today is negative.
  • Concerns about the destabilising nature of US economic policy since Donald Trump started to interfere (euphemism), have all proved prescient in recent months. After imprudently wasting fiscal space last year, Trump is doing all he can to make world trade increasingly costly, without forgetting to chip away at the Fed’s credibility each day – a Fed that is doing what it can (through rate cuts) to limit the damage. The stand-off with China has probably reached a point of no return. We think it is illusory to continue hoping that the two countries will reach a trade deal. US consumers are benefiting from wage and job gains, their spending is solid and, for the time being, they are little exposed to the effects of the price war. But this is not true for companies. Uncertainty is leaving a visible mark today on business confidence and the investment outlook. Compounding all this, some sectors, such as oil and aerospace, also face specific problems.
  • China is engaged in a difficult balancing act as it tries to reconcile the contradictory objectives of boosting activity, keeping a tight rein on indebtedness and avoiding speculation in the housing market. The authorities are rolling out a raft of selective measures to loosen monetary and financial conditions. The slowdown remains under control at this stage, but it is still a slowdown. By allowing its currency to depreciate, China has given itself a little leeway to absorb the trade shock. But this tool needs handling carefully if it wants to contain capital flight and avoid adding to President Trump’s ire on the subject of “monetary manipulation”.
  • In Europe, some political problems have been resolved (the “yellow vests” protests in France and tensions between Rome and Brussels after Salvini’s failed gambit), but the biggest of all – Brexit – has still not been settled. The economy has two faces: a depressed face (manufacturing) and a more reassuring one (other sectors). By and large, there is little contagion between the two, except in Germany, where the manufacturing crisis is too severe not to weigh on employment and total activity. There is something lunatic about the German government’s apathy as it clings to its fiscal orthodoxy principles like the shipwrecked to their lifeline. Fortunately, at Mario Draghi’s initiative, the ECB is preparing another major round of monetary loosening, but this is once again at odds with the Germanic proponents of monetary orthodoxy.

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