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Supply-side Reform Needed in Global Economy

Feb 22 , 2016
  • Zhang Monan

    Senior Fellow, China Int'l Economic Exchanges Center

The recent violent volatility in the global markets has added fresh uncertainties in the world economy. With the boom in international commodities coming to an end, global commodity prices have been on a downward trend, and the deflationary pressure has been building up. The global financial markets and the real economy are facing grave challenges in terms of both financial liquidity and economic growth rates.

The real economy is being plagued by continuing deflation. In all economies, both the developed and the emerging, the inflation rates are on a downward trend. According to JPMorgan Chase & Co, the global inflationary rate in the second quarter of 2015 was as low as 1.6%. This rate was not only lower than the 2% of inflation recorded at the end of the previous year, but also far more lower than the global average of 11% during the 1990-2013 period. In European countries and the United States, the core inflation rates went off the preset track, and even if the European central bank launched a new easing of monetary policy, it still failed to reverse the trend of declining inflation, and the inflation rate in the eurozone was still hovering around the tipping point. In the emerging markets and developing nations, internal growth is losing momentum, deep-rooted problems are acute, industrial production is on the downside trend, and in China, in particular, structural adjustments to cut production capacity and to reduce inventories further aggravated the weak global demand, and deflationary risks are spreading over the world.

Factors that caused the overall level of global prices to dip are on the increase while those that helped drive up prices are on the decrease. The interest-rate hike by the US Federal Reserve has escalated volatility in prices on the global markets. Grasping the changes in the dollar-dominated global economic and financial cycles and the money cycle of the dollar are the prerequisites to understanding the trends of the global economy and finance. The exit from the quantitative easing policy by the Federal Reserve marked a shift from the cycle of an easing policy in the past 10 years to a cycle of tight monetary policy. During this process, the appreciation of the dollar had its impact on the overall price level through the channels of “import, purchasing price, PPI and CPI.”

The United States is not only an “importer” of global deflation, but also an “exporter” of the same. Because the dollar is the base pricing currency in the global commodity markets, continuing appreciation of the dollar would lead to further decline in the prices of commodities. In 2015, the prices of global commodities dropped sharply, with the Bloomberg Commodity Index declining by 25%, hitting a new low since 1999. The Brent Crude, a benchmark in the global oil prices, had tumbled below $30 a barrel, hitting hard the international oil markets.

The lackluster growth in real economy and the growing surplus in production also contributed to a weaker inflation, or were even important factors leading to deflation. Since the sub-prime crisis in 2008 and the eurozone debt crisis, the dynamic and pattern in global demand have undergone tremendous changes, characterized by a shift in new demand which used to be dominated by the United States and Europe, and the weakness in global industrial production and new orders index showed a slow or stagnant recovery in the manufacturing sector. In particular, after China launched the program of “deleveraging, cutting capacity and de-stocking” in the past year, growth in new demand has slowed remarkably, and surplus in production has grown. Under this scenario, all countries were competing for the limited global market, which directly drove down the overall level of the global prices. The Baltic Dry Index, an economic indicator and a potent index for international trade, has dropped from 1,464 points in November 2014 to 905 points, the lowest level in 30 years, indicating a slowdown in the global economy and stagnant trade triggered by weak imports and exports of raw materials.

The pressure of global debts was also accumulating. According to IMF data, aggregate debts of the developed economies in 2014 amounted to $50.95 trillion, a year-on-year increase of $2.32 trillion; and the debt ratio of the developed economies was 108.32%, a year-on-year rise of 0.66 percent, and debt risks were still lurking over the developed economies. Latest statistics showed the proportion of overall global debt burden (including debts of the private and public sectors) in gross national income rose from 160% in 2001 to about 200% in 2009 after the global financial crisis, and further up to 215% in 2013.

With the dollar entering a new cycle, many emerging economies that use the dollar to price their overseas debt will probably see growing risks, and this will push up the global debt burden and financing costs. According to IMF statistics, the debt size issued by non-financial enterprises from the emerging markets has rocketed since the global financial crisis in 2008. In essence, this meant that big enterprises from the emerging markets, via their offshore subsidiaries, conducted arbitrage trading via bond issues on the offshore markets and cross-border foreign currency loans. According to estimates by the Institute of International Finance, from 2014 to 2018, the amount of corporate bonds issued by the emerging economies that need renewal will reach $1.68 trillion, and of which, about 30% were priced in US dollars. If the dollar enters into a cycle of appreciation, the costs for renewing the bonds will rise remarkably, and the risks of their debts will spike accordingly.

At the same time, demographic changes are having a far-reaching impact on the global economy and overall price levels. Major economies in the world have now reached a demographic turning point, coupled with the fact that between the global financial crisis in 2008 and 2014, the United States and China, the two largest economies in the world, also witnessed the demographic turning point. The proportion of the working population between the ages of 15 and 64 was declining. The United States and China experienced the peak in their working population between 2006 and 2009, while in the eurozone and Japan, the demographic peak had already occurred between 1988 and 1992. The demographic changes and the aging trend have led to changes in savings and consumption. The growth in consumption has become stagnant, and this has led to an imbalance between supply and demand, which further contracted global demand and stimulated a decline in overall price levels.

Practices in the past seven years since the global financial crisis have proven that the growth track and pattern of the world economy have undergone changes, and that to avoid deflation and escape from the trap of liquidity, it would not be enough nor possible through the tool of solely maintaining an easy monetary policy by the central banks. At present, the slowdown in global economy and the deflation are structural issues. For such structural problems, structural reforms should be adopted accordingly. The fundamental solutions would be to find new “supply substitution,” to improve the productivity and innovative output of all factors, and to earnestly promote global economic growth.

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