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The Black Swan Could Turn into a White Swan

Feb 14 , 2017
  • Zhang Monan

    Senior Fellow, China Int'l Economic Exchanges Center

Forecasting is not an easy thing. But more and more facts demonstrate that “black swan” events can evolved into “white swan” events. Chaos, turmoil, conflicts and contradictions are part of the normality in today’s world, especially in the global financial market.

Currently, the world economic recovery is very weak and gets stuck in the risk of a “low-growth trap”. The world’s major economies continue to have different growth rates with a serious lack of new growth momentum. The IMF predicts that 2016 will witness only 3.1% GDP growth, a decline for the fifth consecutive year. Long the world economic growth engine, international trade will probably grow 1.5 times or even twice as much as the world economic growth rate. However, this engine is beginning to slow down sharply and could even stall. According to the world trade growth report, international trade showed an average growth of 6.9% from 1990 to 2007 and about 3.1% from 2008 to 2015. Over the past year, global trade fell to 1.2%, lower than one-fifth of the 6.7% average trade growth 10 years before the financial crisis. The year of 2017, the WTO adjusted the trade growth figure from 2.8% down to 1.7%, indicating a much weaker trade effect on GDP.

Nowadays, the degree of monetary easing in the major economies is unprecedented and has nearly gone to the extreme. Countries with negative interest rates account for one-fifth of the world economy. But in the coming years, the world may enter a new “financial period” and the risk of divergent monetary policies will further cause the shift of asset and capital allocation.

The US Fed has already moved up its benchmark interest rate by 25 basic points within the target range from 0.5 to 0.75% and hints that in 2017, it will speed up interest-rate hikes, possibly three interest-rate hikes. It forecasts that interest rates will climb to 3% within two or three years to match the economic growth. In terms of asset structure, the Fed now holds $4.5 trillion worth of assets. Among which, mortgage-backed securities (MBS) account for $1.76 trillion and Treasury bonds stay at $2.46 trillion. As to the date of maturity, 55% of the Treasury holdings will mature within five years and 8% of them will mature in the coming year. If the Fed stops reinvesting in Treasuries, the balance sheet will be reduced by $1.35 trillion five years later. The “shrinkage” of the balance sheet will have more direct impact on the dollar’s liquidity and the global capital flow than the interest rate hikes because the base currency is directly affected and exponential shrinkage will occur via money multipliers.

In this new global financial period and new US dollar period, risk preference and incremental capital gains are the key factors that determine the capital flow. IMF World Economic Outlook data show that 50% of the global capital still flows to the US, UK, etc. The stable recovery in the US attracts a large amount of global capital to buy US assets. The US net capital inflow was estimated to reach $460 billion in 2015, up by 18.3% over the same period and at a growth rate 14.8% higher than that in the previous year, accounting for 38% of the world total capital flow.

In the future, the global structural change coupled with the periodic change will strengthen the trend.

First, the global demand is changing significantly; the global aggregate demand led by developed countries continues to shrink, so the world continues to be constrained by inadequate demand. The long-term sluggish demand also causes the decline of the economic supply. The golden window of China’s hyper export growth has gone; the export sectors that have allocated a large amount of resources such as labor to the labor-intensive products are beginning to have a lower efficiency. At same time, China is getting close to the turning point of demographic dividend; the population is aging, the labor cost will gradually affect the enterprises, thus leading to their savings decline.

Second, the global capital structure is also undergoing a substantial change: The US used to be the world largest industrial capital exporter. But with the “reindustrialization” moving forward in the US, the US capital and technology outflow will gradually reverse and the US may become a net importer instead of an overseas direct investment exporter, weakening China’s attraction for global manufacturing capital.

Next is the capital-cost structure. The long-term interest rate is lower against balanced global savings and planned investment. The correction of the global imbalance and the rise of the real interest rate also increase the cost of US bond financing such as Treasury bonds, pushing up the global real interest rates.

All in all, the “black swan” is very likely to become a “white swan” in 2017. The “Trump Era” will reshape the deep political and economic structure in the US, which certainly will bring new challenges to the monetary policy, exchange rate policy, trade policy and even the overall macro-economic policy. However, the writer believes that the contradiction and incompatibility of the “Trump new polices” may cause bigger variants in the policy trend: on the one hand, as Trump many implement the supply-side policy of increasing investment in infrastructure, large scale tax reduction and the Fed will increase interest rates to go in line with the capital return to the US, “siphoning effect” may occur.

On the other hand, however, once the US government deficit increases, private investment expands and trade protectionism rises, trade surplus will narrow. In essence, a stronger US dollar is also a potential risk for the US. A stronger currency squeezes export and stimulates imports, thus the trade deficit will swell, increasing the US debt risk which will be followed by financial risk.

The election campaigns in most European countries could produce an extremely right-wing trend, Britain starts the “withdrawal from Europe Union” negotiations and the world faces greater trade, investment and capital flow barriers. Due to these factors, the global financial market will have higher vulnerability and systematic risks. The credit condition and debt situation in the newly emerging markets will further aggravate, in particular against the global regression and global liquidity reversal. It is urgent to have international policy coordination to prevent the risk spreading in the foreign exchange markets, credit markets, asset cost and the cross-border capital flow.

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