EXPERTS’ views about components of the local economy, such as the behavior of the stock market, the balance of foreign trade, or the peso-dollar exchange rate, more often than not include a reference to “global economic conditions.” This is usually offered as an explanation for why the economic indicator being discussed is not performing as well as hoped, and sounds plausible enough, particularly when some equally plausible-sounding examples of the “global conditions,” such as “the slowing economy in China” or “the impact of the Brexit” are provided.
When an analyst or policymaker says “global economic conditions,” what he usually means is “stop asking me questions,” because most economic factors cannot be explained simply, and some really cannot be explained at all. Providing an imprecise reason like “global economic conditions” reduces the apparent margin of error of the results of imprecise predictions.
That is not to say global conditions—to put it in plainer terms, things affecting the economies of other countries—do not have a wider impact. They do; where economy watchers get it wrong is in identifying which global factors potentially have the greatest impact, and in describing just what that impact might be. The two “global conditions” mentioned above, China and the Brexit, are joined these days at the top of the business news pages by another favorite, the imagined movement sometime in the near future of benchmark interest rates by the US Federal Reserve.
The trouble is, these factors may not be the ones having the most significant real impact, but affect economies throughout the world as self-fulfilling prophecies. In other words, if left alone, the factors would probably not have a noticeable effect.
China’s economy has slowed from its torrid pace of the past couple years, but China’s economy is enormous; spread out over the entire world, the effect of a minor slowdown—which is not even uniform across the entire Chinese economy—is minimal at worst. The Brexit has not happened yet; it will, and it may have a significant effect on the European and wider global economy at that point, but the only real step that has been taken so far is the suspension by several banks of lending to foreign buyers of property in the UK.
Likewise, speculation over a Fed rate hike sometime later in the year is just that for now, speculation; its actual effect on lending rates and bond yields will not be felt until the Fed actually makes a rate decision.
Markets, however, do not often reflect actual reality. What happens instead is that markets believe something like a possible future Fed rate hike has an immediate effect (even though it doesn’t), and so they react as though it does, which makes the response of the markets and the wider economy virtually indistinguishable from the real thing.
An optimistic view of this sort of behavior, particular in the financial markets, is that it anticipates things that will eventually happen anyway, so that the impact of the factors being anticipated is not as extreme when they finally manifest. On the other hand, the behavior of markets today affects the behavior of markets and the wider economy tomorrow, and changes the conditions upon which assumptions of future effects are based—markets are then forced into a state of constant lagging behind actual economic conditions.
And while markets focus on the nebulous, they may be overlooking developing circumstances that would have a more immediate and widespread impact. Some of those circumstances can be found in South America, where the continent’s three largest economies are all suffering some degree of turmoil. The worst is Venezuela, which has produced a stream of tales of economic woe for most of the past two years. On Friday, the International Monetary Fund (IMF) forecast a 10 percent retraction in Venezuela’s GDP this year—which would match last year’s dreary performance—and inflation to rise to a whopping 700 percent. In Brazil, attempts to correct several years of bad economic management and alleged corruption have gotten tangled in a political quagmire, shrinking the economy by 0.3 percent in the first quarter. Also on Friday, Argentina’s central bank forecast a 1.4 percent contraction in 2016, with GDP expected to shed a full two percent in the third quarter.
It is not rational that the world economy should be rattled by a planned divorce of the UK from the EU, or largely cosmetic changes in Asia’s largest economy, and fail to notice that an enormous swath of an entire continent elsewhere is going to hell in a handbasket, economically-speaking. By not paying closer attention, we are risking a major shock, and probably soon.