‘Like an ocean liner without lifeboats’: HSBC’s dire warning for global economy

HIS name is Stephen King, and he’s got a horror story to tell about the global economy. The Titanic is about to sink — and there aren’t any lifeboats.

THE world economy is in serious danger of falling into another recession — and if it does, governments have few tools left at their disposal to combat it.

That’s the dire warning from HSBC chief economist Stephen King, who describes the situation as like being on an “ocean liner without lifeboats”.

With interest rates at near zero across the developed world, record levels of public debt and little room for further stimulus spending, the conventional “monetary ammunition” that has been built up following previous recessions is all but non-existent.

“In effect, the world economy is sailing across the ocean without any lifeboats to use in case of emergency,” he writes in a new report, ‘The world economy’s titanic problem’.

That’s bad news. As the UK’s Telegraph points out, the United Nations has cut its global growth forecast for this year to 2.8 per cent — only slightly above the 2.5 per cent which used to be regarded as a recession.

The biggest danger comes from China. If the Chinese economy weakens so much that the authorities have no other choice than to let the renminbi slide, it will have severe knock-on effect.

“[In this situation, collapsing] commodity prices lead to severe weakness elsewhere in the emerging world,” Mr King writes. “The dollar surges, but the Fed is unable to respond via interest rate cuts. The US is eventually dragged into a recession through forces beyond its control.”

And the situation in China is already worse than authorities are letting on, experts have warned.

China accounted for 85 per cent of global growth in 2012, 54 per cent in 2013, and 30 per cent in 2014 — that figure is expected to fall to 24 per cent this year. “If there is only one statistic that you need to know in the world right now, this is it,” RBS economist Andrew Roberts told The Telegraph.

In every recession since the 1970s, the US Federal Reserve has cut interest rates by a minimum of 5 percentage points.

“That kind of traditional stimulus is now completely ruled out,” HSBC’s Mr King writes. “Meanwhile, budget deficits are still uncomfortably large and debt levels uncomfortably high.”

While in the past, deep recessions have typically been followed by strong recoveries, this time around, “a deep recession has been followed by an insipid recovery: more L-shaped than V-shaped”.

“Today, inflation isn’t just low. It is, arguably, too low,” he warns.

When debt levels are low, interest rates are high and budget deficits are small, dealing with recessions is relatively easy, he says. “When debt levels are high, interest rates are at zero and budget deficits are large, dealing with recessions is a lot more troublesome.”

Attempts in various global economies to “rebuild their ammunition” over the past six years have failed. The European Central Bank had “egg on its face” after trying to raise interest rates in 2011, only to be forced to drop them again.

The danger for policymakers is firstly, that it’s hard to know in advance what the next financial crisis will look like; and secondly, that regardless where it comes from, none of the tools that have helped governments pull themselves out are available this time.

Mr King also points out that each of the last four US recoveries have been weaker than the last, and the effectiveness of fiscal stimulus has diminished over time.

In the 1930s, it was a novel idea, but the chances of it working to boost economic activity were high given the healthy starting position and an absence of future spending commitments.

“Today, it is much more difficult to make the same argument. The best that can be said — and this certainly chimes with the Greek experience — is that pursuing aggressive fiscal austerity in the midst of a deep recession is likely to end in tears,” Mr King says.

Writing in Business Spectator, Alan Kohler pointed to a key piece of economic data due to be released today that could reveal whether Australia is headed towards recession.

The estimate of services firms’ investment intentions for 2015-16, which fell by 7 per cent in the first reading for the year, is a crucial indicator of whether the services sector is picking up the slack from the end of the mining boom.

If that number doesn’t turn around, it will be bad news. Part of the problem, Kohler points out, is that businesses’ so-called “hurdle rates” are too high. That is, the rate of return they expect before they commit capital.

“The trouble is that it is circular. If firms don’t invest, the economy will stagnate and interest rates will remain low; if interest rates remain low but firms don’t bring down their hurdle rates, they won’t invest,” he wrote.

On the plus side, even in the event of a global downturn, Australian authorities are better placed than those in other developed economies, according to AMP Capital chief economist Dr Shane Oliver.

Our cash rate is still at 2 per cent, and net public debt to GDP is at around 20 per cent compared with around 100 per cent in the US and Europe, and higher in Japan, he argues.

“If there was a real fiscal emergency [the Australian government] could look to stimulus again — it’s not ideal, but again we’ve got a cash rate that’s still positive and we haven’t even done quantitative easing, so Australia is arguably better placed than other countries,” he said.

Dr Oliver added he wasn’t as concerned as HSBC about the ability of central banks to fight another relapse. “Yes it’s a concern, but I probably wouldn’t be quite as alarmed as Stephen King. If there was another relapse I think there is more scope for quantitative easing, even if everyone is up in arms about it.”

According to HSBC’s Mr King, one easy answer to break out of the vicious cycle would be for the retirement age to rise. This would help combat the “savings glut” which helps keep interest rates down.

“The underlying problem is that countries with ageing populations tend to suffer from slower growth, yet to pay for all the extra retirees the countries need to have faster growth,” he writes.

“[Thanks] to people’s collective savings behaviour, their individual wealth targets remain out of reach: the more they save, the more interest rates fall; the more interest rates fall, the lower the returns on their wealth; and the lower the returns on their wealth, the more they have to save.”

By raising the retirement age, the urge to save for a nest egg would be greatly reduced. Lower levels of savings would mean higher levels of consumption, higher levels of demand and, hence higher levels of investment.

“Importantly, faster economic growth would also provide higher tax revenues and higher interest rates. The ammunition needed to repel the next recession would be replenished.”

But such a politically unpopular move would likely never happen.

“As a result, the recession-fighting ammunition will remain in short supply and the risks of a major economic contraction will be that much greater,” Mr King says.

“We will carry on sailing across the ocean in a ship with a serious shortage of lifeboats. Many — including the owner of the Titanic — thought it was unsinkable: its designer, however, was quick to point out that ‘She is made of iron, sir, I assure you she can’.”

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