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Summary of the Document: "Economics - Where Lies North?"

Core Content

This document, authored by DBS Group Research on 16 May 2016, analyzes global economic conditions, focusing on market volatility, monetary policy effectiveness, structural reforms, and inflation trends. It argues that while the world is preoccupied with slow growth, many major economies are actually performing better than previously thought. The document also highlights the irony that China, which is undergoing significant structural reforms, is the most feared economy, despite its relatively strong growth trajectory.

Main Points

• Market Volatility:

  • The first quarter of 2016 saw extreme market swings, with the S&P 500 dropping 12% and rebounding within six weeks.
  • This volatility confused investors, analysts, and central banks alike, with the Fed and others struggling to interpret the situation.
  • Financial market conditions have actually loosened since early February, with the dollar weakening, mortgage rates and junk bond yields declining.

• Monetary Policy Ineffectiveness:

  • The ECB and BoJ's easing policies (including negative interest rates and expanded QE) have backfired, causing their currencies (yen and euro) to strengthen instead of weaken.
  • QE has not significantly boosted growth or inflation, but it has influenced currency behavior by signaling long-term low rates.
  • The Fed, despite its initial concerns about "tight financial conditions," has not raised rates despite rising core inflation, indicating a possible misalignment in policy.

• Global Growth Trends:

  • The US, Europe, and Japan are growing at or near their potential rates, with the US expected to grow at 2% in 2016.
  • Japan and the Eurozone have shown improved growth compared to previous years, with Japan expected to grow at 1.2% over the next four quarters.
  • China's growth is slowing, but this is attributed to structural reforms rather than a crisis, and is expected to continue in an L-shaped recovery.

• Inflation Dynamics:

  • Headline inflation is not under central bank control due to low oil prices driven by supply, not demand.
  • Core inflation, however, is rising across the G3 (US, EU, Japan) due to better growth and lower energy costs.
  • The US core CPI has surpassed the Fed's target, and core PCE is also on the rise, indicating a potential rate hike.

• Structural Reforms in China:

  • China is the only major economy pursuing substantial structural reforms, including RMB internationalization and shadow banking regulation.
  • These reforms, while slow, are seen as necessary to sustain long-term growth despite short-term slowdowns.
  • The document suggests that China's growth slowdown is not due to a crisis but is part of a deliberate structural adjustment.

• Population and Productivity Trends:

  • Working-age population growth (WAPG) has slowed globally, significantly impacting potential GDP growth.
  • Productivity growth in high-income countries has been below the 1.5% historical norm, contributing to slower potential growth.
  • The document posits that growth in the G3 (US, EU, Japan) is already at potential, and further monetary stimulus may not be effective.

• Longer-term Outlook:

  • Global growth is expected to slow over the next 10–20 years due to demographic shifts and rising incomes in Asia.
  • Asia's growth is projected to decrease by about 0.1–0.15 percentage points annually, but the region's economic weight is increasing.
  • The shift in economic gravity from the West to the East is accelerating, with Asia growing at a rate equivalent to adding Germany’s GDP every 3.2 years by 2021.

Key Information

• Market Reactions:

  • The S&P 500 dropped 12% in 6 weeks but rebounded.
  • The Fed's response to market volatility was misaligned with actual financial conditions.

• Monetary Policy Impact:

  • The ECB and BoJ's easing led to unexpected currency strength, suggesting that their policies may not be as effective as intended.
  • The Fed's focus on supporting the stock market is questioned, with the argument that it should stick to its traditional mandates.

• China's Structural Reforms:

  • China's reforms, such as RMB internationalization and shadow banking regulation, are progressing faster than expected.
  • Despite capital outflows, these reforms are considered successful and necessary for long-term growth.

• Inflation and Growth:

  • Core inflation is rising due to better growth, not demand-side factors.
  • Headline inflation remains low due to oil prices, which are driven by supply, not demand.

• Potential GDP Growth:

  • The US, Japan, and Europe are growing at their potential rates, with the US at 2%, Japan at 0.5%, and Europe at 1.5%.
  • Central banks may be overreaching in their efforts to stimulate growth, as the economy may not require further monetary easing.

• Global Growth Outlook:

  • The document suggests that global growth is not on an upward trajectory but is instead on a path of moderation.
  • Asia's growth is slowing due to rising incomes, but this is seen as a positive sign of economic development.

Conclusion

The document challenges the prevailing narrative of a global economic crisis, arguing that many economies are on a path of sustainable growth and that the focus should shift from cyclical concerns to structural changes. It emphasizes that while China is the only major economy pursuing significant reforms, it is also the most feared, highlighting the irony of global economic anxieties. The Fed and other central banks are urged to align their policies with the current economic reality rather than being swayed by market volatility or outdated expectations.