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Global economy doing just fine thank you very much

David Bassanese
Wednesday, September 09, 2015

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By David Bassanese

Despite the still swirling degree of uncertainty in global markets, I remain of the view I outlined last week that the United States Federal Reserve should, and will, raise interest rates next week. If I’m right, we should expect to see a “well sourced” media leak appear in a major financial news outlet at some stage over the next few days.

If I’m wrong, the media will remain quiet and the Fed will again baulk at doing the inevitable – though we can at least expect to see a strongly worded post-meeting statement that hints at a probable rate rise within the next few months.

As I’ve argued, leaving the markets on tenterhooks in this way would be the worst things investors should want. It’s time to rip of the bandage.

Of course, last week’s so-called “mixed” US employment report had market analysts still debating whether the US Federal Reserve will act. Adding to the cloud of uncertainty was the weekend G-20 meeting, at which the International Monetary Fund and a gaggle of developing economies tried to warn off the Fed from raising rates.

The global economy is just too unstable the critics contend. As many developing economies, in particular, are dealing with a crash in commodity prices and capital outflows, a US rate rise would only wreak further havoc.

In what was perhaps the silliest comment over the weekend, IMF managing director Christine Lagarde suggested "it is better to make sure that the [US] data are absolutely confirmed, that there is no uncertainty, neither on the front of price stability, nor on the front of employment and unemployment, before it actually makes that move."

As any central banker will tell you, no one ever operates with the privilege of pure certainty. If the need for a Fed rate hike was completely certain, it would likely suggest the Fed had already fallen well behind the curve, with sharply rising consumer price inflation – or more likely – dangerously inflated asset prices bubbles.

To my mind, the US August employment report was far from mixed. Although the headline rise in employment during the month was around 50,000 lower than expected at 170,000, employment growth in the previous two months was revised up by a healthy 44,000. Employment growth over the past year has averaged a solid 247,000 per month.

Most critically, however, the unemployment rate edged down further – to a near full-employment level of 5.1%.

Just think about that for a minute. The Fed has kept official interest rates at a near-zero “emergency” level for the past 7 years – and has watched the unemployment rate inexorably push lower.

As for global economic troubles, I still fail to see what all the fuss is about. The world’s leading economy is still going gangbusters. Despite China’s stock market volatility and some slowing in growth, its political leaders are rightly stimulating the economy though an easing in credit conditions and more fiscal stimulus. Whether China feels the need to devalue its currency a lot further remains to be seen, but this will happen whether the Fed hikes rates or not.

Further Chinese devaluation could potentially be destabilising for the global economy, but its real exchange rate – due to a peg to the US dollar - has already become uncomfortable high. As elsewhere in the world, China is and must learn to allow its currency to find its own true value.

Europe also has the firepower to deal with its own problems, with ECB President Mario Draghi hinting at further quantitative easing if need be.

As for Japan, despite still low inflation, its unemployment rate has steadily declined to its lowest level since the last 1990s. We can’t ask for more growth in an economy where the labour force is contracting.

Among other economies such as Russia and Brazil, it’s hard to avoid a world of pain when the price of your major commodity exports has slumped. These economies need to fix themselves – though greater economic and financial market flexibility – rather than rely on a low US dollar and low US interest rates. Brazil itself is also suffering from a post-World Cup hangover, while Russia’s military adventurism has proved a badly timed own goal by bringing forth economic sanctions.

Let’s also not forget that commodity prices are largely weak due to rising supply – and that weak commodity prices, while bad for commodity exporting nations, is actually a net-positive for the global economy overall. What we’re seeing is an income transfer from commodity exporters to commodity importers – reversing the flows evident over the previous decade.

Given the imminent rise in US interest rates – either next week or later this year – I’d still be cautious about expecting the current correction in global stock markets to end anytime soon. If you see a great corporate bargain, by all means buy it, but remain prepared for continued overall market volatility in the months ahead.

Published: Wednesday, September 09, 2015

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