Eaton expects the People’s Bank of China to devalue its currency aggressively over the coming months. The impact of that would be to flood the global economy with cut-price Chinese goods, putting added pressure on competing developing nations and turning ultra-low inflation to outright deflation in the west.
All this would happen at a time when other central banks and finance ministries are low on ammunition. In previous economic cycles, countries have gone into recessions with healthy public finances and relatively high levels of interest rates. That has allowed public spending to rise, taxes to be cut and the cost of borrowing to be lowered. Almost seven years into the recovery from the downturn of 2008-09, interest rates in the developed world are barely above zero and the repair job on public finances remains unfinished.
Christine Lagarde, the managing director of the International Monetary Fund, said last week the global economy would remain fragile in 2016. She said there was likely to be an “increased divergence” in monetary policy in developed countries. The fund thinks the Bank of Japan and the European Central Bank will be providing extra stimulus at a time when the US Federal Reserve and the Bank of England are pushing up interest rates. In the past, this has tended to be a recipe for trouble in the markets.
Lagarde also predicted that China’s attempt to rebalance its economy towards consumer spending rather than exports would prove a bumpy process rather than a trouble-free one: the transition was leading to lower demand for commodities, with knock-on effects for those countries producing oil and industrial metals.
Pressures on commodity producers are already evident. Russia and Brazil are in recession; Saudi Arabia has announced an austerity budget and is planning to sell a stake in its state-owned oil company Aramco. If the Saudis are feeling the pinch from an oil price that has fallen from $115 a barrel in August 2014 to $33 a barrel on Friday, other countries in the emerging world are probably getting close to breaking point.
The last time the developing world was in crisis, Alan Greenspan, the then chairman of the US Federal Reserve, rode to the rescue with cuts in interest rates. The dotcom bubble resulted, and when that went pop Greenspan responded by again slashing interest rates. That led to the US sub-prime housing bubble. When that went pop, China came to the rescue while the west sorted out its wrecked banking system.
So what happens if the first week of 2016 is more than a temporary wobble? More quantitative easing? Negative interest rates? Helicopter drops of money? Nobody really knows. As Sir Alex Ferguson once said: this is squeaky bum time.
