By Michael Roberts
The G7 meeting in Quebec, Canada was a landmark in many ways. First, there was a clear break in the usual bland unity of purpose and policy expressed at G7 meetings by the leaders of the top seven capitalist countries in the world.
Just before the G7 meeting, US president Donald Trump had announced a series of protectionist tariff measures against the rest of the G7, including its closest neighbour Canada, on the grounds of “national security” – apparently Canada is now a security risk to the US. In doing so, Trump fulfilled his election promises.
At the meeting Trump slammed into the other leaders, claiming that their governments were imposing ‘unfair’ trading rules on US products and they needed to reduce their surpluses on trade with the US. The other leaders had already responded to the US tariff measures with planned reciprocal tariffs on key US exports and now they replied to Trump’s attacks with arguments and evidence that, on the contrary, it was the US that restricted foreign imported goods and services.
And thus, the trade war has begun – a war that the major capitalist economies have not engaged in since the 1930s depression and which was supposed to be resolved by international agreements like the General Agreement on Tariffs and Trade (GATT), the World Trade Organisation (WTO) and the North American Free Trade Agreement (NAFTA) in the post-war period. Trump has called the WTO the worst possible trade deal and NAFTA the next worst (for America). America had protected European and Japanese capitalist states with its armies and nuclear weapons against the supposed Russian threat and now it was time they paid their way both in defence spending and in ‘fairer’ trade deals. The real irony in this argument by Trump was that then he called for Russia, the supposed enemy, to be restored to a place at the top table – talk about adding insult to injury.
Trump’s antics reveal old period is over
What all these Trumpist antics revealed is that the period of the Great Moderation and globalisation, from the 1980s to 2007, when all major capitalist states worked together to benefit capital in all countries (to varying degrees) is over. The Great Recession of 2007-8 and the ensuing Long Depression since 2009 has changed the economic picture. In a stagnating world capitalist economy, where productivity growth is low, world trade growth has subsided, and the profitability of capital has not recovered, cooperation has been replaced by increasingly vicious competition – the thieves have fallen out.
Trump is the ‘populist’ and nationalist leader of the largest capitalist power; Italy (the weakest of the G7) has gone ‘populist’ and nationalist too. And Britain is locked in the pit of ‘Brexit’, a disaster for British capital of its own making. Trump’s attack meant that the G7 meeting, which was to discuss rising inequality, automation and climate change – the key long-term challenges for capitalism’s survival – was paralysed.
But no matter, for now. The world economy is actually looking at its best since the end of the Great Recession. The World Bank estimates that global real GDP growth will 3.1% this year, the same as in 2017. That may not seem very high, but that is a pick-up after the near recession period of 2015-6, when global growth dropped to just 2.4% and the G7 economies could manage no more than 1.5%. Now the G7 economies are expanding at around a 2.5% rate. Unemployment in the US, the UK and Japan is at all-time lows. And even in Europe, the unemployment rate has fallen to 8%, still above pre-crisis levels but getting back there.
However, in its latest Global Economic Prospects, the World Bank’s economists were not convinced that this mild recovery (still some 30% below pre-crisis world growth rate) is going to be sustained. “It is expected to edge down in the next two years, as global slack dissipates, trade and investment moderate, and financing conditions tighten. Growth in advanced economies is predicted to decelerate toward potential rates, as monetary policy normalizes and the effects of U.S. fiscal stimulus wane.” Moreover, “Risks to the outlook remain tilted to the downside. They include disorderly financial market movements, escalating trade protectionism, heightened policy uncertainty, and rising geopolitical tensions, all of which continue to cloud the outlook”.
Now I have suggested at the end of last year that the short-term trade cycle from the trough of 2015-16 would peak in 2018 and then subside back to 2019-20. “What seems to have happened is that there has been a short-term cyclical recovery from mid-2016, after a near global recession from the end of 2014-mid 2016. If the trough of this Kitchin cycle was in mid-2016, the peak should be in 2018, with a swing down again after that.” And I reiterated that forecast in April.
New slump not too far away
The World Bank economists seem to agree. They expect world economic growth to subside to 2.9% by 2020. “The global economic expansion remains robust but has softened…. Global activity still lags previous expansions, and growth is projected to decelerate in 2019-20 as trade and investment moderate. Progress in per capita income will be uneven and insufficient to tackle extreme poverty in Sub-Saharan Africa.” And “Notwithstanding the ongoing global expansion, only 45 percent of countries are expected to experience a further acceleration of growth this year, down from 56 percent in 2017. Moreover, global activity is still lagging previous expansions despite a decade-long recovery from the global financial crisis. So the World Bank reckons the Long Depression will continue.
And this is assuming no new world slump in the next two years. While there is no immediate sign of a new global recession (indeed, the apparent opposite), there are many factors building up that suggest it is not too far away. The first is that obvious fact that the current very weak recovery from the Great Recession is the second-longest expansion in the post-1945 period, reaching ten years next summer 2019 – if it lasts that long.
And then there is profitability. In the first quarter of 2018, the top 500 US companies achieved a 26% increase in earnings per share. But this was mainly due to a huge tax reduction engineered by the Trump administration. When you look at the profits of the whole corporate sector before the tax reductions, there was a fall in Q1 2018 (-0.6%) which followed a fall in Q4 2017 (-0.1%). With the tax reductions, profits rose 6%. The Trump bonanza was a one-off. And average profitability in the G7 economies remains below pre-crisis levels even after ten years of recovery.
And the big risk ahead is the combination of falling profitability and high and rising debt in the corporate sectors of G7. If profits should start to slip while the cost of servicing debt rises as interest rates rise, then this a recipe for corporate bankruptcies and a new debt crisis. Global debt, particularly corporate debt, is at all-time highs.
In 2017, debt rose 10.2% from 2016 to 2017. Breaking it down by sector, non-financial corporate debt grew 11.1%, government debt grew 6.7%, household debt grew 12.5%, and financial sector debt grew 11.3%. The level of emerging market debt will be unsustainable because, among other reasons, debt matures and must be either repaid or refinanced.
Many emerging market businesses and financial companies have borrowed money in dollars, as the dollar was relatively weak and US interest rates ridiculously low. Much of the inflow of capital into emerging economies was not productive investment but loans and bonds for speculative activity. Long-term capital flows to the productive sectors of the emerging economies (Foreign Direct Investment) have been in decline ever since the Great Recession.
Now, the loan bonanza is over. Some $4.8trn in emerging market debt matures from this year through 2020, and much of which will need to be rolled over at generally higher rates and, if dollar strength continues, in a disadvantageous currency environment.
‘Emerging economies’ in crisis
The cracking signs are already appearing in some of the largest so-called emerging economies. Argentina has crashed and been forced to borrow $50bn from the IMF as it can no longer borrow in international bond markets at affordable costs. The economy is plunging, inflation is rocketing and the currency has dived. Brazil is not far behind. The Brazilian economy is struggling to grow at all and yet it has the highest interest costs for debt in the world. In Q1 2018, South Africa’s economy contracted at its fastest rate in nine years as corporate investment fell sharply. And Turkey’s currency, the lira, hit all-time lows as annual inflation reached over 12%; foreigners withdrew their money and the central bank hiked its interest rate to nearly 18%.
But the real pivot point is likely to be corporate debt in the G7 economies. US non-financial corporate debt hit a post-crisis high of 72% of GDP. At around $14.5 trillion in 2017, non-financial corporate sector debt was $810 billion higher than it was a year ago, with 60% of the rise stemming from new bank loan creation. At present, bond financing accounts for 43% of outstanding debt with an average maturity of 15 years vs. the average maturity of 2.1 years for US business loans. This implies roughly around $3.8 trillion of loan repayment per year. “Against this backdrop, rising interest rates will add pressure on corporates with large refinancing needs.” (IIF)
Aside from higher interest rates, the companies that need credit (as opposed to high-rated ones that borrow only because they can do it cheaply) tend to be riskier. A recent Moody’s report found that 37% of US nonfinancial corporate debt is below investment grade. That’s about $2.4trn.
Furthermore, all corporations, both investment grade and speculative, have added significantly more leverage since the Great Recession. Some companies borrowed to fund share buybacks and have vast cash flow and reserves. They can easily deleverage if necessary. But smaller, riskier companies have no such choice. The average non-financial business is roughly 20% more leveraged than at the time of global financial crash in 2007-8. A lot of that debt is rated BBB, the lowest investment grade rating. That means they are just one step above junk. The number of BBB-rated companies is up 50% since 2009.
Global recession is not with us in 2018 – on the contrary, the global economy is growing faster than at any time since 2009. But that growth may well have peaked and in the next 18 months the world economy could head down to a possible slump. How will we know? Well, as I have argued before, profitability of capital must start to fall again and eventually total profits of corporations in the major economies must stop rising. If the cost of servicing all this debt has also risen, then the conditions are set for corporate bankruptcies.
One reliable signal for this in the past has been the inversion of the bond yield curve. The interest rate for borrowing money for one year is much lower usually than the rate for borrowing for ten years for obvious reasons (the lender gets paid back quicker). So the yield curve between the ten-year rate and the one year rat is normally positive (say 4% compared to 1%). The general idea is that a steepening yield curve, where long rates are rising faster than short rates, indicates that credit is easy to access and profits are high enough from faster economic growth. But when short-term yields rise above the prevailing long-term bond rate it indicates credit conditions have become unusually restrictive compared to profits and that there is a very high probability that a recession will arrive within about a year.
RBC investment strategist, Jim Allworth reckons that: “There hasn’t been a recession in more than 60 years that wasn’t preceded by an inversion of the yield curve. On average, the yield curve has inverted 14 months prior to the onset of a recession (median 11 months). The shortest “early warning” was eight months. We are not there yet in the US and certainly nowhere near in Europe. But the US curve is going in that direction.”
Trump’s trade tantrums and the growing risk of a trade war that could stifle the current ‘recovery’ only adds to the underlying risks of new global slump ahead.
June 11, 2018
First published on Michael Robert’s blogsite:
