The Global Economy Looks Good for 2018 (Unless Somebody Does Something Dumb)
Everyone in the world—plus the two SpaceX customers who technically won’t be in the world when they do figure eights around the Earth and the moon for two weeks this coming year—can look forward to another year of healthy growth in 2018. We’ve gotten so used to complaining about sluggishness that it’s a shock to realize the global economy has quietly accelerated to a respectable and sustainable cruising speed. Market volatility is historically low. Even the skeptical Germans sound happy. “The data we get and the indicators we see are very positive,” says Clemens Fuest, president of the IFO Institute at the University of Munich. “There is no obvious obstacle.”
The big story for 2018 is likely to be how to manage the continued expansion. A turning point may come at the end of September, when the European Central Bank might stop or curtail monthly bond purchases. The central banks bought bonds to drive down long-term interest rates; while the Japanese will keep buying, the Americans and soon the Europeans are betting that the patient, the economy, is finally well enough to get along without life support.
The International Monetary Fund, which has reported subpar growth for years, now says “the global upswing in economic activity is strengthening.” In its World Economic Outlook, published in October, the IMF says now would be a good time to deal with issues that went unaddressed during the convalescence from the 2007-09 financial crisis, including sometimes-unpopular measures such as raising retirement ages and making it easier for companies to hire and fire.
Bloomberg economists predict the U.S. will grow 2.5 percent in 2018; China, 6.4 percent; Japan, 0.9 percent; and Germany, 1.6 percent. In most cases those numbers are in line with the growth expected for 2017, which has turned out to be a better year than many forecasters expected.
The upswing hasn’t benefited everyone. The IMF points out that prospects are “lackluster” in many nations of sub-Saharan Africa, the Middle East, and Latin America. Even in wealthy nations, those at the bottom are hurting. In the U.S., wage growth remains anemic despite an unemployment rate in the low 4s.
Still, brisk growth that’s not shared by all is better than no growth at all. One reason for optimism about the outlook is that the global expansion seems to be based on strong fundamentals, not froth. In a virtuous spiral, confident consumers are spending, which allows employers to hire and invest, which leads to more consumer spending, and so on. Global spending by companies on plants and equipment is “in high gear with room to run” in the coming year, economists at JPMorgan Chase & Co. wrote on Oct. 25. The synchronized expansion reflects “a self-reinforcing turn in the global profit cycle that has boosted business confidence and spending in all corners of the world,” the economists said in an earlier note. To put it another way: “The expansion is not dependent on just one region or one sector,” says Richard Turnill, global chief investment strategist for BlackRock Inc. in London.
Healthy growth puts the world in a better position to deal with the next downturn, whenever it comes. Governments fight recessions by lowering interest rates, cutting taxes, and raising spending. Those tools are blunted if interest rates are already low and government debt is so high that governments can’t get away with bigger budget deficits. Policymakers’ goal for now is to normalize interest rates and repair their countries’ finances, gaining altitude so the next downdraft can’t plunge them into a hillside.
It’s also possible that we’re already headed for a crash. Economists are lousy at picking turning points. After Queen Elizabeth II questioned the failure to foresee the financial crisis last decade, a group of British economists wrote her a letter saying it “was principally a failure of the collective imagination of many bright people, both in this country and internationally, to understand the risks to the system as a whole.”
A key question for 2018 is whether consumers and businesspeople will continue to shrug off some pretty scary geopolitical threats. So far they’ve been nonchalant. The best example is South Korea, which has been rocked by threats of nuclear attack from the north, corporate scandals, and even a warning from President Donald Trump that its free-trade agreement with the U.S. might not survive. Despite all that, people are still shopping, and stocks are at or near record highs. The Bank of Korea is confident enough in the outlook that it’s signaling another interest rate hike on the horizon. (Economists expect it to happen next year.)
Similarly, on the other side of the planet, the economy of the U.K. has trundled along at a better-than-expected clip given the uncertainty over Britain’s exit from the European Union, which must take place by the end of March 2019. This is all the more remarkable considering the cack-handed way the government of Prime Minister Theresa May has conducted the talks. The headwinds of Brexit will “continue to stiffen as the clock winds down to March 2019,” Paul Sheard, chief economist of S&P Global Inc., wrote in October.
Or how about Spain, which could lose a fifth of its economy if Catalonia secedes? In the fraught leadup to Catalonia’s unauthorized September referendum on independence, Spain somehow managed to post the fastest growth of the big four Continental economies. Spanish imperturbabilidad will be tested in the months ahead.
One of the big stories to watch in 2018 will be how the EU reimagines itself in light of Brexit, the crisis in Catalonia, and the differing Euro-visions of French President Emmanuel Macron and German Chancellor Angela Merkel. Macron wants more fiscal integration than most Germans are comfortable with. “There is a window of opportunity” in the first half of 2018 for the French and Germans to come to some kind of compromise on governance, says IFO’s Fuest. After that, he says, Europe will be distracted by the approach of Brexit, European Parliament elections, and the choice of a new European Central Bank president in 2019. S&P Global’s Sheard agrees that “2018 is shaping up to be a defining year for the EU.”
Of all the world’s hot spots, it’s the U.S. that has the most potential to rock the global boat, at least according to one analysis. Dun & Bradstreet Inc. prepares a quarterly “global risk matrix,” and in the third quarter, 4 of the top 10 causes of concern were American. The biggest risk emanating from the U.S., D&B said, is that politics will “impede pro-growth economic policies,” which in turn will make businesses curtail hiring and spending, “sapping global momentum.” D&B’s three other American risks: The Federal Reserve raises rates too quickly; tax reform falls short of expectations; and U.S. productivity growth fails to accelerate.
Much of the rest of the world does look at the U.S. with a tinge of alarm. Trump pulled out of talks on the 12-nation Trans-Pacific Partnership as one of his first acts in office and repeatedly threatens to end talks with Mexico and Canada to renegotiate the North American Free Trade Agreement. “There is a risk that we do after all blunder into serious trade conflicts, with the U.S. leading the jump off the precipice,” says Willem Buiter, the chief global economist at Citigroup Inc. “I’m feeling more optimistic about things outside the United States right now than inside,” says Michael Froman, who was the U.S. trade representative under President Obama.
Constitution Avenue, home of the Federal Reserve, will be as important as Pennsylvania Avenue, home of the president. In 2013 the mere hint that the Fed would end its unprecedented emergency measures caused bond investors to throw a “taper tantrum” that walloped emerging markets. The markets seem to be taking the actual tightening in stride. But that could change abruptly, warns Erik Weisman, chief economist of MFS Investment Management in Boston. “We’ve never done this before,” he says. “It’s completely uncharted territory.”
China’s economic growth is predicted to slip slightly in 2018 as President Xi Jinping, beginning his second five-year term, pushes for changes that are good for productivity growth but disruptive, such as shutting down weak companies. Xi didn’t attempt such reforms in 2017 because he didn’t want to risk slowing the economy before the 19th National Congress of the Communist Party in October.
In Japan, 2018 could be the year the Financial Services Agency presses Japanese nonfinancial corporations to put to work more of the 250 trillion yen ($2.2 trillion) in cash on their balance sheets. More investment in plants and equipment would help fight disinflationary forces. A big question for 2018 is whether Prime Minister Shinzo Abe will reappoint Haruhiko Kuroda as governor of the Bank of Japan to an unprecedented second term.
One concern for the global economy as a whole is that the recovery has been built on too much debt, which companies will be hard-pressed to service when growth inevitably weakens. Marathon Asset Management LP, a firm that scoops up the bonds of distressed issuers after their prices fall, is looking at raising a new pool of investable funds in 2018. “When is our next default cycle? It’s not this year or next year, but possibly in 2019,” Chief Executive Officer Bruce Richards said at a September conference.
Even if the global economy does well in 2018, financial markets might not. Prices of stocks and bonds are so high that it wouldn’t take much of a jolt to send investors rushing for the exits. Investors Intelligence says newsletter writers with bullish outlooks outnumber ones with bearish views by the biggest margin since early 1987—months before the worst one-day stock crash ever. Bullishness is just as strong on the debt side, where even Tajikistan, six levels below investment grade, was able to issue bonds yielding barely more than 7 percent in September, note strategists at Eaton Vance Corp.
Some policymakers are invoking Hyman Minsky, the late American economist who said that stability creates its own instability by breeding overconfidence and bubbles. In October, People’s Bank of China Governor Zhou Xiaochuan said, “If we’re too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a Minsky Moment. That’s what we should particularly defend against.”
Politicians can’t relax, either. Economic improvement hasn’t healed political divisions or reduced “long-term fragilities,” wrote Bloomberg View columnist Mohamed A. El-Erian, chief economic adviser at Allianz SE, in October. Another way to say that is that a lot of ordinary workers remain angry about their situations and doubtful about their prospects. “It is way too early to declare ‘mission accomplished,’ ” El-Erian wrote.
So there’s plenty of reason for caution. For now, though, enjoy the ride, like those space tourists who will blast off in 2018. Says MFS’s Weisman: “This is about as good as it gets.”