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Is the Global Economy Much Worse Than Experts Say?

Investopedia logoInvestopedia 11-07-2016 Lawrence Pines

Despite dour economic news in 2016, economists remain optimistic about global growth. Excessive debt levels, slow growth in China, Japan and Europe, wage stagnation in the United States, and commodity deflation have failed to derail modest growth expectations for the global economy. Although the International Monetary Fund (IMF) lowered its global growth estimates from 3.4% to 3.2% in April 2016, the forecast still exceeds 2015 levels.

The June 23, 2016 Brexit vote in the United Kingdom may lead economists to lower growth estimates again. However, weak economic news in 2015 and 2016 has failed to alter economists' fundamental belief that global economies are improving. Despite economists' optimism, investors should worry. The actions of global central banks, commodities markets and labor markets suggest that the global economy is in far worse condition than experts admit.

Central Banks Remain Overly Accommodating

Actions by global central bankers remain overly accommodating, despite official claims that economic growth is on the mend. On March 10, 2016, the European Central Bank (ECB) cut its main refinancing rate to 0% and its deposit rate to -0.4%, and expanded its bond-buying program. Similarly, the Bank of Japan pushed short-term rates into negative territory in January 2016 in an effort to stimulate investment and consumption. Even the Federal Reserve Bank (Fed) in the United States remains overly accommodating. After jawboning about the need for higher interest rates, the Fed raised rates only 25 basis points in December 2015. The rate hike was the first in 10 years, and the Fed has not moved rates higher since this decision. In fact, since the Brexit vote, markets are pricing in no chance of a rate increase at the next three meetings and only an 8% chance of a hike in 2016.

The central banks in developing markets have also remained extremely accommodating. The People's Bank of China (PBOC) moved its benchmark one-year lending rate to a record low of 4.35% in 2015. An April 2016 survey found that economists expect the PBOC to cut the rate to 3.85% by the end of 2016. If the prospects for global growth were as strong as the IMF suggests, then central banks are expected to tighten, not loosen, monetary policy.

Commodities Price Slow Growth

Prices for a broad basket of commodities have been steadily declining from 2011 to 2016. The Bloomberg Commodities Index, which traded at $156.86 on July 1, 2011, closed at $86.66 on June 27, 2016. Key commodities, such as oil, have mirrored those steep declines. The price for a barrel of crude tumbled from $94.94 on July 1, 2011 to $46.59 on June 27, 2016. Since oil is used in virtually every industry, its decline should be troubling for investors. Similarly, prices for copper have experienced steep declines. Copper futures dropped from $430.25 on July 1, 2011 to $212.60 on June 27, 2016. If growth is as strong as economists say, commodity prices should experience some inflation, not deflation. The implications for investors are troublesome, since deflationary conditions limit pricing power for companies.

Stagnant Wages Erode Purchasing Power

Growth in real median household incomes in the United States, the world's largest economy, has been negative for most of the 21st century. In other words, consumer incomes have remained below their purchasing power in 2000. Real incomes, which are adjusted for inflation using the consumer price index (CPI), reached a low of -9.6% in 2011, before steadily climbing to close to 0% at the end of 2015. However, real incomes are ticking lower in 2016 and stand at -1.5%. If the recovery was as strong as economists suggest, then real wages should be rising. However, declines in real wages suggest labor market slack. Despite low unemployment numbers, economic purchasing power for consumers remains weak.

Emerging markets, such as China, show similar anemic wage growth and, in some cases, declines. In 2016, migrant workers expect income increases of 7%, which is a decline from the 7.2% rise in 2015. Louis Kuijs, chief Asia economist at Oxford Economics in Hong Kong, summed it up succinctly: "You cannot expect wage growth to continue to power ahead if business conditions and profit developments are weaker."

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