Is the world economy really recovering?

 Or has it started a new recession?

I collect and maintain hundreds of time series from countries all round the world: North America, South America, Asia, Africa, Europe, Australasia.   I have a program which adds together all the series and produces a composite index of them all.   It's unweighted, but the number of component series is highest for the US, China and Europe.  Most countries are represented.  I monitor PMIs, industrial production, retail sales, unemployment rates, inflation rates, business and consumer confidence, money supply, car sales, and so on, for most of these countries, and for the big ones, many more.  For example, "jobs easy to find" in the USA, and "production of bullet trains" in China.  Where necessary, I seasonally adjust each time series.  My world composite index is made up of 430 series.

The result is shown below.  The year-on-year rate of change in my world composite index is compared to the rate of change in my weighted world index of industrial production.

The YoY % change in my world IP index is barely above zero, and for my composite index, it's off its lows, but is still below zero.  In other words, it's still falling, but is falling more slowly.

This is consistent with a sluggish recovery, but not a new recession.  This view is confirmed by my US leading indices, which point to the strong likelihood of a sustained recovery, though as I said in my previous post, my leading indices do not include fiscal stimuli.  Be that as it may, my US leading index leads the world economy by +-6 months, and it's only levelled off in the last couple of months.  This recent blip is not at all consistent with a deep recession.

So why have world stock markets fallen so sharply? The reason is probably because there was excessive optimism.  Investors and traders believed that there would be a strong recovery, and marked up share prices accordingly, misled perhaps by the rebound from "revenge spending" in services.  There was also a nice little bubble around AI, which has been hyped.  It reminds of the dot-com boom in the early 2000s.  The market is beginning to doubt that AI will make much money for the global IT behemoths.

I don't think there will be a renewed recession, what has been called a "double dip" recession.  But I do think there will be a very sluggish recovery for the next few months.  China is weakening; Europe is struggling, and the rate cuts by the ECB (European Central Bank) have been too little, too late; the US is slowing as fiscal stimulus drains out of the system, and the Fed should have started cutting rates a few months ago.  Emerging markets are in strife, because their currencies are falling because of  "the flight to quality", imposing new and unwelcome constraints on their economies.

My guess is that the fears engendered by the stock market plunge will bring forward and accelerate rate cuts, not because Central Banks care about investors per se, but because sharply falling share prices suggest that seasoned observers of the economy have seen what is happening more clearly than they have.  And of course, plunging share prices will affect business and consumer confidence.

Interesting times.  

Central Banks were too late raising interest rates after Covid, and are now too late cutting them.  Their staffs are paid quite a lot to get things so wrong.

Debt and deficits after coronavirus

A fascinating chart from Getup!

See how Federal deficits in Australia surged during both world wars, as did the ratio of outstanding debt to GDP.  For example, the (Federal) deficit to GDP ratio peaked in 1944 at 20%.  The debt to GDP ratio peaked at over 100% two years later.  The debt to GDP ratio didn't fall because the Federal government ran a surplus (though there was a small one in 1949) but because the denominator in the equation rose.  Debt to GDP  was high in all post-war belligerent economies, not just Australia.  But they understood the thesis that Keynes had made, which was that raising taxes and cutting expenditure to repay debt was counter-productive, because these actions reduced economic activity, so although the deficits naturally reduced as war ended, they didn't attempt to create fiscal surpluses as had been done after WW1.   The truth of Keynes's theory was conclusively demonstrated during the Euro crisis of 2011, when forced deficit reduction led to a "double-dip" recession.

Once again, governments are running large fiscal deficits, to keep economies afloat during the covid crash.  And it will be interesting to see whether "austerity", which has been discredited again and again, will be introduced after the recession is over to pay back sharply higher debt levels, or whether they'll do as most economies did after the war, and allow the ratio of debt to GDP to fall as a result of economic growth.

There is in any case a difference between debt incurred to fund the construction of capital goods (railways, roads, schools, housing, factories) and debt incurred to fund current expenditure (wages and salaries, running costs, etc.)  It makes sense to fund, say, a railway with bonds, repayable over 25 or 30 years.  However, only in the rarest circumstances, borrowing to fund current expenditures is unwise.  This is one of those rare circumstances.

Europe continues to slow

I mentioned the close correlation between Austria's economy and the economy of the whole of Europe before.  The latest PMI survey data for September show another fall for Austria after the "flash" (preliminary) estimate for Europe also fell.  Though both surveys are still above 50%, i.e., are still growing, the gap between them and 50% has narrowed, showing the growth is lower.

In 2012, when the European economy experienced a "double-dip" recession as a result of the debt crisis, these indices fell below zero.  The ECB (European Central Bank) and the European government don't seem to  be managing this very well, frankly.  Growth for the last 6 years has for the most part been sluggish.  If the current cycle is to end soon, that is not good news.

The perils of ill-advised austerity

Europe's real GDP, i.e., after adjusting for price rises, is still below the pre-GFC peak.  An astonishing achievement.  This assumes a small rise in QII (data not yet available), which may not happen given the state of PMIs across Europe.  IP (industrial production) across core Europe is slowing, GDP will surely follow.  7 years of blunder and failure.  A triumph.  Provisional PMI for July out tomorrow.  We'll see what that shows.