The mood at the annual IMF gathering of economic bigwigs in October was notably more downbeat than a year earlier, with warnings about record government debt and anti-globalisation adding to 'secular stagnation' gloom. The IMF has been surprised by the weakness of the US economy in 2016 – it now projects GDP growth of only 1.6%, versus a 2.8% forecast in October 2015. With the US engine stuttering, the global policy-making consensus fears that the world economy will soon hit the buffers.
Investors should stay calm. The bigwigs have no record of foresight. This year’s US economic slowdown was predicted by a weakening of monetary trends in late 2015 – to which I drew attention a year ago. The monetary runes in the US and globally are now signalling a brighter outlook.
The chart shows six-month growth of real (i.e. inflation-adjusted) narrow money in the Group of Seven (G7) major economies and seven large emerging economies (the “E7”). Narrow money comprises currency in circulation and demand deposits – the forms of money most closely related to spending in the economy. Real money growth has been picking up since late 2015 and usually leads activity by six months or so. Sure enough, industrial output has been rising at a faster pace since spring 2016.
G7+ E7 output, real money and leading indicator (% 6m)
Source: Thomson Reuters Datastream, 31 January 2005 to 31 August 2016
The positive signal from monetary trends was confirmed in early 2016 by an upturn in a non-monetary G7 plus E7 leading indicator that combined a range of forward-looking economic and financial series. The indicator has continued to firm in recent months, while real money growth has reached its highest level since 2009. Global growth could be much stronger than the consensus expects in 2017.
Global narrow money strength reflects pick-ups this year in the US and Japan coupled with continued Chinese buoyancy. Real money growth is now solid across the major economies, strengthening conviction in a brightening outlook.
Business spending may drive economic acceleration. Firms reduced outlays in response to pressure on their finances in 2015 but earnings have rebounded in 2016 – Chinese industrial profits are rising at a double-digit annual pace, with S&P 500 earnings likely to match this rate of increase by late 2016.
Fiscal developments are much less important than monetary trends for assessing economic prospects. The monetary pick-up, however, has been accompanied by fiscal loosening: the “structural” budget deficit (i.e. adjusted for the cycle) of advanced economies will widen in 2016 for the first time since 2010, according to the IMF. A post-election US “stimulus” package may contribute to a further increase in 2017.
Global economic acceleration is occurring against a backdrop of tight G7 labour markets and modest demand expectations of commodity suppliers. This suggests the potential for an upside inflation as well as growth surprise in 2017, in turn implying a need for global monetary policies to shift from easing towards tightening.