The world’s economy is in “quite a mess right now,” and while the American economy is doing well, its growth remains “mediocre by historical standards,” argued Carl Weinberg, chief economist of High Frequency Economics. It’s hard to overstate the deleterious effect of falling commodity prices, Weinberg said in a Thursday webinar. “There’s a crash in commodity prices right now that’s potentially catastrophic to the global economy,” he said.
The steep price declines in everything from iron ore to gold to agricultural products — not to mention oil—“10 or 20 years ago” would have had only a modest effect on global GDP, but that’s not now the case, he said. “It used to be that emerging market economies didn’t matter so much,” but Weinberg pointed out that the share of global GDP from developed countries — accounting for about a third of global GDP — is “no bigger than the share of emerging markets.”
The problem is that the commodity “crash” is reducing income within developing markets, and since “they’re poorer, they import less from the rest of the world.” In the developed world, “we feel richer with lower oil prices, but in the countries that export this stuff, it’s catastrophic.” That’s already happening throughout the developing world in countries like Venezuela, Russia, Nigeria and Saudi Arabia, he said. “They’re facing a decline in imported goods, and their economies are going to need to figure out how to finance their governments.”
Asking whether China poses a potential headwind to global growth, Weinberg expressed little concern. “Lower commodity prices in China won’t affect inflation; there is no inflation in China.” In fact, while the Chinese stock market’s problems have prompted contagion fears and stock market declines around the world, he argued that “Shanghai shares don’t correlate with GDP,” and that Chinese companies will “do better” as commodity prices fall, producing higher corporate profits in China.
“It’s a speculative, oversubscribed” stock market in China, he said, but “economics have little to do with the market.” What does concern him about China is a drop in its foreign exchange reserves, saying the Chinese government has “sent abroad $1.25 trillion over the last five quarters,” using its foreign reserves to “inject the yuan into foreign markets,” along with China’s political influence.
Returning to his theme of falling commodity prices and slowing global GDP, Weinberg said he couldn’t point to direct causation between the two developments, but there’s certainly correlation. “Every time commodity prices have dropped, we’ve seen a drop in world GDP.” He’s also deeply troubled by the decline in world trade (12% in value in the latest report from the International Monetary Fund in October) and noted that the sequence of decline in commodity prices is different than the last time such a steep drop occurred — in 2008-2009 — when “demand dropped and prices fell. Now it’s prices falling first.”
Weinberg used this anecdote to explain the effect of falling commodity prices. “If you take money out of a rich person’s pocket in Norway and give it to a person in Nigeria, the Nigerian will spend most of it; the Norwegian won’t really feel it. If you take money out of a Nigerian’s pocket and give it to someone in Connecticut, it will mean less is spent.”
The “icing to this cake” of a decline in oil prices and other commodities is that “we’ll see continued declines in year-over-year inflation rates,” and especially if oil prices continue to decline, “we won’t get an acceleration in headline CPI” but rather “we’re looking at potentially negative CPI year over year and for the next year.”
Back home, Weinberg said that higher interest rates fostered by the Federal Reserve’s moves will “lead to a stronger dollar and more capital flows” into the country, handing off a discussion of the U.S. economy and markets to HFE’s chief U.S. economist, Jim O’Sullivan.
O’Sullivan said that while the 7% year-to-date decline in the S&P 500 is “attention grabbing,” the lower oil prices and a strengthening dollar “are much more negative for the S&P 500 than the economy at large; the U.S. economy is doing better than equity markets.”
While acknowledging that worries about the stock market “can become self-fulfilling” prophecies, his bottom line for the U.S. economy is that “outside of manufacturing and mining,” the economy is “doing fine, with enough momentum to keep unemployment down, and the Fed to do more tightening.”
Yes, GDP growth has been relatively weak, with some volatility, but O’Sullivan said HFE expects “2.0% to 2.5% growth to continue,” with the jobless rate declining, despite a “sizable slowing in the labor force and productivity,” partly due to demographic factors. One area of concern to him is manufacturing, suggesting economic watchers “keep a close eye” on the manufacturing ISM export orders index, which he said “is weak, but not in a freefall.”
Unemployment has been “falling more rapidly than expected by Fed officials,” O’Sullivan said, bringing the U.S. “very close to full unemployment level,” and “core inflation remains tame.” He reminded Fed watchers that its mandate “relates to labor market and inflation, not GDP and inflation,” and said even “wage gains are showing signs of acceleration.”
Addressing the markets, O’Sullivan repeated that the “high level of anxiety in the markets as reflected in S&P have been triggered by equity market weakness in China,” and expressed some concern that if U.S. equities keep falling, there could be a “feedback effect on the economy,” but reiterated that there is “no correlation between the S&P 500 and the Shanghai index,” nor between “equity markets and GDP.”
— Check out Gundlach: Why Q1 Could Be ‘Really Ugly’ on ThinkAdvisor.