Voices

Here’s what will signal a new global economic crisis

Just because the IMF has been wrong before doesn’t mean it is wrong now. This is a warning to take seriously, albeit with caution
(AFP/Getty)

The International Monetary Fund (IMF) has sharply downgraded its world growth forecasts, and warns that risks are rising. It is worried that a trade war might knock near half a percentage point off growth in the long term, and it thinks that a return to quantitative easing (printing money to you and me) may be needed if there is another crisis.

The fund has this week published two reports to coincide with its annual meetings. One is the World Economic Outlook, its twice-yearly assessment of the global economy; the other the Global Financial Stability Report, which has just taken a look at the past decade since the financial crash of 2008 and the subsequent global recession.

What should we make of all this?

Well, the IMF does not carry quite the cachet it did a decade or more ago. Its annual meetings are shorter events and commercial bankers no longer flock there in the numbers they once did; instead (ahem) they go to Davos.

The reputation of the IMF has suffered too. It still gives one of the best snapshots of what is going on, but it has had a run of serious misses. It failed to catch the Great Recession of 2009 – a failure that led to its current scrutiny of financial stability. Since 2012 it has been far too optimistic about world growth, repeatedly predicting a much faster pickup than took place. Only once was it too pessimistic, in October 2016, and only once was it more or less right, in October last year. On average, over the past decade, its predictions have been 0.5 per cent too high. That is huge.

However it was also far too pessimistic about the UK in the aftermath of the Great Recession, when actually it turned out that we had, until the Brexit vote, the second fastest recovery (after the US) of any G7 economy.

This context is important. Just because the IMF has been wrong in the past does not mean it is wrong now. But it does mean that we should take what it says with caution. It collects a lot of data, gives a useful framework for thinking about the future, and useful warnings about risk. There is a global economic cycle, and there will be a downturn somewhere in the future. So what should we look for in terms of warning signs, and what are the chances that policymakers will be able to respond better next time than they did last?

Here are my top three warning signs.

The first is that global inflation will rise faster than people expect: interest rates have to rise, and consequently there are serious defaults. The worst case would be a sovereign default, where a sizeable developed country declares it will reschedule its debts. Italy is the obvious candidate, but because it is so obvious it may not be the best place to look.

Not holding things together when Lehman Brothers was allowed to go under was a massive failure of policy. Central bankers and finance ministers were both scared and scarred by it

The underlying point is that 10 years of very low interest rates and a huge increase in global debts is a toxic mixture. Can the world’s central banks keep rates down? Not if inflation surges.

A greater than expected rise in interest rates would undermine asset values. Just in the past week we have seen US share prices held down by rising US bond yields, but they are still very high by historical standards. (UK shares, by the way, are pretty much in the mid-range of valuations.)

The second warning sign would be escalation of trade tensions – one of the key concerns identified by the IMF. It is hard to know what are mere words and what is substance. The momentum behind global trade is very strong, and the politicians would have to hit it jolly hard to make a material dent. But maybe we all take global prosperity too much for granted. America and China may miscalculate. The EU and the UK may miscalculate. I don’t want to get into the rights and wrongs of either of those current tussles, though I would just say that the US/China relationship is much more important than our little squabbles with Europe.

The big point here is simply that businesses – who run world trade – need certainty. Sudden, impulsive changes in policy undermine that. Once damage is done, putting things together again is slow work.

The third warning sign would be currency volatility: a surge in the dollar, a breakup of the eurozone, a collapse of the Chinese yuan... whatever. Currency volatility is damaging in itself for it can bankrupt businesses. It is also damaging as a symbol of a lack of faith in monetary institutions.

So faced with new and possibly unexpected challenges, how might the authorities cope?

Here I am more optimistic. Allowing the banking pressures to build up, and then not managing to hold things together when Lehman Brothers was allowed to go under, was a massive failure of policy. Central bankers and finance ministers around the world were both scared and scarred by it. That folk memory will last a generation.

You can see now in the planning for a rough Brexit that the Bank of England does not want to be caught unprepared again. I am sure the European Central Bank will brush up its act too. Both the US Federal Reserve and the Peoples Bank of China are well led; they are headed by thoughtful, experienced central bankers.

What we don’t have is similar thoughtfulness and experience in global politics. That is the result of the whole populist surge, which is by no means over. You can believe that old elites in the developed world overreached themselves and became detached from their electorates, but still want reasonable competence among politicians.

I suppose in a way the IMF reflects the vision of the old elites. It was after all one of the three Bretton Woods institutions founded after the Second World War to build prosperity. It gets things wrong, but it did help build that prosperity.