US interest rate dilemma highlights fragile global economy
on September 16, 2015

McKinsey scenarios Sept15Should it really matter that the US Federal Reserve might raise US interest rates by 0.25% tomorrow?  Surely the IMF/World Bank should not need to argue that such a small increase could really be critical for the world economy?

The fact that such a debate has been taking place at all, highlights the damage done by stimulus policies to the US and global financial system, as the New York Times notes:

The banking system is almost comically awash in money. In June 2008, banks had about $10.1bn in their Fed accounts. The total is now $2.6tn. Picture all of the money in June 2008 as a single brick; the Fed has added 256 bricks of the same size. On top of that first brick, there is now a stack five stories tall”.

The volatility created by the “will she/won’t she” debate over Fed Chair Janet Yellen’s intentions has already led to enormous uncertainty in currency and other markets.  It has also confirmed the underlying fragility of the US and global economy. The Atlanta Fed’s GDP Now model is currently showing US Q3 GDP growth at just 1.5%.

As companies move into Budget season, they therefore need to focus their planning on mitigating the very real uncertainty about the outlook for 2016 – 2018.  One excellent way of doing this would be to debate the Scenarios above, developed by the McKinsey consultancy:

  • Global synchronicity describes a world where most major economies tackle their structural challenges, and are able to exit from aggregate demand stimulus smoothly
  • Rolling regional crises describes the opposite outcome. With structural challenges remaining largely unaddressed, the world economy becomes more vulnerable to regional crises and grows increasingly insular.
  • Pockets of growth describes the potential for growth to accelerate, but the major economies diverge
  • Global deceleration describes a situation where convergence takes place but at lower growth rates

Importantly, McKinsey highlight the need to understand demographic pressures, just as we have argued in Boom, Gloom and the New Normal.   It seems almost every commentator is now becoming aware of the critical importance of the changes underway, due to globally ageing populations and collapsing fertility rates.

Policymakers are virtually alone in choosing to ignore this common sense insight – as their presentations at the recent Jackson Hole, USA conference confirm.  This, of course, is why their policies have failed to spark the economic recovery they first promised 6 years ago.

  • They assured us that the 2008 Crisis was just a liquidity crisis, and said the need was to use stimulus to unblock the financial plumbing system
  • But in fact it was a balance sheet crisis, where there was too much debt – as people hadn’t saved enough to fund their extended retirement
  • They also promised us that that lower interest rates would stimulate demand
  • But in fact, the average European and Japanese household  is now headed by someone over 55, and the US is moving in that direction.  Lower interest rates actually destroy demand amongst this age group who are more dependent on their savings for spending money
  • A 5% interest rate on an average $30k saving pot would give them $1500/year to spend, or $125/month.  But instead today’s low interest rates mean they have to save more, and spend less, if they hope to have sufficient income to survive their likely 20 years of retirement

Policymakers’ theories about the economy were formed a long time ago, when the BabyBoom was well underway, and so essentially target the ‘average 40-something white male’ .  This is why they have failed to work as promised.

They ignore the complete change that has taken place in populations since 1970, with increasing female participation in the labour force, and the growth of multi-culturalism.  Biologists’ models of ‘competing populations’ would solve this problem overnight, if policymakers were prepared to look outside their own narrow field of academia.

This is why McKinsey’s Scenarios represent such a valuable contribution.  As they note in another new paper:

The world’s biggest corporations have been riding a three-decade wave of profit growth, market expansion, and declining costs. Yet this unprecedented run may be coming to an end

Today’s New Normal world means that the strong and constant growth seen in the BabyBoomer-led SuperCycle is unlikely to return.  Thus McKinsey’s Scenario 1 is probably the most unlikely scenario of all to be realised.  And all the others imply major change is underway – whatever interest rates moves the Fed makes tomorrow.

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