The global economy is still weak, and worries lurk
While the IMF will release its latest forecasts next week, managing director Christine Largarde has provided a sneak preview in a talk to the Georgetown University, and it is worrying. Without divulging exact numbers, she says the global economy is weaker than envisaged even six months ago and, as a result, the potential for growth has also been pared down—needless to say, the rebound is the strongest in the US and the weakest in the euro area. While this is par for the course after the world nearly got into the next great depression in 2008, what’s worrying is that many of the legacies of 2008 remain in the form of high debt burdens and large unemployment, a potent combination against any form of structural reform. Since, and Lagarde doesn’t specifically talk of QE, much of the Fed’s stimulus went into financial markets, asset valuations are at an all-time high and spreads/volatility at an all-time low. Which is why there is so much fear about how markets will react as US interest rates start rising—the simple fact is people just don’t know.
What complicates things is the shadow banking that was the precursor to the 2008 financial crisis, risks hidden in the non-banking sector that is nowhere as well regulated as banks. The shadow banking sector is larger than the formal banking sector in the US, though the IMF believes the systemic risk here is similar to that of the formal banking sector. Even so, since shadow banking by its very nature relies on short-term funding, this remains prone to sharp fluctuations in prices and can cause, as it did in 2008, its own sets of asset price crises if all investors want out at the same time. In China, with even less information available of non-bank products and with little central control, the worry seems accentuated—more so since the assets of the shadow banking system is largely invested in real estate. In other words, the world is still a risky place and is prone to sharp ups and downs, though hopefully the 2008 kind of oscillations are behind us. Continuous vigil, clearly, is required.