As the Federal Reserve (Fed) interest rate hike continues, it has triggered turbulence in global capital markets since October; the expectation of the global economy has become increasingly pessimistic, which also raises questions about the Fed's policy framework. The U.S. President Donald Trump has repeatedly criticized the negative impact of the Fed's decision to raise interest rates on the economy. However, the economic indicators such as inflation and employment rate in the United States are still normal and maintain a healthy growth trend, whereas, many institutions and scholars have made different expectations for the future of the United States and the global economy from that of the Fed. The reason behind this divergence is that the structure of the global economy itself has undergone tremendous changes since the 2008 financial crisis. Whether we can fully recognize this change is an important issue to be taken into account in judging the current economic situation and expectations.
In fact, the development in the decade since the financial crisis has confirmed the scenario in Crisis Triangle model "urbanization - capital surplus - crisis", as predicted by Anbound's chief researcher Mr. Chan Kung. Since the financial crisis, the world economy that has been immersed in excess capital for a long time is now struggling to return to the conventional "normalization". At present, the excess capital has been accounted for a larger share of the world's total capital than in the past; the financial bubbles have become a natural part of this credit-expanding world and the world's economy is more virtual than it used to be.
In the past decade, the global liquidity flood resulted from the financial crisis rescue, the increasing dependence of economic growth on the allocation of financial resources, and the high debt leverage have become the main dangers faced by the current global economy. According to the statistics from Institute of International Finance (IIF), by the end of the first quarter of 2018, global debt has climbed to US$ 247 trillion, which has increased by US$ 75 trillion or 43% since the end of 2008. Moreover, the proportion of US$ 247 trillion global debt in global GDP has risen to 318%, which is far exceeding the 150% warning level. The total debt of households, governments, and non-financial institutions soared to US$186 trillion, a 50% higher than that of 2008; while the financial sector debt rose to a record high, up to US$61 trillion. At the same time, global GDP grew by just US$ 24 trillion, an increase of 37 % over 2008, and the debt-to-GDP ratio expanded from 2.9 to 3.2 times. The mismatch between income and debt is worsening and the increased burden of debt is making economic activity more sensitive to interest rate changes.
At the same time, we must also realize that there is a lot of the injected funds flow into the financial and asset markets. According to the relevant data, the total value of stocks in the world has risen to US$52 trillion (as at the end of March 2018), which is about 2.6 times than that of 2008. The increase in global liquidity in the past decade has made the bubble of financial assets much bigger, which would also have an increased impact on the real economy. In such a world, it is even more difficult to withstand the changes in valuation brought about by rising financial costs (interest rate). Underestimating this sensitivity and vulnerability factor could make this tighten monetary policy disastrous for the global economy.
Judging and estimating the economic situation requires an adequate assessment of the impact of financial markets on the economy. Bank of America (BofA) has also released its latest recession forecast, with Michelle Meyer's team of economists measuring a variety of market indicators putting the risk of a recession in the United States in 2019 in the 20-30% range. However, those indicators based on economic data show a less than 10% chance of a recession in the next six months.
From the perspective of the real economy, American agriculture, which is most vulnerable to risks, has been the first to signal a crisis. According to the Federal Reserve Bank of Minneapolis, data from farmers in Wisconsin, North Dakota, South Dakota and Montana who filed for bankruptcy restructuring under Chapter 12 of the bankruptcy law have risen sharply, doubling as compared to the same period in 2013-14. At the same time, the farmers' delinquent payments are on the rise, leaving banks worried that the worst is yet to come. Clarity Financial analyst, Jesse Colombo, who had accurately predicted the 2008 financial crisis, said the recent wave of farmer bankruptcies in the United States was just the beginning of the negative impact of the Fed's long-term low-interest rate policy and that a deeper recession is on its way. In this round of drops in prices for crops, the soybean, corn and dairy products have suffered the largest decline due to the rapid growth of production. Rising interest rates have been blamed for a wave of bankruptcies among American farmers. After the last economic crisis in 2008, the Fed maintained a low-interest rate environment for nearly seven years, during this period, farmers borrowed heavily to buy expensive agricultural machinery and land. As the Fed gradually raised interest rates in the past three years, farmers faced more pressure to repay their loans. Colombo also noted that the current bankruptcies in the agricultural sector have confirmed his judgment that "raising interest rates will trigger the next economic crisis." In the last cycle of quantitative easing, the Fed released the "wrong signal" by lowering interest rates to encourage borrowing that would eventually push the economy into recession as the interest rates rose.
Therefore, Anbound's chief researcher Mr. Chan Kung believes that the worsening global debt problem makes the current economy very vulnerable to rising interest rates, and the Fed's policy framework may be too academic under the current situation. The current fragile situation cannot only be measured from the perspective of the financial framework at all. If the Fed does not consider from the perspective of economic structural changes, but only considers the inflation and employment target of the United States to judge whether to raise interest rates or not, it is inevitable to underestimate the negative impact of rising financial costs and the shrinking liquidity. In this respect, President Trump's economic instincts may be closer to reality. As the problems in the U.S. economy gradually exposed, it is likely that if interest rates continue to rise, there will be more bankruptcies of businesses and farmers in the U.S. and the capital markets will plunge. A similar situation exists in other countries as well; in the current fragile global economy, it is likely that countries with quantitative easing in the past will not be able to withdraw from its low-interest rate environment.
Final analysis conclusion:
The Fed raises the interest rate based on traditional financial frameworks, and its exit from quantitative easing and returns to "normalization" has resulted in de facto tightening. But the current global and U.S. markets have become less tolerant of higher interest rates. The world, accustomed to quantitative easing, can no longer afford the so-called "normalization" of currencies.
