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World economy downhill from here

When I planned for this week's article, I wanted to write about the illusions of today's economic picture such as the robust GDP growth in emerging economies, declining inflation rates, booming travel business, strengthening of the Thai baht, and so on. But even with the economic data and theories to back up my claims, who would believe me? Who would believe that the current robust demand is nothing but an example of short-term, pent-up demand after two years of the Covid-19 outbreak? Who would consider the fact that consumers have no increased purchasing power to sustain today's level of consumption? Most of all, who would imagine that things would change drastically in the fourth quarter after consumers face the reality of a higher cost of living and stagnant income?

Dr Chartchai would just be seen as a pessimistic economist who cannot accept the resilience of the world economy. And then the International Monetary Fund (IMF) will come swooping in to the rescue.

In a report preparing for the two-day G20 summit that wrapped up yesterday in Bali, Indonesia, the IMF said the global economic outlook is getting “gloomier” and is surrounded by abundant risks. The IMF’s argument is based on the declining Purchasing Manufacturing Index (PMI), which shows the prevailing direction of economic trends in the manufacturing and service sectors. An index above 50 indicates the sectors are expanding while one below 50 means they are contracting. The global PMI for October was 49.0. It is projected to further decline for both the G20 countries and emerging economies. According to the IMF, countries representing one-third of global output are projected to face an economic contraction.

The IMF adds that while there are multiple headwinds weighing on growth, further policy tightening is expected amid the need to bring down elevated levels of inflation. Prolonged high inflation could also result in higher-than-anticipated interest rate increases. In short, if you believe the IMF’s view about the world economy, you should give up the dream that the US Fed and other major central banks will slow down their policy rate hikes.

There are basically three reasons why so-called “beautiful world” economists have an optimistic view on the global economy.

First, US inflation has been on a declining trend. That peaked at 9.1% in June and contracted to 7.7% in October, below the projected rate of 8.0%. The improved rate of inflation has led many analysts to believe the Fed will implement a 50-basis-point hike in December rather than the 75 points it has been raising rates by recently.

Second, air travel demand has been surging after most countries lifted their travel restrictions. Bain and Company, an airline industry consultant, forecasts that 2022 air travel revenue will amount to 84% of the level seen in 2019. The boost in sales mainly comes from international travel between Europe and America, as well as domestic ticket sales in China.

Third, emerging economies are performing much better than expected, particularly in Asean. In the first nine months of this year, Malaysia’s economy grew 9.36%, Vietnam’s expanded 8.8%, the Philippines’ grew 7.76% and Indonesia’s 5.39%. Even a developed economy like Singapore posted growth of 4.2%. Thailand has not announced its third-quarter growth yet. But in the first half of the year, its economy expanded 2.4%. Why is Thailand lagging so far behind its Asean neighbours? That would require a separate article to explain. But in a nutshell, the Thai economy lacks the internal strength to grow on its own accord, as it depends on “external” income such as exports and tourism.

The other camp of economists, which includes the IMF and myself, has a completely different view of things. This can be summarised as follows.

First, central banks around the world still have a lot of work to do to contain inflation. Let’s take the US as a typical example. Despite the fact that inflation has been subsiding for five straight months, core inflation remains excessively high. This currently stands at 6.28%, compared to the long-term average rate of 3.66%. It’s also much higher than the Fed’s desired rate of 2%. Theoretically, the Fed would need another rate hike of 3%, thus bringing the Fed Funds Rate to 7%, to achieve the long-term average core inflation rate, before later being able to lower interest rates to 4-5%.

While raising interest rates, central banks will suck out liquidity (money) from economies, which, in turn, weakens domestic demand. The first category of demand to (substantially) decline is durable goods such as housing, automobiles, high-priced electronic products, and electrical appliances. This is the reason why the IMF foresees a contraction in world output.

Second, what the world is currently experiencing is not actual demand but rather pent-up demand in the wake of Covid. When this has been satisfied, the economy will show its true strength. Remember the glowing economies of Malaysia and Vietnam that we mentioned before? Malaysia’s PMI for October was 48.7% — its lowest in 13 months — which means the economy is already contracting, while Vietnam’s PMI for the same month was 50.6%, putting it on the verge of an economic contraction.

Third, China is a troubled economy and will remain so over the medium term. The root problem is that its economy is facing a serious bubble. The government has been stimulating growth by pumping excessive amounts of money into its economy. China’s broad money-to-GDP ratio is 211.9%, as opposed to 111.5% in the US and a global average of 143.5%. (For those who have been misinformed that the US is simply printing too much money, to the point that the greenback will soon become worthless, the People’s Bank of China has been printing twice as much money as the Fed.) China’s real-estate bubble is a byproduct of this excessive money supply.

The trick is that the world cannot see this excessive money supply in government debt, which is merely 20.3% of GDP, or household debt, which is 62.4% of GDP, because it is hidden in state enterprise debt.

But bad debt cannot be hidden forever. With the slowdown in China, severe debt problems will surface throughout its economy. And Evergrande Group is just the tip of the iceberg. China is likely to need three to five years to clean up its debt problems. Until then its growth will slow, causing havoc for its trading partners.

I hope myself and the IMF are mistaken, and the world economy is on the road to recovery. But the odds don’t look good.

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