Investment is a tricky thing. You put up a lot of money in the expectation that you’ll have a small return year over year. Currently, the expected rate of return is historically small in the developed world, on the order of a few percent. It has to be weighed against the risk that the initial investment will never be paid back, winding up in default.
The slowdown in the global economy is not actually a decline in output all over the world, but a pause in the rate of growth. It wasn’t expected, either, which is the real problem. The developed world is largely stagnant, save some hope in the US for better times ahead. The developing world need to catch up, but appears to be taking a breather after a tremendous run.
As we consider the next few years and the potential for a genuine boom ahead, it is becoming clearer that we aren’t ready for anything more than muddling through until there is a reckoning and a realization of how the next economy will work – for everyone. That will take some patience and public investment all over the world.
The price of oil is the clearest sign that things aren’t right in the world. Global demand for oil was expected to increase by a bit over 2% in 2014, from 90M bbl per day to 92M bbl per day. It wound up increasing by only 0.9M bbl per day, with the rest stockpiled in large tank farms. Supply has been running ahead of demand for nearly a year now, and the result has been a general collapse in the price.
The reasons for this have everything to do with the restructuring of the global economy. The US economy is firing up with little change in overall demand for oil, stuck at around 19M bbl per day since 2010. Europe isn’t growing much, and demand is also stagnant.
Growth is expected to come from the developing world, but the second largest consumer of oil, China, is facing a decline in its incredible rate of growth. They are still expected to consume 10.7M bbl per day in 2015, but that’s up only 0.3 bbl per day or 3%.
The reason for this is a general slowdown in China that has their incredible rate of growth slowing down below 8% per year for the first time in two decades. Their expectation was that they could continue growing like that forever, and it’s priced into everything. The slowdown has made investors nervous for about a year and a half now, with many expecting a general failure of their banks as a result. When loans are made under the assumption that growth will be robust, everything has to run like clockwork to make it happen.
Failure to meet expectations is a failure. Growth has to be more than good, it has to be perfect.
The central bank of China has responded by lowering the capital requirements for banks in an effort to free up money for investment across the nation. Foreign investors are reasonably nervous about this strategy for obvious reasons. The slowdown in demand, either for Chinese goods in developed nation or as internal Chinese demand by their still-waiting-to-develop middle class, cannot be goosed by more investment money. There is only so much a central bank can do.
It is a mirror of what has happened throughout the developed world in that everything is being run by central banks. They are only able to control the supply of money, which is to say how much cash is available for investment. This is what “supply side” economics is genuinely about – the money supply. The theory is that more cash available to invest creates more investment, which creates jobs, which fires everything up.
It doesn’t work that way when there is a general slowdown in demand.
The alternative, demand side management, is trickier. It’s often called Keynsianism after its first big promoter, John Maynard Keynes. He was the one who called for direct job creation programs in the Great Depression of 1929 in order to stimulate demand for goods, which would in turn create more production and create opportunities for investment. Central banks can’t do this – it’s up to governments and private industry (not necessarily in that order, of course).
What this comes down to, however, are the expectations of people in their own private lives. Will more gadgets and more consumption make us all happier? If you ask the developing world, the answer is generally a solid “Yes!”. They don’t like being left behind. If you ask the developed world, however, there is every reason to believe that stagnant population growth and lower expectations resulting from years of Depression have people much happier with less – at least in terms of more every year.
This thing called an “economy” remains nothing more than a collection of values, after all.
How can we increase demand around the world? The short answer is that we probably can’t, at least in the short term. The restructuring to the next economy is far from complete, and the values of the people who make up this great big global economy have not been determined. The developing world has its own infrastructure and civil problems to take care of before they can say they have a stable consumer class.
Expectations have been running high since the world pulled out of the worst of this Depression starting around 2012. They shouldn’t. We are doing fine on our own, and some activity such as a slowdown in the growth of oil consumption will be good for everyone in years ahead. It just makes it harder to set big expectations for a quick turnaround. Where high growth has been priced into investments, such as in the stock market, there is only a setup for disappointment.