What’s Really  Driving the Global Cycle

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I came across some fascinating research over the weekend.

It was from Tuomas Malinen at GNS Economics, and I’m going to share it with you today.

Because if he’s right, then you’ll need to pay special attention to what’s happening in China right now.

Let me explain…

Not the US this time

Usually it’s the US economy that drives the global cycle.

As the world’s biggest economy, it makes sense. And it played out like that for most of the 20th century.

The ‘they sneeze, the rest get pneumonia’ sort of thing.

But Malinen says that it’s China that is now driving the economic cycle, not the US.

Let me take you through his thinking…

Here’s a graph that shows this effect in action:

Money Morning

Source: GNS Economics

[Click to open in a new window]

These leading indicators show that most big economies have been following China’s (the yellow line).

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Malinen goes onto explain how they came upon this relationship:

This was revealed to us, when we were making an in-depth analysis on the world economy in early 2017 to understand, why it had recovered with a break-neck speed from the deep slump of 2015.

The “culprit” for this mystery turned out to be the shadow banks of China.

Shadow banks are unreported or unofficial lines of credit. And in China they’ve been growing fast.

Money Morning

Source: GNS Economics

[Click to open in a new window]

So, basically China’s huge increases in debt have filtered out into the world economy and supported growth.

Malinen calls it ‘the biggest debt-stimulus ever seen.

That debt has kept the world ticking over since the slump of 2015 to the present day. But in fact, this driver of growth started ever since the GFC in 2008.

GNS Economics estimate that China has accounted for a whopping 50% of all capital investment in major economies between 2009 and 2017.

Money Morning

Source: GNS Economics

[Click to open in a new window]

Now here’s the worrying part…

The sugar hit is ending

Malinen and his team say that productivity in China has been falling since 2011. Meaning that all that new debt was creating less and less economic growth every time it was unleashed.

The sugar hit is wearing off.

Effectively the economy has become ‘zombified’.

Money Morning

Source: GNS Economics

[Click to open in a new window]

Recognising this effect, China started to scale back its lending in 2017.

And this was starting to slow down the global economy in 2018, until the Trump tax cuts carried the world economy forward again.

Since then, the big economies have joined in to keep new sugar hits coming.

In 2019 we’ve had rapid falls in global interest rates, the restarting of money printing in the US, Europe, and China, all in a vain effort to keep the economy going.

It’s not even disguised anymore.

As the new head of the European Central Bank (ECD), Christine Lagarde said recently:

We should be happier to have a job than to have our savings protected.

Expect the attempts at can-kicking to continue…

But Malinen says, the power of debt and QE is reaching an end point and is becoming less effective every time it’s used.

He concludes:

Alas, it’s useless to think that the #centralbanks, with their additional mon. easing and QE, could turn the global cycle around. We are currently experiencing a ‘bounce’ from China’s massive early fall stimulus, which is unlikely to continue and/or to be effective.

The rather mediocre “stabilization” seen in econ. indicators across the globe is thus a ‘red herring’. Markets will gain a boost from the artificial liquidity central banks are currently conjuring, but the world #economy is still heading down.


My take

It’s very interesting stuff.

And it’s similar to the views of my bearish colleagues such as Vern Gowdie. He has long warned that the power of debt would eventually stop working.

Myself, I’m a bit less pessimistic…

While China may have run out of ammunition, other economies are starting to pick up the slack.

Lakshman Achuthan, of The Economic Cycle Research Institute (ERCI), told Bloomberg yesterday that Europe is surprisingly beginning to see an up-tick in industrial activity. GDP numbers in France and Italy are stronger than expected.

And don’t forget this…

In the US, President Trump has an election to win in 2020. And I expect him to pull a rabbit out the hat when it comes to a US–China trade deal when it’s politically expedient.

Again this should flow into a bump in economic growth.

And although China’s debt is a problem, a rising juggernaut of middle class growth could quickly get this back to manageable levels, if China’s economy can get through this rocky patch.

Yesterday the online shopping frenzy in China called ‘Singles Day’ sold a mind-boggling two parcels for every single person in China. Clearly consumers here are still in the mood to buy.

Lastly, I always have one eye here…

The Indian economy is a dark horse that could contribute to global growth in the next few years in a very meaningful way.

In short, don’t let the market pessimists scare you too much. Have a plan if they’re right (and they will be one day).

But it could be a lot further out than they imagine.

Good investing,

Ryan Dinse,
Editor, Money Morning

PS: US–China trade tensions have actually created some incredible opportunities for Aussie investors. Click here to discover three unique plays on the US–China trade war.

About Ryan Dinse

Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately…

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