Put a frog in boiling water and it will immediately jump out. But place it in cold water and raise the temperature gradually, and the frog will sit there comfortably until it boils.
In recent years, the problems brewing in the world economy have been like water gradually heating – and policy makers have failed to recognise that the frog is getting boiled.
Year after year, the global economy has been shifting down a gear. But the policy response has largely been monetary easing, which has proven inadequate.
Global growth is similar to the level during the global financial crisis
The growth we are seeing this year is what one would expect at a time of crisis. Global growth is similar to the level during the Exchange Rate Mechanism crisis of the early 1990s, the Asian financial crisis in the late 1990s, the bursting of the dot-com bubble, and the global financial crisis.
Yet, today there is no crisis, and no sense of urgency on the part of policy makers to take decisive action to boost growth. This is the main problem.
We need more fiscal policy action
Unfortunately, ultra-loose monetary policy is not having the desired impact on GDP growth. Clearly, fiscal policy needs to be brought to the fore. However, despite discussions of ‘helicopter money’ and unconventional fiscal policy to kick-start economic activity, we are far from seeing meaningful changes in the policy mix.
To make matters worse, we are seeing an increasing interplay between economics and politics. The Brexit vote serves as a reminder that the voices of dissent among electorates around the world need to be taken seriously.
Globalisation has been going strong for the past 50 years, and has helped to reduce economic inequality between countries. But inequality within countries has increased. Large segments of the population in the West, particularly lower-skilled and older people, have borne the adjustment costs of globalisation.
Monetary policy is not only losing its potency to kick-start growth, it is also driving income inequality higher, by diverting funds to the wealthier parts of the population. The Bank of England estimated that 40 per cent of assets purchased are held by wealthiest 5 per cent of households.
Don’t be surprised by rising voices of dissent
Although it’s clear governments need to take action through fiscal policy, this is unlikely to happen any time soon. In the US, we think that a gridlocked congress would make it impossible for the new president to implement any meaningful stimulus. The region that is in great need for a more expansionary fiscal policy is Europe, but Germany is convinced of the need to keep running surpluses.
In such an environment, one should not be surprised by the rising voices of dissent.
There are some positives. Easy monetary policy is keeping markets supported. That was one of the main reasons behind our positive view on financial markets for 2016. And Asia is a bright spot in a stagnant world economy. We expect Asia ex-Japan to contribute two-thirds of global growth.
Asia has gone from relying on the rest of the world for its growth to becoming the key contributor to the world’s growth
It is also worth highlighting an important shift: whereas Asia was seen as a high-beta region in the past – doing well when the rest of the world performed well, and vice versa – this time it is performing well when many parts of the world are stagnating.
Asia has gone from relying on the rest of the world for its growth to becoming the key contributor to the world’s growth. This is a long-term trend that is likely to strengthen further, especially as China – the world’s second-largest economy – continues to move from an export-led economic model towards domestic growth drivers.
We are positive on emerging markets
Like the frog in the pot, the world is slowly getting lulled into a false sense of security, as it becomes accustomed to lower growth. This is particularly true in the West, where monetary policy is the only game in town.
Although the US Federal Reserve is signalling another hike by year-end, we do not expect this to materialise. Interest rates will be low for a long time, even with one more hike. And although this is unlikely to help the real economy, it should support sentiment in financial markets.
Meanwhile, we are positive on emerging markets, particularly Asia. Growth is higher, policy is moving in the right direction, and low yields make it an attractive destination for capital.