Bad things happen in October. It was in this month 13 years ago that the global banking system came close to imploding. There was a stock market bloodbath in October 1987. And it was in October 1929 that the Wall Street Crash triggered the Great Depression.
One consequence of the economic horrors of the 1930s was the creation of the International Monetary Fund, with the idea to create a multilateral body that would help countries through short-term problems and prevent systemic crises from developing.
Judged by this metric, the IMF has been a success. There has been no repeat of the Great Depression, although in 2008 the world came close to it. The annual meeting of the IMF that year came only a couple of weeks after the collapse of the investment bank Lehman Brothers raised doubts about the viability of many other financial institutions. Finance ministers and central bank governors got together in Washington to piece together a rescue plan that stemmed the panic.
This week it is again time for the IMF to hold its annual meeting, and while there is no present crisis, there are plenty of signs that one might be just around the corner. Economists are always looking out for black swans – unexpected events that have a massive impact – that might lead to a stock market meltdown or a deep recession but in this case that’s not necessary because there are plenty of big problems plainly visible.
Here’s how things look. The global recovery from last year’s pandemic-induced lockdowns has started to lose momentum, and in its half-yearly world economic outlook, the IMF will revise down its growth estimate for 2021, mainly because of recent developments in the US and China.
Joe Biden’s honeymoon is over. The economy is still expanding but at a slower pace, while inflationary pressures continue to mount. A row in Congress over how much the government can borrow, which could lead to Washington defaulting on its debt, has been kicked down the road for two months. The central bank in the US has clearly signalled its intention to remove some of the policy stimulus it has been providing during the pandemic.
China’s already slowing economy has been further hit by energy shortages and blackouts. Evergrande, once the country’s biggest property developer, is on the brink and there are fears that others may follow. The government in Beijing is grappling with the tricky task of overseeing slower but more sustainable growth without causing a full-blown recession.
The rapid pace at which countries in all parts of the world bounced back from recession has caused supply-chain bottlenecks. There are shortages of workers, raw materials and goods, and they are pushing up prices. The cost of energy has surged as a result of a pickup in demand, particularly from Asia.
Meanwhile, the world’s poorer countries are still waiting for the vaccines promised to them by the G7 and other rich nations earlier this year. With the threat from Covid-19 still real, the hoarding of doses by the west is inexcusable. Kristalina Georgieva, the IMF’s managing director, last week rightly told the hoarders to make good on their pledges without delay.
Stock markets have recovered from the sell-off they experienced in the first few weeks of the pandemic and are ripe for a correction. Charles Dumas of TS Lombard says the S&P 500 – the best gauge of Wall Street’s mood – is roughly 40% overvalued. Another analyst, Dhaval Joshi of BCA Research, has noted how US tech shares – responsible for much of the strong performance of the wider stock market – go up and down in line with US Treasury bills.
Put simply, when bond prices go up the interest rate – or yield – paid to investors goes down, and vice versa. Bond prices tend to fall when inflation is rising, which is currently the case. There is, Joshi says, little “wriggle room” for bonds to sell off before they bring the stock market down with them.
Albert Edwards, of Société Générale, says the current state of affairs has echoes of July 2008, when the European Central Bank raised interest rates as oil prices approached $150 (£110) a barrel, only to be faced three months later with the deflationary consequences of the Lehman debacle.
Central banks in Norway, New Zealand and Poland have already increased interest rates, while the Bank of England and the Fed are gearing up to tighten policy. So, Edwards says, shouldn’t we be talking about the R-word?
It is a reasonable question. Every sharp increase in energy prices since the early 1970s has been followed by a recession and this may be no exception. In the short-term, rising oil and gas prices are inflationary but over the longer term they are deflationary because they add to business costs and reduce the spending power of consumers. This pattern was established in the first oil shock of 1973 (another October event), where a burst of inflation was followed by rising unemployment as companies went bust.
Politicians appear to be oblivious to this risk. There was not the slightest hint at last week’s Conservative party conference, for example, that the recent slowdown in the economy could be followed by a tough winter. Energy-intensive businesses are really suffering.
The financial markets seem to assume that the pandemic is all but over, that economic recovery will continue apace and that inflationary pressures are transitory and relatively painless. If they are right on all counts, then this will not be one of those Octobers that lives in the memory for the wrong reasons. But last week share prices rallied after Vladimir Putin said he might provide Europe with more Russian gas. Some might see that as a sign of trouble ahead.