The global economy is defying gravity. It cannot last

Even as wars rage and the geopolitical climate darkens, the global economy provides unbridled joy. Just a year ago everyone agreed that higher interest rates would soon bring a recession. Now the believers are also confused. The U.S. economy roared through the third quarter, growing at a staggering annualized pace of 4.9%. Around the world, inflation is falling, unemployment is mostly low and major central banks may have stopped their monetary tightening. China, plagued by an asset crisis, could benefit from a modest stimulus. Unfortunately, however, this good cheer could not last. The foundation for growth today seems unstable. Looking ahead, threats abound.

Even as wars rage and the geopolitical climate darkens, the global economy provides unbridled joy. Just a year ago everyone agreed that higher interest rates would soon bring a recession. Now the believers are also confused. The U.S. economy roared through the third quarter, growing at a staggering annualized pace of 4.9%. Around the world, inflation is falling, unemployment is mostly low and major central banks may have stopped their monetary tightening. China, plagued by an asset crisis, could benefit from a modest stimulus. Unfortunately, however, this good cheer could not last. The foundation for growth today seems unstable. Looking ahead, threats abound.

An uncontrollable economy has discouraged betting that interest rates, while no longer rising fast, won’t fall much. The European Central Bank and Federal Reserve have kept rates steady over the past week; Shortly after we published this on November 2nd, the Bank of England was expected to follow suit. Correspondingly, long-term bond yields have risen sharply. The U.S. government now has to pay 5% to borrow 30 years from just 1.2% in the depths of the pandemic recession. Even economies known for low rates have seen sharp increases. Not long ago Germany’s borrowing costs were negative; Now its ten-year bond yield is nearly 3%. There is Bank of Japan All was abandoned On a promise to fix ten-year borrowing costs at 1%.

An uncontrollable economy has discouraged betting that interest rates, while no longer rising fast, won’t fall much. The European Central Bank and Federal Reserve have kept rates steady over the past week; Shortly after we published this on November 2nd, the Bank of England was expected to follow suit. Correspondingly, long-term bond yields have risen sharply. The U.S. government now has to pay 5% to borrow 30 years from just 1.2% in the depths of the pandemic recession. Even economies known for low rates have seen sharp increases. Not long ago Germany’s borrowing costs were negative; Now its ten-year bond yield is nearly 3%. There is Bank of Japan All was abandoned On a promise to fix ten-year borrowing costs at 1%.

Some, including US Treasury Secretary Janet Yellen, say these higher interest rates are a good thing—a reflection of the increasingly poor health of the global economy. In fact, they are a source of danger. As high rates are likely to persist, today’s economic policies will fail, and so will the growth they fostered.

To see why today’s benign conditions cannot continue, consider one reason in particular why the U.S. economy has been better than expected. Its consumers are spending the money they raised during the pandemic on handouts and stay-at-homes. That excess savings was now expected to be depleted. But the latest data suggests households still have about $1 trillion left over, which explains why they can get less savings out of their incomes than at any point in the 2010s.

If those excess savings buffers are depleted, higher interest rates will start to bite, forcing consumers to freely spend less. And, in our summary Explains, if rates remain high for a long period of time problems will begin to emerge throughout the global economy. Business bankruptcies are already on the rise in Europe and America; Even firms that lock in lower rates by issuing long-term debt may face higher financing costs. Home prices will fall, at least to adjust for inflation, as they respond to dearer mortgages. Banks holding long-term bonds — backed by short-term debt, including from the Fed — must raise capital or merge at higher rates to plug holes in their balance sheets.

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The financial boom has added to the global economy’s sugar rush. In a long-term world, that too seems unsustainable. According to the IMF, Britain, France, Italy and Japan will all run deficits of 5% of GDP by 2023. The US deficit in the 12 months to September was $2trn, or 7.5% of adjusted GDP. For accounting distortions – more than double what was expected by mid-2022. At a time of low unemployment, such borrowing is irresponsible. Government debt as a share of GDP in the rich world is now higher than at any time since the Napoleonic Wars.

When interest rates were low, even high debts were manageable. Now that rates have risen, interest charges are draining the budget. Over-the-term, inflation-targeting central bankers threaten to pit governments against one another. Already, Ms Yellen has felt compelled to argue that Treasuries have no risk premium, and Fed Chair Jerome Powell has insisted his bank will never cut rates and allow inflation to ease pressure on the government’s budget.

Despite what Mr Powell says, a longer period could make investors question the government’s promises to keep inflation low and lead them to default on their debts. The ECB’s bonds are already skewed toward Italian government debt Implicitly stands behindA task made more difficult in the high-rate world. While Japanese government-bond yields were at a low of 0.8% last year, 8% of Japan’s budget was paid in interest. Imagine the difficulty if yields reach even Germany’s relatively modest levels. Some governments will tighten their belts as a result. But doing so can have an economic impact.

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These strains make it difficult to see how the global economy can achieve many of the things it is currently hoping for: a tricked-out recession, low inflation, strong credit and high interest rates all at the same time. By bringing economic weakness that allows central bankers to cut rates without rising inflation, the over-longer era is more likely to kill itself.

One promising possibility is that productivity growth will rise, perhaps thanks to the development of artificial intelligence (AI). This results in increased income and revenue making higher rates more bearable. In fact, figures released on November 2nd are expected to show that US measured productivity increased in the third quarter. And AI’s potential to unleash productivity gains may explain why the longer term hasn’t cracked the stock markets yet. The S&P 500 index of U.S. stocks would have fallen this year had it not been for the rise in prices of seven technology companies, including Microsoft and Nvidia.

Against that optimism, however, is a world beset by threats to productivity growth. Donald Trump pledge Converts new charges Should he return to the White House? Governments are increasingly distorting markets with industrial policy. Government spending is growing as a share of the economy as the population ages, calls for a green-energy transition, and conflicts around the world require more spending on defense. In the face of all this, anyone betting that the global economy can continue is taking a huge gamble.

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