Global economy walked tightrope in 2016

It may be hard to remember now, but when the clock ticked into 2016, the financial world was squarely focused on China and whether credit lending and spending booms of previous years were giving way to an old fashioned economic correction and “hard landing.”

Throughout much of the past 15 years, China has served as the world’s main engine of growth, importing raw materials and commodities and exporting intermediate and finished goods to the rest of the world.

{mosads}By 2015, however, many began to see the China economy as unstable.

Investment had risen to nearly 50 percent of GDP (for comparison, the US stood at 16 percent), the size of the Chinese banking system had more than tripled since the end of 2008 as credit growth continued at a breakneck pace, and the country’s overall debt-to-GDP ratio had doubled.

Meanwhile, capital was also leaving the economy at a startling rate. Foreign exchange reserves in China declined more than $500 billion in 2015 as the private economy exchanged renminbi for dollars and euros.

Given that the country ran a large current account surplus (it brought in more financial capital than it sent out) and received about $250 billion of direct investment, the overall extent of capital flight likely amounted to about $1 trillion. The exact amount remains unknown.

At the same time, investors were beginning to sour on the U.S. economy. After six years of recovery, it was showing some serious cracks because of the significant appreciation of the U.S. dollar and decline in oil prices.

The trade-weighted U.S. dollar had appreciated more than 20 percent since the middle of 2014, making U.S. exports more expensive relative to imports, and oil had fallen from over $100/barrel to $27.

The manufacturing and tradable sectors of the U.S. economy were cutting back on production, given their uncompetitive status, and the energy sector, after years of significant investment in the shale oil boom, was engaged in a severe retrenchment.

Trade and energy are relatively small portions of the US economy and, on their own, are unlikely to send the U.S. economy into a recession. Consumption – what households buy on a daily basis – is the main engine of the U.S. economy and accounts for about 70 percent of all U.S. economic activity.

For all the talk about a globalized economy, the U.S. is still relatively closed and dependent on domestic trends.

That said, households cannot spend if they are not employed, and the labor market was beginning to look shaky. After adding more than 280,000 jobs per month in the fourth quarter of 2015, job growth slowed to only 24,000 in May. Historically, when employment growth slows in this fashion, recession risk rises. 

A “hard landing” in the Chinese economy could easily send the global economy into a recession, given the ties between China’s growth model and the developed and emerging countries that have deep trade linkages with China (think emerging Asia, Australia, and Europe, for starters).

Simultaneous recessions in the U.S. and China would mean there is nowhere to hide; the two countries account for about 40 percent of the global economy.

Fortunately, neither outcome occurred. The Chinese government did what it has done repeatedly during economic slowdowns — it increased public spending to offset the slowdown in the private sector and, in the process, postponed any downturn for a later day.

In the U.S., the Fed backed off its rate hike plans and gave the economy time to adjust. U.S. labor markets held up and households kept the economy afloat while the industrial side of the economy stabilized.

If the first half of the year was about what did not happen, the second half was about what did. Since the end of the Great Recession, regardless of geography, a wave of populism has affected the global economy as markets and voters have turned inwards and questioned the benefits of trade and immigration.

In June, voters in the United Kingdom sent a shockwave through global markets by electing formally to exit the European Union.

While discontent with the Brussels-based EU across the continent was well known, the extent of it was not. The decision by a wealthy, productive country to exit the 28-country bloc that began after the Second World War was a signal of just how far anti-globalization momentum had come.

In analyzing the results of the U.K. election, we found strong evidence that age, income, educational attainment, and industry association explained much of the variation in voting across the country.

Older voters who scored lower on the income and educational attainment and had greater attachment to construction and manufacturing were mostly likely to be “leave” voters. This was true even inside the London metro area, which voted by large margins to remain.

Applying the results of the U.K. referendum on EU membership to the U.S. presidential election using state-level demographic data told us that six important swing states were likely to be receptive to a nationalistic, anti-globalization message.

These states, in order of their anti-globalization propensity, were Ohio, Wisconsin, Iowa, Pennsylvania, North Carolina, and Michigan. President-elect Trump carried all six states, much to the surprise of pollsters, who generally had these states tilted the other way.

In 2016, the good news is that the major potential pitfalls were avoided and, in the process, the U.S. and global economy registered another year of economic growth, increased employment, and moderate inflation.

The potential bad news is that the major elections in 2016 signal that large swaths of the population no longer see deeper economic and political integration as beneficial.

The problem is not so much that voters are wrong; in democratic societies, voters have an important say in how their politics and economy intertwine. The problem is that de-integration may be easy to say in principle, but hard to enact in practice. A little pulling apart may inadvertently lead to too much.

A healthy nationalism based on self-interested dealing need not lead to adverse outcomes. But history also suggests nationalism can turn unhealthy in unexpected ways.

Important national elections in France, Germany, and other parts of Europe next year will provide further clues as to whether Europe holds together. As Ben Franklin might say, either Europe will hang together or they will surely hang separately.

In the U.S., the Trump administration campaigned on reorienting activity inward and away from trade, which is why we expect tariffs and “border adjustments” likely to be part of the agenda.

Such policies need not be recessionary, particularly if they come alongside a large dose of fiscal stimulus, but anti-trade policies are generally not growth enhancing.

At a minimum, the average American would likely end up paying more for less, as higher import prices would mean the consumer’s dollar does not go as far as it used to. This may be a trade the public is comfortable making if it comes with better job opportunities and a rejuvenated manufacturing sector. Time will tell.

Elections have consequences, and the year ahead will tell us a lot about what U.S. voters actually signed on for. 

Michael Gapen is the Managing Director and Head of U.S. Economic Research for Barclays. Gapen has also taught finance and economics at the Kelly School of Business at Indiana University, Mendoza College of Business at Notre Dame, and Johns Hopkins University. He holds a Phd in economics from the Department of Economics at Indiana University.

The views expressed by contributors are their own and not the views of The Hill.