Global economic outlook Macroeconomic trends shaping the world
China’s slowdown, plummeting oil prices, the risk of a US recession: Tanya Ott spoke with Ira Kalish, Deloitte’s chief global economist, about the major economic factors affecting today’s post-OPEC world.
There are huge shortages, not only of consumer goods but of food, of medicine. The government continues spending above the amount of revenue they collect, and they’re funding that by printing money. The result of that is an inflation rate that’s probably above 200 percent right now.
TANYA OTT: Oil prices fall, and Venezuela—and others—are squeezed. But will the US fall into recession? That’s the big question, isn’t it?
Welcome to the Press Room, Deloitte University Press’s podcast on the issues and ideas that matter to your business today. I’m Tanya Ott. That guy you just heard is Deloitte’s chief global economist, Ira Kalish. He and all of Deloitte’s macroeconomists are gathered in China for their annual meeting.
IRA KALISH: And it’s sort of fortuitous that we’re having the meeting this year in China because there is a lot going on in the world, and a lot of it does have to do with China. Probably not as much as most people think, but this will be a good opportunity for all of us to get to understand the Chinese economy better.
TANYA OTT: Let’s help our listeners understand what’s happening in China right now. For the past 15 years, we’ve had pretty dramatic capital inflows into emerging markets like China, places like Brazil, and others. But those spigots have, not exactly been turned off, but have been definitely slowed. What’s going on in China? What’s the situation there?
IRA KALISH: Well, up until about two years ago, you’re correct, there was a lot of capital flowing into China, a lot of demand for Chinese assets, a lot of Chinese people trying to bring money into the country in order to invest in Chinese assets like housing. And one of the effects of this capital inflow was to put upward pressure on the currency. The Chinese authorities massively intervened in currency markets by buying dollars in order to hold down the value of their currency. This led the Chinese central bank to accumulate about $4 trillion in foreign currency assets.
Then about two years ago, everything started to change for a number of reasons. Chinese companies wanted to become more globalized and invest in assets outside of China. There was some deregulation of China’s capital markets, and Chinese investors wanted to diversify their portfolios, so they’ve been selling Chinese assets and buying assets overseas. This capital outflow has involved, for example, buying lots of residential property in English-speaking cities like Hong Kong, Vancouver, London, Sydney, here in Los Angeles. And that massive outflow of capital has put downward pressure on the currency. The authorities didn’t want the currency to fall too much either, so what they’ve done is massively sell dollar reserves in order to stabilize their currency.
But that’s not something they can do forever because there’s a finite supply of reserves. So periodically they’ve actually let the currency fall and when they’ve done that, that has spooked financial markets, because global investors are worried that a decline in Chinese currency will be deflationary for the rest of the world, will hurt the profitability of global companies that are active in China, will hurt the profitability of global companies that compete with Chinese companies, and will exacerbate the problems that Chinese debtors have in servicing their foreign debts.
TANYA OTT: How challenging is it for us to really know what’s going on in China?
IRA KALISH: We do know that the Chinese economy has slowed down. It’s not growing as fast as it did. Right now, the official numbers say that China’s economy is growing a little bit less than 7 percent. And that’s a sizable slowdown from when it grew 9, 10, and even 12 percent. But if you look at other data like electricity generation or freight rail volume or other real indicators from the private sector, that suggests that China’s economy is growing even slower than that. Many private sector economists think that China’s economy is growing maybe 3–5 percent. We just really don’t know. And that uncertainty, I think, has had a negative impact on global financial markets because we just really don’t know what the full impact of China’s slowdown will be.
TANYA OTT: I’m hearing the word “contagion” a lot these days. Could China’s economic issues be catching?
IRA KALISH: I don’t think the word contagion is really applicable here. When we use the word contagion, we’re usually talking about how stress in one financial market is contagious and leads to problems in other asset classes. So, for example, if you have a big drop in the price of one financial asset, that might scare people and change their risk perception and make them start selling other assets. Or it might make them need to sell other assets in order to cover the losses in the original asset that declined. That’s what financial contagion is. And we may be seeing that in some areas, but it’s not related to China.
Rather, what we’re seeing with China is the fear that a slowdown in China, and that a currency depreciation will have a big spillover effect on the rest of the world, is affecting asset prices around the world. And it may be overwrought, because China’s economy, while it does have a big footprint, may not be as impactful as a lot of people think. The slowdown in China has a big impact on commodity-exporting countries like Australia, Brazil, South Africa. It has a big impact on other East Asian economies that are highly integrated into China’s manufacturing supply chain, countries like South Korea and Taiwan. But China’s impact on the US and Europe is not as great as people think.
The main vehicle by which a slowdown in China will affect the US is by reducing the amount that China imports from the US. But US exports to China are a fairly small share of US GDP, so even a sizable slowdown in China’s economy wouldn’t have that big an impact on the US economy, and yet investors are reacting as if it would. Which means that it’s possible that asset prices in the US have come down more than they need to, at least in response to the problems in China.
TANYA OTT: China’s not the only thing that’s grabbing headlines right now. Of course, oil, the price of oil, is really grabbing a lot of attention these days. Not too long ago, crude was at over $100 a barrel. But so far in 2016, it’s been hovering at just a fraction of that —mostly in the $20s, right around $30 or so. What’s going on?
IRA KALISH: Well, that’s the thing that’s probably more impactful to the global economy than China. Normally when you think about declining oil prices, you think about the net positive impact they have. When you have lower oil prices, you get lower inflation, which is usually a good thing. You get lower import bills for oil-importing countries. You have more discretionary spending power for consumers in those countries. So that’s all good. Yet we’re seeing some negative repercussions from the drop in the price of oil.
When oil fell from $112 down to $50 a barrel, that was probably, on balance, a good thing for the global economy. But when oil fell, say, from $40 to $30, that didn’t have that big a positive impact for consumers, but it had a really big negative impact for the energy industry, the industries that serve energy companies, and for financial markets.
TANYA OTT: Of course, the really curious thing about it is prices are down so low, but the OPEC countries keep producing even more. And that’s generally not how supply and demand is supposed to work. What’s up with that?
IRA KALISH: Well, supply and demand presumes that you don’t have an oil cartel. And there is an oil cartel that’s not functioning like an oil cartel. So . . .
TANYA OTT: You’re talking about OPEC.
IRA KALISH: Right, OPEC. And in reality, supply and demand is working just fine. If OPEC were a cartel that functioned well, they would get together now and cut back on production, and the price would go up. But the biggest producer in OPEC is Saudi Arabia, and the Saudis have made clear they’d be willing to cut back production if the other members of OPEC and non-OPEC oil producers would do likewise. They’re not getting that kind of agreement. And the Saudis have been burned in the past. Back in the 1980s, when there was a big drop in the price of oil, the Saudis decided to cut back on production in order to boost the price, but instead what happened was other oil producers dramatically increased their production. The Saudis were stuck with low prices and lower revenue, and they don’t want to be burned again. So they’ve made clear they’ll cut back production if others do, but others don’t want to—especially the Iranians, who now have the opportunity, now that they’ve been relieved of some sanctions, to boost production.
In the end we’re getting a lot more production than there is demand in the world, and that’s putting downward pressure on prices. It’s leading to a glut of inventories, which will take a long time to unwind. So there’s plenty of reason to expect that at least for a while that the price of oil will stay low. The big question is, what will happen with US production, which has increased dramatically in recent years because of the fracking of shale oil. And what we have seen is a big drop in investment by the shale producers, which ultimately should lead to a cutback in US production. We haven’t seen it yet, but we probably will at some point. And when we do, global production will decline, the global price will go back up, and then we’ll be, once again, in a new world.
TANYA OTT: So Saudi is producing at high levels. Iran, Iraq also, pumping full tilt. How long can they all keep it this high with this low of prices?
IRA KALISH: Well, the Middle Eastern producers have very low cost, so they can continue to do it for a long time. Now, in fairness, the Saudis are clearly losing money. They depend on oil revenue to fund their government. Their government is now running a budget deficit of about 10 percent of GDP. The Saudi government has decided to cut back expenditures in order to hold down their budget deficit. So this is somewhat problematic for them, but they can continue for quite a long time. They have sizable dollar reserves, as do the other Gulf producers.
From Iran’s perspective, they’re better off producing even cheap oil than not producing anything at all. So they’re happy to boost their production. Moreover, they have a lot of oil sitting in tankers that they haven’t been able to sell because of the sanctions. Now, with the lifting of sanctions, they can go out and sell that oil. It’s 100 percent profit because it’s just sitting there. So, I think we’ll continue to see a high volume of production coming out of the Middle East for quite some time. The big question, though, is what will happen with US production, and will it decline as a result of the low prices.
TANYA OTT: I think one of the other questions, outside of the Middle East and US, is what happens to countries like Venezuela, for instance, one of the world’s largest oil producers. And we’re hearing conflicting reports on this, but some say that the country is already cutting back on social service programs. How long can Venezuela hold on with these low prices?
IRA KALISH: During the period when prices were high, Venezuela took on a lot of debt under the regime of Hugo Chavez. They’re having great difficulty servicing that debt right now with the very low oil prices. So they have dramatically cut back on all types of imports. And the government has been keen to avoid default, so they’ve been cutting back on everything else so that they can preserve enough cash to service their debts.
Meanwhile, the government continues spending above the amount of revenue they collect, and they’re funding that by printing money. The result of that is an inflation rate that’s probably above 200 percent right now. I don’t know what’s going to happen in Venezuela, but unless there’s a dramatic rebound in the price of oil, it certainly can’t be good. And then there are other oil producers that are facing difficulties: Nigeria, for example, Azerbaijan have had to go the IMF and the World Bank for help because of trouble servicing their debts. So the low price of oil is certainly having a big negative impact on a lot of oil producers. Russia, of course, is in recession right now in part because of that.
TANYA OTT: You made reference to OPEC not operating like a cartel in the way a cartel normally would. Since the beginning of modern oil-producing time, it’s almost always been managed, but OPEC hasn’t really done a whole lot since 2008 or so. It’s not taking action on this current glut. Is this possibly a post-OPEC world? And if so, what does that mean?
IRA KALISH: It is a post-OPEC world. OPEC really only had a sizable impact on global markets in the 70s and early 80s. Ever since then, it really hasn’t had that much of an impact. There are two reasons. One is it’s hard for them to agree among themselves and to have discipline. Even when they make agreements, there are members who cheat. And second, OPEC’s share of the global oil market is much lower than it was in the 1970s. Unless they have sufficient market power, they can’t really influence the global price of oil. So, rather than being a true cartel, OPEC is a, sort of, debating society more than anything else.
TANYA OTT: So if moving forward, OPEC doesn’t really have any power, doesn’t take any action, what does that mean?
IRA KALISH: I think it means we have essentially a free market for oil. And the price of oil is driven by supply and demand conditions but also by geopolitical trends.
A few years ago, everybody was talking about peak oil. People were expecting we were in a new era of high prices, because there’s not that much oil left to produce, and demand is very high, and emerging markets are growing very rapidly, buying a lot more oil. And it turns out that was wrong. It turns out that there is plenty of oil there. There are new technologies that are being used to tap into that oil—especially the fracking here in the United States, which has led to a dramatic increase in global oil production. It turns out, also, that global demand is not as strong as people expected. Emerging markets are not growing as fast as people expected. And in oil-consuming countries, people are using oil a whole lot more efficiently than anybody expected. For example, here in the United States, even though the economy’s been growing at a decent rate for the past few years, our oil consumption has not been growing very much, in part because Americans are driving less than they used to for a variety of reasons. So, for all of these factors, we’re seeing tremendous downward pressure on the price of oil, at least right now. That may change in the future, but this is the nature of the oil market today.
TANYA OTT: I want to tick through sort of the major things we’ve talked about and then leave you with one big question at the end. You game?
IRA KALISH: OK.
TANYA OTT: OK. So, we’ve got more oil production. We’ve got signs of less demand, which some people say is a symptom of less demand for everything in the world economy. We’ve got stock markets falling. Bank stocks have fallen. China is buying fewer commodities, which hurts countries that export to them. All of this leads a lot of people to the R word: recession. What’s your thinking on how markets in the US and beyond are going to react? And is that reaction based on reality or perception—or something in between?
IRA KALISH: Well, I think the global economy has some more risks now than maybe was perceived a few months ago. But I think the fear that the US economy is facing a recession is perhaps misguided. There’s always a risk of recession at any given time. Recessions are usually unexpected. That being said, the things that are making people worried about recession are a decline in manufacturing production in the US. And in the past, when we’ve had recessions, there’s been a decline in manufacturing production. So that’s one factor. But on the other hand, in the past when we’ve had declines in manufacturing output, there were declines in the output of other sectors. That’s not the case today. Clearly, the decline in manufacturing today is more related to the rise in the value of the dollar and the loss of competitiveness of US exports.
Another factor that’s making people nervous is the rise in risk spreads and the tightening of credit market conditions. That is often a precursor to problems in the overall economy. And yet, those factors in the financial markets right now are mostly related to what’s going on in the energy sector and don’t appear to be spilling over into other sectors of the economy.
Instead, we see other areas of the US economy quite strong. The consumer sector is very strong right now. Consumer cash flow is very good. Employment is growing strongly. We’re beginning to see a pickup in wages. Consumers are evidently more willing to borrow than they were. The housing market, which was the source of pretty much all the trouble in the world six years ago, is doing quite well. Demand for housing is strong. House prices are rising. Borrowing costs remain relatively low, and a strong job market is fueling demand for housing.
So, I would say that the US economy, while we may see decelerate a bit because of trouble stemming from the price of oil and the value of the dollar, is likely to continue growing this year, and I think the fear of recession is probably misguided. The drop in asset prices that we’ve seen may simply be a normal correction from an over-valued market.
TANYA OTT: There you have it, folks. Ira Kalish says the fear of a recession in the US is misguided. Kalish is the chief global economist for Deloitte LLP, and you’re going to hear his voice again soon, because throughout the year we’re going to check back in with him to talk all things economics. You can find more interesting perspectives on the economy, emerging markets, and new technologies in our archives at dupress.com.
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