The global outlook: beware falling objects

The world economy has in the past few years undergone a dramatic shift. Chinese industrial growth – for decades 10 percent or higher – has declined nearly to nil. Global commodity prices have shifted from high to low. At the same time, the U.S. dollar has surged from low to high against most other currencies. Partly this latter surge has occurred in response to the expectation of rising U.S. interest rates; and partly in response to turmoil elsewhere (most recently, the Brexit vote). When the world shifts in a way that is unfavorable, the first reaction of those adversely affected is to hang on for dear life. That tends to work for a while. Budgets can be cut; credit lines called upon. But eventually, those hanging on by their fingertips tend to fall. Some jump, recognizing that the shift is irrevocable and hoping they might land somewhere soft. Others hang on until they lose their grip. And thus, a few years into this dramatic shift, the world outlook is: beware falling objects. What might fall as a result of this economic shift? To answer that question, go back in time. We don’t have to go too far back: more or less this same shift occurred in the early 1980s (see chart). Commodity prices were high in the 1970s; in the 1980s they were low. U.S. real interest rates were low in the 70s; in the 1980s they were high. The US dollar (not shown) was weak in the 70s, and strong in 80s. The first objects to fall were the emerging markets (see chart; I first wrote about this...

Is a wave of sovereign defaults on the way?

The sovereign debtor that would win hands down a nomination as “most likely to fail” is surely Greece, which has just threatened to default on its next payment to the IMF. But Greece could be a distraction – history suggests sovereign default risk is rising elsewhere, and that a wave of such defaults could be on the way. Contemplate for a moment the following graph produced by Oxford Analytica, as part of the publicity materials for their new online tool that prices political risk. The graph tracks three indicators over time: oil prices, expropriations of foreign direct investment, and sovereign defaults. The relationship between oil prices and these two types of country risk is strikingly apparent. When oil prices rise, governments move to expropriate. High oil prices mean that natural resource investments are suddenly spectacularly profitable, and seizing these investments therefore becomes increasingly attractive. In the 2000’s, regimes from Kazakhstan to Chad to Russia to Bolivia indulged this temptation, and not only in oil – some mining investments, also with soaring profitability, were similarly nationalized. High oil prices also give cover to governments wishing to pursue extremely unorthodox economic policies. Venezuela, which seized not only oil but much foreign investment in the country, stands out as a recent example. On the graph, the link between oil prices and expropriation is obvious in the mid-1970s: expropriations peaked just after oil prices surged. The link is apparent again in the 2000’s, as a second surge in oil prices triggered another wave of expropriations, albeit with a less dramatic peak. The relationship between oil prices and sovereign defaults is precisely the opposite....