Global Economy Slows, but Seems to Be Faring Better Than Feared
A weak start to 2023 is expected in many rich countries, but U.S. and European slumps could be relatively short
A weak start to 2023 is expected in many rich countries, but U.S. and European slumps could be relatively short
The global economy continued to deteriorate as 2022 draws to a close, but not as severely as economists previously feared, raising the possibility the world could avoid a deep slump next year.
Business surveys released Wednesday pointed to declines in output across the U.S. and Europe’s largest economies in November. But the figures and other economic readings pointed to a mixed outlook, with some parts of both economies continuing to show resilience despite high inflation and rising interest rates.
In China, the world’s second-largest economy, the outlook is highly uncertain as the country faces a surge in Covid-19 cases. Economists expect a rebound in growth next year as Beijing attempts to ease tough pandemic policies.
A tight U.S. labour market and still strong household balance sheets are supporting consumer spending, the economy’s main engine. A healthy consumer helped power retail sales in October and could keep the world’s largest economy growing at the end of this year. The U.S. outlook depends in part on how it weathers the Federal Reserve’s interest-rate increases aimed at cooling inflation that is running near a 40-year high.
Europe is experiencing less economic disruption from Russia’s decision to limit energy supplies than analysts earlier feared. Many households and businesses in the region are adapting by, for instance, cutting back on energy consumption, said Adam Posen, president of the Peterson Institute for International Economics. European governments also distributed larger-than-anticipated sums of fiscal support to households to help address rising energy and food costs, he added.
“We’re going to end up with more than 75% of the world’s economy actually doing pretty well,” Mr. Posen said. The U.S. and European Union “are likely to have relatively short, not terrible recessions and return to growth possibly by as early as the fourth quarter of 2023.”
Still, many developing countries are falling behind. David Malpass, the head of the World Bank, earlier warned developing countries face an additional economic risk: Policies adopted by advanced economies to address inflation and economic slowdown could leave insufficient capital for poorer nations.
S&P Global said its composite output index for the U.S., which includes services and manufacturing activity, fell to 46.3 in November from 48.2 a month earlier, among the quickest contractions since 2009. An index below 50 signals contracting economic activity, while above 50 signals growth.
“Companies are reporting increasing headwinds from the rising cost of living, tightening financial conditions—notably higher borrowing costs—and weakened demand across both home and export markets,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.
U.S. businesses reported that inflationary pressures eased in November, however, with prices for materials and freight costs cooling.
The economic cost of higher energy prices was evident in surveys of purchasing managers at European businesses, which recorded another month of declining activity in November. S&P Global said its composite output index for the eurozone rose to 47.8 in November from 47.3 in October, but remained below the 50 mark that distinguishes a contraction from an expansion.
The global economic outlook remains highly uncertain. One big question in the U.S. is how quickly inflation comes down. The pace at which it does will help determine how high the Fed raises interest rates and how long it keeps them there. The central bank has raised rates at the fastest pace since the 1980s this year. Many economists expect higher borrowing costs to hurt spending with greater force in the coming months, threatening U.S. growth.
Fed staff early this month saw a U.S. recession next year “as almost as likely” as their baseline projection of weak growth, according to minutes of the policy makers’ Nov. 1-2 policy meeting released Wednesday. That represented a downgrade of the economic outlook due to the tightening in financial conditions that had occurred this fall.
Europe’s economies face the strongest economic headwinds in the months ahead. Russian natural-gas giant Gazprom PJSC on Tuesday threatened to further throttle exports to Europe via Ukraine from next week, putting in question one of the last remaining routes for Russian gas to reach Europe.
A reduction in Covid-19 restrictions in China is key to an expected rebound in growth there next year, but the recent surge in infections has raised questions about how quickly that can proceed.
“This fine-tuning of its Covid-19 policy is now being tested as cases continue to climb, especially in its manufacturing hub of Guangzhou,” said Magdalene Teo, head of fixed income research in Asia for Julius Baer. “China is realising that reopening this winter will not be easy.”
Many forecasters see global output rising by around 2% next year. That would be a sharp deceleration from this year and well below its 3.3% average in the decade leading up to the start of the Covid-19 pandemic, but still producing a small rise in output per person.
Even with a weak start to 2023 expected in many of the world’s richest countries, economists are wary of forecasting a global recession.
“Even though we do not formally forecast a global recession from a narrow technical viewpoint, it will feel like one for large parts of the global economy,” said Marcelo Carvalho, global head of economics at BNP Paribas.
In practical terms, this means the hardship many nations, businesses and consumers around the world have experienced this year—with strong regional variations—isn’t over.
The U.S. is expected to eke out meagre gains next year. The Organization for Economic Cooperation and Development projects U.S. economic output will grow at an annual rate of 0.5% in 2023, down from an estimated 1.8% in 2022. Economists surveyed by the Wall Street Journal think U.S. gross domestic product will grow at an annual rate of 0.4% in 2023, and they see a rising chance for a recession in the next year.
Europe seems likely to avoid the worst outcomes from energy disruptions. A mild October and high levels of gas storage make it less likely that Europe’s factories will face energy rationing. As a result, economists at Barclays expect a 1.3% drop in gross domestic product there, less than their worst-case scenario of a 5% decline.
While conditions could start improving next year, economists warned the global economy remains in a precarious position.
“The risks that things could go wrong are increasing compared to where they were in the past few months,” said Alvaro Pereira, acting chief economist at the OECD.
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Crypto’s lack of connections with traditional finance means its problems haven’t spilled over to the economy
This year’s crypto collapse has all the hallmarks of a classic banking crisis: runs, fire sales, contagion.
What it doesn’t have are banks.
Check out the bankruptcy filings of crypto platforms Voyager Digital Holdings Inc., Celsius Network LLC and FTX Trading Ltd. and hedge fund Three Arrows Capital, and you won’t find any banks listed among their largest creditors.
While bankruptcy filings aren’t entirely clear, they describe many of the largest creditors as customers or other crypto-related companies. Crypto companies, in other words, operate in a closed loop, deeply interconnected within that loop but with few apparent connections of significance to traditional finance. This explains how an asset class once worth roughly $3 trillion could lose 72% of its value, and prominent intermediaries could go bust, with no discernible spillovers to the financial system.
“Crypto space…is largely circular,” Yale University economist Gary Gorton and University of Michigan law professor Jeffery Zhang write in a forthcoming paper. “Once crypto banks obtain deposits from investors, these firms borrow, lend, and trade with themselves. They do not interact with firms connected to the real economy.”
A few years from now, things might have been different, given the intensifying pressure on regulators and bankers to embrace crypto. The crypto meltdown may have prevented that—and a much wider crisis.
Crypto has long been marketed as an unregulated, anonymous, frictionless, more accessible alternative to traditional banks and currencies. Yet its mushrooming ecosystem looks a lot like the banking system, accepting deposits and making loans. Messrs. Gorton and Zhang write, “Crypto lending platforms recreated banking all over again… if an entity engages in borrowing and lending, it is economically equivalent to a bank even if it’s not labeled as one.”
And just like the banking system, crypto is leveraged and interconnected, and thus vulnerable to debilitating runs and contagion. This year’s crisis began in May when TerraUSD, a purported stablecoin—i.e., a cryptocurrency that aimed to sustain a constant value against the dollar—collapsed as investors lost faith in its backing asset, a token called Luna. Rumours that Celsius had lost money on Terra and Luna led to a run on its deposits and in July Celsius filed for bankruptcy protection.
Three Arrows, a crypto hedge fund that had invested in Luna, had to liquidate. Losses on a loan to Three Arrows and contagion from Celsius forced Voyager into bankruptcy protection.
Meanwhile FTX’s trading affiliate Alameda Research and Voyager had lent to each other, and Alameda and Celsius also had exposure to each other. But it was the linkages between FTX and Alameda that were the two companies’ undoing. Like many platforms, FTX issued its own cryptocurrency, FTT. After this was revealed to be Alameda’s main asset, Binance, another major platform, said it would dump its own FTT holdings, setting off the run that triggered FTX’s collapse.
Genesis Global Capital, another crypto lender, had exposure to both Three Arrows and Alameda. It has suspended withdrawals and sought outside cash in the wake of FTX’s demise. BlockFi, another crypto lender with exposure to FTX and Alameda, is preparing a bankruptcy filing, the Journal has reported.
The density of connections between these players is nicely illustrated with a sprawling diagram in an October report by the Financial Stability Oversight Council, which brings together federal financial regulators.
To historians, this litany of contagion and collapse is reminiscent of the free banking era from 1837 to 1863 when banks issued their own bank notes, fraud proliferated, and runs, suspensions of withdrawals, and panics occurred regularly. Yet while those crises routinely walloped business activity, crypto’s has largely passed the economy by.
Some investors, from unsophisticated individuals to big venture-capital and pension funds, have sustained losses, some life-changing. But these are qualitatively different from the sorts of losses that threaten the solvency of major lending institutions and the broader financial system’s stability.
To be sure, some loan or investment losses by banks can’t be ruled out. Banks also supply crypto companies with custodial and payment services and hold their cash, such as to back stablecoins. Some small banks that cater to crypto companies have been buffeted by large outflows of deposits.
Traditional finance had little incentive to build connections to crypto because, unlike government bonds or mortgages or commercial loans or even derivatives, crypto played no role in the real economy. It’s largely been shunned as a means of payment except where untraceability is paramount, such as money laundering and ransomware. Much-hyped crypto innovations such as stablecoins and DeFi, a sort of automated exchange, mostly facilitate speculation in crypto rather than useful economic activity.
Crypto’s grubby reputation repelled mainstream financiers like Warren Buffett and JPMorgan Chase & Co. Chief Executive Jamie Dimon, and made regulators deeply skittish about bank involvement. In time this was bound to change, not because crypto was becoming useful but because it was generating so much profit for speculators and their supporting ecosystem.
Several banks have made private-equity investments in crypto companies and many including J.P. Morgan are investing in blockchain, the distributed ledger technology underlying cryptocurrencies. A flood of crypto lobbying money was prodding Congress to create a regulatory framework under which crypto, having failed as an alternative to the dollar, could become a riskier, less regulated alternative to equities.
Now, stained by bankruptcy and scandal, cryptocurrency will have to wait longer—perhaps forever—to be fully embraced by traditional banking. An end to banking crises required the replacement of private currencies with a single national dollar, the creation of the Federal Reserve as lender of last resort, deposit insurance and comprehensive regulation.
It isn’t clear, though, that the same recipe should be applied to crypto: Effective regulation would eliminate much of the efficiency and anonymity that explain its appeal. And while the U.S. economy clearly needed a stable banking system and currency, it will do just fine without crypto.
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