Thu. Sep 19th, 2019

Pushing a rope | Economy


The advances and setbacks in the trade war between the US and China have been, are and most likely will continue to be, the main guiding factor of expectations about the global economic cycle and of the behavior of the main financial assets. Since the spring of 2018, all episodes of financial turbulence and its subsequent phases of calm and renewed investment commitment to risk assets have come hand in hand with events related to the commercial confrontation between the two powers.

The sway suffered in the markets at the beginning of August has the same origin and, for the moment, draws a similar pattern: an initial shock caused by an unexpected announcement; the deepening of the movement when reprisals are announced by the other party, and the recovery of a relative calm at the first signs of partial recourse by the parties. In this case, the initial shock occurs on July 31 when Trump announced the imposition of tariffs on 300,000 million Chinese imports as of September; the panic comes with the intense depreciation of the yuan of August 5, and the announcement of tariff exemptions and return to negotiations return some calm.

There are however important differences compared to past episodes. The US and China are crossing very relevant red lines, making reverse gear more difficult and raising the risk of accelerating the protectionist spiral and competitive devaluations. On the other hand, despite the renewed effort of monetary accommodation of central banks, the global cycle continues to emit very worrying signals (with Europe at the top). The risk that the brake on trade and business investment will eventually push the world into a deeper deceleration is today higher.

The sinking of type curves, especially in its long stretches, is very worrying. Doubts about the ability of central banks to stimulate the economy in the current situation are growing. At this point, the metaphor that monetary policy would be "pushing on a string" (originating in 1935), takes full force. The expression warns of the absence of symmetry in the ability of monetary policy to achieve its ends. The central bank can easily curb an economic expansion by raising interest rates; but it may happen that interest rate drops or other stimulus measures have little effect if the economic agents do not respond to them (for example, if banks are not willing to lend or if consumers and businesses do not want to borrow to consume and / or invest). In the first situation, the central bank pulls the rope to curb the economy; in the second, when pushed, only wrinkles. In this environment, and with these interest rates, that fiscal policy does not close the shoulder is irresponsibility.

(*) José Manuel Amor and Salvador Jiménez they are professors of Afi School of Finance

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