The Estonian economy and that of the other Baltic and Nordic countries depends primarily on what is happening in the United States and Germany, John Javeus, chief strategist for SEB Group, says in an interview.
When we last talked about the economy a year and a half ago, you were quite optimistic in terms of the future, and you were right. Where do we stand now? What has changed?
A lot has changed since last year. The economic cycle is coming down. Economists like myself tend to concentrate on the U.S. economy, because what happens in America soon happens everywhere else. The U.S. has a leading position in that sense
Last summer, we were rather optimistic in terms of the U.S. economy. The U.S. purchasing managers index was very high (it came close to the record level from 2014 in August of last year – T. O.), while it has been in decline since then and has dropped below 50 now, pointing to recession.
Spring saw the inversion of the U.S. bonds yield curve that has historically been a very good indicator of looming recession. (The yield curve is considered inverted when long-term bonds – traditionally those with higher yields – see their returns fall below those of short-term bonds. Since the 1950s, this development has always been followed by a recession – T. O.)
We recently published SEB’s new macroeconomic forecast where we remain relatively optimistic. While we see a temporary slump, we believe growth will return in 2020. But this growth will be far from rapid.
That is the bank’s primary scenario, while I remain a skeptic and perceive the risk of the second half of next year culminating in a recession in the U.S. Whether that will happen or not depends on market developments – both bond markets and stock and currency markets. It is vital, and the next few months will be very interesting.
What has happened? There has been a lot of talk about a trade war between the U.S. and China. It seems to me that it has rather remained on the level of statements. Why has it affected the global economy?
It is more than just statements as we have seen hostile steps from both sides. Recent measures concern 2 percent of global foreign trade volume. This is not enough to materialize a bad scenario, but it still has a negative effect. It contributes to risks, and people considering investing will increasingly likely decide to hold off. The psychological effect of this trade tension has already manifested.
What you said holds true regarding Europe as we have not seen a tariffs rally.
I believe we will see tensions ease up soon and it seems the U.S. and China will come to an agreement. It will not be a full trade deal but some kind of an intermediate agreement. It is clear both countries need one.
The Chinese economy is the weakest it has been in three decades, with the U.S. a year away from presidential elections. Trump wants the economy as strong as possible by that time, while that is impossible in the conditions of a trade dispute.
Still, as concerns the economic cycle coming down, which we have seen in Europe, USA and China recently, I would not attribute it to trade disputes. Other factors are at fault here.
We have seen an extraordinarily long growth period over the past ten years. It has to come to an end eventually. Whether it will be now, next year or whether we can avoid it in the coming years is something we don’t know. I dare say the risks are considerable.
You said the U.S. economy will likely start falling next year. What about Europe?
The situation in Europe is a little peculiar because its economy usually follows that of the States.
Today, Europe has its own problems. We have political problems, such as Brexit, constant opposition between the European Commission and member states, like Italy and other southern states. Also, the car industry that has been struggling for years. The car industry is a very important part of the European economy and its problems always have a major effect.
I believe that 5 percent of German labor is tied to the car industry in one way or another. Problems there will translate into problems for the entire country. It seems to me that the car industry is going through the greatest changes it has seen in decades. Both regarding electrification and self-driving vehicles. Both fundamental changes have seen car manufacturers in the passenger seat. They are very late to the party and having difficulties implementing these changes.
I don’t know how long it will take to make these changes, but it seems the problem is not an easy one to solve.
In Estonia, analysts and entrepreneurs are talking about a crisis rather than a recession. Will there be a crisis in the near future?
Like I said, risks have increased, and while a crisis is not included in SEB’s main scenario, we need to keep an eye out for signs to suggest one is coming.
There are various types of recession or crisis. The crisis of the early 1990s that encompassed almost all European countries was very serious. Then, we had the dot-com bubble burst around the turn of the century that was a rather moderate crisis from a macroeconomic perspective, while it was terrible for the stock markets. And then, we had the economic crisis ten years ago that was again very serious.
The question is what we identify as a moderate or severe crisis. The Bank of International Settlements did an interesting study on the subject where it found that if the real economy, mostly industry, and financial markets slide simultaneously – as was the case in the early 1990s and during the previous crisis – the ensuing crisis will be severe.
But if financial markets go up while industry goes down, as with the dot-com bubble, it will rather be moderate. Right now, it seems that financial market instability – that we could be seeing, especially in the U.S. – isn’t nearly as serious as it was ten years ago. This part of the economy seems to be growing and this growth could persist for some time, especially if interest rates remain very low.
This suggests that a potential crisis could be rather modest and not as destructive as what we saw a decade ago. That is the positive side of a future recession or crisis.
Crises are usually preceded by bubbles, while I cannot see a bubble anywhere. Some are talking about a credit bubble, while there could also be a startup bubble in the making.
I have not had much contact with startups, but it is one sector that could be nearing a bubble or already have one.
There have been a lot of studies on what causes bubbles. There is usually a favorable environment, like what we have today: a very long period of economic growth, very loose monetary policy, cheap capital etc. I believe that the startup sector is fueled by negative rates because investors have a bunch of money they hope to turn into profit. You cannot invest in government bonds because of negative yields. You could invest in the stock market, buy shares or startups.
The latter prioritize growth over profit. In a normal situation of higher interest rates, investors would likely be less forgiving toward companies that do not yield profit. An investor wants a return eventually. But in a situation where those returns are nowhere to be had, one’s patience grows much longer.
That is why startups currently find themselves in a cushy situation where they are not required to show profits. And that is a potential risk.
What to think of China? Growth is slowing in China, but will we see a recession there inside the next decade?
Economists are in trouble and very often miss the mark even in annual forecasts. (Laughs.) There could be major growth and recession inside a decade that all developing economies have experienced but that we haven’t seen in China yet. Many economists predict that their boom will run its course, while they have been mistaken so far as the Chinese authorities have always found the will and means to support their economy and keep it growing.
I would not bet on Chinese growth running aground in the next decade. I also wouldn’t rule it out completely, but I would not bet on it either as too many people, myself included, have missed the mark there over the past 20 years.
Does this mean that a managed market economy is possible?
It seems so. On the other hand, we are hearing that imbalance is growing constantly and it’s just a matter of time before it all goes to hell. Whether that will be in the next ten years, five or two – who knows.
We can say that while the Chinese model is not a good one from a political point of view, the way their government can make the economy work much as it wants is more successful than what we have in the West.
The risk is that political decision-makers could make mistakes the market wouldn’t. But so far, we have nothing with which to refute their success because they have managed to maintain a stable economy for a very long time.
How is the Swedish economy doing? Our entrepreneurs are saying that Swedish exports have started falling.
Growth has also slowed in Sweden. It is clear that Sweden, the other Nordic countries and the Baltics are extremely dependent on the huge North European economy called Germany. This means that Germany having problems always spells trouble also for Sweden and the other Nordics.