I. Eight issues need to be monitored in the world economy now and in the future.

The following eight issues merit close attention for their significance and urgency.

i. Inflation or deflation

It goes without saying that most economies have come under mounting inflationary pressure. However, there are divergent views on how prices would evolve and what policies are needed. Some people say that without proper policies in place, inflation will spiral out of control. The reason, they argue, is that the flood of liquidity has led to a steep rise in money supply, as evidenced by the bloated balance sheets of the US, European and Japanese central banks, which stand at a staggering US$25 trillion. Major central banks all pursue ultra-low or even negative interest rates; and massive relief policies have boosted household wealth and pushed up prices as people have more to spend. Other people say that it is only a temporary phenomenon that inflation has overshot central banks’ policy targets, as the slow monetary circulation has offset the momentum of price increase driven by an avalanche of liquidity. Fiscal relief and central bank support policies have hit or are reaching the ceiling. The decline in personal income in the US for three consecutive months reflects a slump in consumer demand. Pessimism still exists in the market. And many of the drivers of the recent surge in inflation are short-term in nature, such as higher energy prices and transportation costs.

Both views make sense. Another variable that must be taken into account when it comes to inflation in advanced economies is the policy tools at the disposal of their central banks. Undoubtedly, they have far more tools and room to deal with inflation than to tackle deflation. The International Monetary Fund (IMF) expects price pressures in most countries to subside by 2022, but will persist in some emerging markets and developing countries. Overall, inflationary pressures in advanced economies are not moderate in the short term, but will ease in the medium to long term, while stagflation of a certain degree cannot be ruled out.

ii. Where advanced economies will go on the macro policy front?

In the wake of the financial crisis in 2008, as monetary policy quickly fell into a liquidity trap, the central banks of the US, Europe and Japan switched to unconventional monetary policy, that is, ultra-low or even negative interest rates, alongside quantitative easing. Since the outbreak of COVID, the Fed has refrained from negative interest rates on the grounds that negative interest rates in Europe and Japan have failed to promote growth or prevent deflation. In addition, it has other policy tools ready to use. One of them is unlimited and indefinite quantitative easing. At the annual meeting of global central banks in Kansas City in August 2020, the Fed announced an update to its long-term goal and monetary policy statement, saying it would seek to achieve its long-term target of 2% average inflation. This means that the Fed can use the “balance” of future inflation to make up for the “gap” of the past. Subsequently, the European Central Bank changed its medium-term inflation target from “below but close to 2%” to 2% in July 2021. Whether to make a correct judgment on the severity and duration of inflation has become the main source of macro policy risk in the US. Overall, central banks in major economies now have far more tools and room to deal with inflation than deflation. On November 3, 2021, the Fed announced that it would begin to reduce its bond purchases (taper) by US$15 billion in the middle of the month, twice the amount in December, and expect to end bond purchase in mid-2022. The move can be seen as a sign of shift in US monetary policy. In addition to taper, the Fed can raise interest rates as soon as 2022, maybe three times each in 2023 and 2024. After that, the Fed can also reduce the size of its balance sheet. In view of the fact that asset prices are at a historical high and fragile and sensitive, the supply shock that currently pushes up prices will be alleviated in 2021. Failure to exit at the right speed, intensity and time is very likely to lead to asset price fluctuations and reversals in investor expectations. The risk of a bankruptcy tsunami may rise. And stagflation may set in.

iii. Monetary policy shift may hurt emerging markets and developing countries.

The negative spillover effects of the Fed’s exit policy may include foreign capital flight, debt crisis and complications caused by exchange rate fluctuations in emerging markets, especially for those countries that rely heavily on foreign capital inflows. Market volatility in February and March 2021 led to a significant decline in non-resident portfolio flows to emerging markets. Although the fall was made up for over the next three months, taper tantrum still exists.

US monetary policy is an important driving force in the global financial cycle. It first affects global high-risk asset prices and credit creation, then international capital flows and investor risk aversion, and subsequently the leverage ratio of global financial intermediaries. Impact is also felt in the monetary situation of other countries, especially highly open ones, posing a challenge to their monetary policy sovereignty. Once developed economies such as the US and Europe start to tighten monetary policy, emerging economies will face the following risks. In the face of supply shocks caused by the pandemic, the policies adopted by developing economies in themselves tend to be one source of risk. Swings in energy prices caused by tighter monetary policy will undoubtedly have a bigger impact on some emerging markets and developing economies.

At present, the external debt balance of low and middle-income countries has reached US$8.7 trillion. In the past decade, the growth of their foreign debt outpaced that of gross national income (GNI) and exports. Once advanced economies start to raise interest rates, their debt burden is bound to increase. Businesses and countries may default. To make matters worse, the policy shift is very likely to make the US dollar appreciate, which will lead to currency mismatch risks and eventually a currency crisis and financial crisis.

iv. Disruptions to supply chains and the decoupling policy pursued by some developed countries.

Over the past year and more, the world has suffered from disruptions to supply chains, especially chip and energy shortages, shipping delays and skyrocketing freight costs. The Institute of International Finance warned about a higher possibility of supply chain disruptions in the US production system. Delivery delays in the manufacturing sector are as severe as in Japan after the 2011 Fukushima nuclear disaster and are beginning to spread globally. Companies are forced to bet on inefficient but resilient supply chains, which will eventually push up prices.

Supply chain resilience has become a hot topic in the past two years. At the national level, increasing economic interdependence has long been regarded as a source of geopolitical stability. Now it is considered to be a fatal weakness, because a high concentration of supply means a high degree of dependence in the eyes of some people, which bears on “national security” and great power competition. As such, the US and other countries have introduced or planned to adopt a series of policies aimed at boosting self-sufficiency or localization, encouraging manufacturing reshoring or supply chain diversification. Some people even openly advocate the so-called “decoupling”, with China as the target.

v. Is US dollar hegemony on the decline?

The US dollar has long been at the center of the international monetary system. As the only source of fundamental collateral in the world, US Treasuries reflect the global demand for strong, liquid and safe currencies or safe assets. However, the status of the dollar is not unshakable. Global foreign reserves totaled US$12.7 trillion at the end of 2020, and the share of global foreign exchange reserves denominated in US dollars had fallen for five consecutive years to 59%, the lowest in 25 years, from more than 70% at the end of 2001. In the meantime, the euro accounted for 21% of global foreign reserves, returning to the 2014 levels; yen assets rose to 6%, the first time in 20 years, and RMB accounted for 2%. The steep rise and fall of dollar-denominated cryptocurrencies in 2021 also deserves close consideration.

Are these changes accidental anomalies or are they a sign of the decline of the dollar? The relationship between Asia and the dollar today bears a striking resemblance to the situation in Europe in the 1960s and 1970s. The collapse of the Bretton Woods system woke most European countries up to the fact that trade within Europe was more important than trade with the US. As a result, the Deutsch mark group emerged and evolved into a single currency decades later. If China were to one day stop pegging the RMB to a basket of currencies and switch to inflation targeting, allowing the exchange rate to float more freely, especially against the dollar, most Asian countries would follow China’s lead.

The progress in European fiscal integration may portend the decline of the dollar’s dominance. In the summer and autumn of 2020, the EU launched a European recovery plan of about 750 billion euros. What is special about the plan is that the vast majority of the funds involved will be raised by the EU through the issuance of euro-denominated EU bonds. This means that EU bonds will become a new risk-free or low-risk asset in addition to US Treasuries. A diverse international monetary system is thus taking shape.

vi. Global issues related to climate change are fast deteriorating and calling for responses.

The United Nations Intergovernmental Panel on Climate Change (IPCC) said in August 2021 that the Earth is issuing a red climate alert to mankind and that a hotter future is almost inevitable. According to a report released by the International Energy Agency in May 2021, if the world is to reduce net carbon emissions to zero by 2050, it must immediately stop investing in fossil fuel projects. A mainstream view in the world is that climate change can be addressed by reducing carbon emissions. However, mankind still faces challenges as to how to strike a proper balance between emission reduction and development, or between energy transition and the normal operation of the economy. Due to the impact of the pandemic, pressure from the public, surging global demand, supply chain disruptions, uneven economic recovery, and the rise of economic nationalism, many countries experienced soaring energy prices, especially electricity prices, or power cuts in the second half of 2021.

In addition to reducing dependence on fossil fuels in a reasonable and orderly manner, it is also important to monitor other sources or channels of greenhouse gas emissions around the world. The world should also strive to make full use of existing institutional designs and create new ones. Some have even proposed the establishment of a new climate club, whereby the US, Europe and China make shared climate goals and work together to promote clean technology innovation.

vii. Accelerating demographic changes exert a far-reaching impact.

Population is a medium- and long-term variable, which will produce significant, immediate effects after a certain period of time. Demographic changes are mainly observed in the number of population, age structure, the proportions of ethnic groups, and cross-border movement of people. According to the United Nations Department of Economic and Social Affairs (UNDESA), global population will increase from current 7.7 billion to 8.5 billion in 2030 and 9.7 billion in 2050, and peak at 11 billion in 2100.

In terms of age structure, industrialized countries or economies have generally entered an aging society. In 2020, people over the age of 65 accounted for 28% of the total population in Japan, 20.3% in the 27 EU countries, 16% in the US, and 15% in Russia. In emerging economies and developing countries, people over the age of 65 accounts for 11% of China’s population, making it an aging society. On the other hand, some developing countries are experiencing population explosion. Africa now registers the fastest population growth, with a total of 1.3 billion, which is expected to increase to 2.6 billion by 2050. Population ageing has a tremendous impact on advanced economies: A shrinking workforce may reduce the potential growth rate; government spending on social security and health care will go up; the elderly are less able and willing to innovate; and consumer demand will fall.

In a sense, the most certain trend over the next 20 years will be a major demographic shift. Some academics describe this shift in three “colors”: grayer (population aging), greener (increasing output per hectare enabled by technological advances), and less white (the proportion of whites in the total population of the US and Europe on fast decline).

viii. Major countries are locked in increasing competition.

The Biden administration has returned to “multilateralism”, uniting allies and partners in a more active manner. With half of the global gross domestic product (GDP), the US seeks to shape rules on the environment, labor, trade and investment, technology and transparency, prevent China from dominating future technologies and industries, and eventually lock its competitors at the lower end of the global supply chain or value chain. Such a confinement policy will underpin US cooperation with China in areas of converging interests, such as climate change, nuclear non-proliferation, and global health security.

Apart from making international rules together with its allies and partners, the US also delivers its confinement strategy by making domestic laws. On June 8, 2021, the US Senate passed the 2376-page US Innovation and Competition Act of 2021, which is directed at China and covers a wide range of areas. In some areas, it breaks through the bottom line of bilateral relations, and steps up efforts to keep China down. Once approved by the House of Representatives and signed into law by the President, this law will have a far-reaching impact on China-US relations, including economy and trade, finance, science and technology.

The China-US economic and trade relationship is the most consequential one in the world. Maintaining its healthy and stable development is not only in the interests of China and the US, but also conforms to the expectation of countries throughout the world. In response to the confinement, China’s basic strategy is to be an active participant, promoter and front-runner in the reform of global governance while firmly defending its sovereignty, security and development interests; uphold fairness and justice, actively participate in and lead the reform of the global governance system, and firmly safeguard multilateralism; raise the level of opening up to the outside world, promote trade and investment liberalization and facilitation, steadily expand institutional openness in rules, regulations, management and standards, and foster new advantages in international cooperation and competition.

II. Outlook of the World Economy

The trend of the pandemic will have a direct bearing on the future performance of the global economy. Before the pandemic, there had been setbacks to the recovery of the world economy, some of which had been exacerbated by COVID. In addition to the eight issues of particular concern mentioned above, the medium- and long-term constraints on global growth in the future include record high debt levels, slow growth in labor productivity, the stalemate in the World World Trade Organization (WTO) appellate body, and difficulties in reaching consensus on WTO reform negotiations, long-standing loopholes in financial regulation, and the rise of economic nationalism, especially resource nationalism. Cyber security, which is closely related to economic activities, has always been a “black swan” that poses huge threats to the stability of the global monetary system and financial markets. In the short term, the biggest risk facing the world economy is probably policy risk. The failure of monetary and fiscal policies in advanced economies to cope with inflation and sustain recovery will trigger asset price volatility, stifle a fragile economic recovery and push the economy into stagflation, hurting emerging economies and developing countries.

Risks, challenges or constraints do exist, but it is also true that the global economy as a whole is returning to the track of medium- and long-term development. The economic recovery of major economies in the first half of 2021 was strong, but since the third quarter, growth had slowed down and become divergent. The whole year was characterized by fast recovery first and slowdown later. In October 2021, the IMF forecast a global economic growth of 5.9% for 2021. In September, United Nations Conference on Trade and Development (UNCTAD) and Organization for Economic Cooperation and Development (OECD) forecast 5.3% and 5.7%, respectively. IMF predicted a global economic growth of 4.9% for 2022, while GDP in emerging markets and developing economies (excluding China) is likely to remain lower by 2024 than before the pandemic, with a growth of about 5.5%. In the medium to long term, global growth remains in the medium and low-speed range of 3.0% to 3.5% in the next three to five years. That said, there will be significant differences in the growth rates among different countries and regions. (All data in the article are up to  November 2021)

 


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Zhang Yuyan is Director of the Institute of World Economics and Politics of the Chinese Academy of Social Sciences.