Less than a decade ago, the world economy sank Great Recession: the deepest most widespread downturn since Great Depression of the 1920s and ’30s. Since stock market crashed in 2008, recovery has been long and slow, marked by persistent bumps in the road along the way. Nonetheless, an economic recovery has, indeed, taken place. The S&P 500 index rose more than 92% over the past five years until market volatility kicked in during the second half of 2015. So far in 2016, the S&P 500 is down almost 9% since the start of the year. U.S. unemployment has dropped from nearly 10% at the height of the Great Recession to 4.9% today.
A lot of this apparent growth, however, has been fueled by government bailouts, loose monetary policy and huge injections of capital in the form of quantitative easing. The problem is that expansion cannot continue forever, fueled only by cheap money and central bank support. Ultimately, the underlying fundamentals of an economy must catch up with the stimulus to create real growth. Because the real economy has lagged in many ways, it might be the case that we are on the verge of another global recession. Here are some signs that a recession may be on the horizon.
The European Situation
The sovereign debt crisis that followed the Great Recession in Europe has been a persistent issue, and Europe represents a significant part of the world economy. The European Central Bank (ECB) has also taken the extraordinary measure of implementing quantitative easing in the Eurozone to stimulate growth. The so-called PIIGS nations (Portugal, Ireland, Italy, Greece & Spain) have been bailed out repeatedly by the European Union and the IMF, with mandatory austerity measures imposed on their populations. Not only has austerity been unpopular, such measures may have also restricted growth by reducing aggregate demand and keeping the debt burdens in these nations high.
The worst of the PIIGS has been Greece, which defaulted on an IMF loan in 2015. The Greeks had elected an anti-austerity government which called a popular referendum, rejecting EU bailout terms and calling for an end to austerity. Even though Greece itself represents a relatively small portion of the Eurozone, the fear is that if Greece leaves the European common currency (the so-called Grexit), other PIIGS countries will follow and contagion will spread, putting an end to the euro experiment. A collapse of the euro would have widespread negative consequences for the world economy, perhaps bringing on recessions.
The Chinese Bubble Has Begun to Pop
The Chinese economy has grown by an extraordinary amount over the past few decades. Chinese GDP is second in the world only to the United States, and many economists believe that it is only a matter of time before China will overtake the United States.
China’s government, however, imposes capital controls in order to keep its money within its borders. Therefore, as the Chinese middle class has grown, they have few options when it comes to investing their new wealth. As a result, Chinese stocks and real estate, two of the places where Chinese people can invest, became increasingly expensive, with the hallmarks of a bubble forming. At one point last year, the Chinese stock market had an average P/E ratio higher than the rest of the world’s, with the Chinese technology sector showing bubble-like valuations of more than 220 times earnings on average. To put that in perspective, the tech-heavy NASDAQ market had an average P/E of 150 times before the dot-com bubble burst. The Chinese stock markets have been experiencing a correction, with the government taking such cautionary measures as curbing short selling. Most recently, in an attempt to curb volatility, China implemented circuit breakers that would halt all trading on the country’s stock exchanges if losses fell to 7%.
Meanwhile, the real estate boom has led to overproduction of building resulting in so-called ghost cities, entire urban landscapes where nobody lives. When the market sees that the oversupply cannot meet demand, prices may collapse in the Chinese housing market.
If the Chinese economy slips into recession, it is likely to drag down the rest of the world as well.