What is behind the recent global slowdown?

Hyun Song Shin, Economic Adviser and Head of Research of the BIS in this speech tries to answer the question. He says the main reason is deep interconnections between trade and finance. With financial sector continuing to bleed, this has affected trade and global growth:

Financing of working capital to sustain manufacturing and trade shines a light on the role of the banking sector. Banks are crucial for the provision of trade financing, and a strong banking sector augments the firms’ own financial resources to meet working capital needs.

Yet the banking sector has been stuck in low gear since the GFC. While post-crisis reforms have increased the resilience of banks by enhancing their loss-absorbing capacity, banks’ lending growth has been disappointingly weak. Above all, the book equity of the banking sector, which serves as the foundation for banks’ lending, has stalled.

Graph 6 shows that book equity growth has slowed drastically since the GFC, reflecting in part the low profitability of the banking sector, as well as continued dividend payouts and share buybacks. As book equity is the foundation for the lending by banks, the slow pace of book equity growth has gone hand in hand with stagnant lending growth.¹⁰The sharp break in trend in equity and asset growth since the GFC is a graphic illustration of how, even a full decade after the crisis, the banking sector has not recovered from it. This is not just a story about Europe. The group of 75 large banks depicted in Graph 6 are drawn from around the world.

The weakness of the banking sector shines a light on the unintended side effects of a prolonged period of monetary accommodation that has weighed on bank profitability through negative interest rates and compressed long-term rates. It is commonplace to say that monetary policy is overburdened in the current economic environment, not least from the BIS. But this is a point that is especially relevant for the impact of monetary policy on GVCs and manufacturing activity. Bank lending and corporate balance sheet strength are key to the financial backing underpinning GVCs. While low interest rates in advanced economies have helped bolster consumption and support strong employment growth, the impact on bank lending that bears more directly on GVCs has been arguably less effective. Nor can we say that the impact of monetary policy on corporate leverage has been unambiguously positive. Companies have taken advantage of low long-term interest rates to borrow long-term through capital markets, and have used the proceeds in financial transactions, either in acquisitions or to buy back their own shares. Real investment unrelated to property is more closely tied to the health of the manufacturing sector and has been subdued. More recently, leveraged loans issued by less creditworthy firms have been receiving increasing attention from policymakers as a potential source of financial stress for firms.

Once the growth of manufacturing and trade through more intensive use of GVCs has run its course, relying excessively on manufacturing and goods trade may be setting the global economy up for disappointment. The experience of 2017 serves as a useful lesson. During 2017, manufacturing and trade grew strongly on the back of accommodative credit conditions and a weaker dollar. However, as we have been seeing in more recent months, some of the expansion of activity was vulnerable to a reversal of credit conditions.

These considerations bring us to the importance of the composition of demand and the role of fiscal policy. When the appropriate opportunities for long-term public investment arise, fiscal stimulus – through such investment projects taking advantage of low long-term interest rates – may be one way to reorient the economy towards domestic activity. The important point here is that such a reorientation would aid the rebalancing of the composition of demand as well as its overall size. The issue of fiscal space and long-run sustainability of public debt will then need to be addressed. These issues are beyond the scope of my presentation today, but I am sure they will figure in the discussions at this forum. I look forward to a lively debate.

Hmm..