Previous posts extending back to 2009 suggested that the global economic recovery from the 2008-09 “great recession” would mirror the revival after the 1974-75 “first oil shock” downturn. Industrial output has indeed followed a similar path but is now starting to diverge – necessary if economic optimists are to be proved correct.
The 2008-09 and 1974-75 recessions were of similar depth and duration. They were preceded by money / credit booms spurred by financial deregulation and loose monetary policy, and were triggered partly by a real income squeeze caused by a commodities-driven inflation spike. Both involved major financial stress – worse in 2008-09, although the UK secondary banking crisis of 1973-75 necessitated a Bank of England bail-out – and ushered in a prolonged period of further monetary accommodation, characterised by negative real interest rates.
The first chart superimposes the path of industrial output in the 1970s / early 1980s on recent performance. The two series have been rescaled so that the pre-recession peak in output equals 100 and the recession troughs (May 1975 and February 2009) are aligned. (Recent performance is measured by the CPB global industrial output series, which begins in 1991; the earlier data refer to the OECD area, which dominated the global economy in the 1970s, with current emerging-world countries playing a minor role.)
The current upswing tracked the 1970s path closely until end-2011, when progress was temporarily derailed by a second Eurozone recession. Stronger 2013 growth coupled with weakness in the earlier cycle have since more than made up the shortfall, with output now 3% above the level implied by the 1970s / early 1980s path.
The post-1975 upswing peaked in February 1980 after 57 months. The corresponding point of the current upswing was November 2013. An initial fall in output in 1980 was followed by a recovery in 1981 before a longer decline to a low in December 1982, equivalent to September 2016 in current-cycle terms.
The post-1975 upswing was derailed by a second oil price shock in 1979 and a generalised tightening of monetary policies in response to high inflation. The oil price surge reflected a loss of Iranian supplies due to revolution. In an attempt to control inflation, the Carter Administration imposed credit controls in 1980 but abandoned the experiment after the economy tanked – this partly explains the 1980 fall in global industrial output and a subsequent temporary recovery after controls were removed. US interest rates then spiked higher, contributing to the second, longer leg of the downturn.
The current upswing has not yet been subject to comparable shocks. There are, however, echoes of the late 1970s. War in the Middle East and the stand-off with Russia threaten energy supplies. Regulatory pressure is constraining bank credit supply. Goods and services inflation is quiescent and monetary policies remain loose but economies and markets may have become addicted to ever-larger doses of stimulus – a small rise in interest rates could conceivably have the same impact as a much larger increase historically.
A previous post argued that the US economy is vulnerable to another recession in 2016, a scenario that would be consistent with global industrial output continuing to resemble the early 1980s path.
A weaker outlook should be signalled by monetary trends. Global real narrow money started to contract in 1979 before the economic upswing faltered in 1980. The current message remains positive but six-month growth appears to have fallen sharply in August, based on data covering 60% of the aggregate – second chart. The global economy is expected here to expand solidly through late 2014 but slow in early 2015.
