The world economy will become gloomy due to prolonged high interest rates

The momentum of raising interest rates by major central banks has gradually slowed, but the continued high interest rates for a longer period of time still pose many risks to global economic growth.

The US economy just boomed in the third quarter, with an astonishing growth rate of 4.9% over the same period last year. Around the world, inflation is gradually cooling, unemployment remains mostly low and major central banks may have stopped tightening monetary policy.

Even China, a country struggling with a real estate crisis, is also recording positive signs of recovery. Unfortunately, however, this positive atmosphere may not last. The foundation for the current growth of the economy is not very stable, and there are many threats that are gradually appearing ahead.

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High and long-term interest rates

It is the strength of the economy that makes many people believe that, although interest rates will no longer increase as quickly as before, they will not be cut too much. In recent weeks, one by one major central banks have decided to leave interest rates unchanged, but no central bank has declared the era of rate hikes is over.

Long-term government bond yields also increased sharply. The US government currently pays a yield of nearly 5% for 30-year bonds, up sharply from just 1.2% during the recession caused by the Covid-19 pandemic.

Even economies known for their low interest rates are now recording strong increases. Not long ago, German borrowing costs were negative; Currently, the country's 10-year government bond yield is nearly 3%. The Bank of Japan (BOJ) has also almost abandoned its commitment to peg the 10-year bond yield at 1%.

US Treasury Secretary Janet Yellen, say higher interest rates are a good thing, because they reflect a strong world economy. However, analysts do not think so and believe that this is dangerous because prolonged high interest rates will cause current economic policies to fail and disrupt growth momentum.

To see why the current favorable conditions cannot be maintained, let's look at why the US economy in particular has recently performed better than expected.

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Consumer spending continues to increase rapidly

The main driving force driving the world's largest economy comes from consumer spending. Data show that consumption in the third quarter grew at an annual rate of 4%, the strongest since the fourth quarter of 2021. Despite pressures from high inflation, rising interest rates and a cooling labor market, Americans continue to use the money they have accumulated during the pandemic.

Initially this amount was thought to have been exhausted, but recent figures show that households still have about 1 trillion USD. However, as these savings eventually dry up, higher interest rates will begin to have a negative impact forcing American consumers to spend less.

Troubles will also gradually appear in many other places as interest rates are maintained at higher levels for longer periods of time. In Europe and America, business bankruptcies are increasing.

According to credit rating agency S&P Global, as of September, 516 US businesses had filed for bankruptcy protection, surpassing the number of bankrupt businesses in 2021 and 2022. MarketWatch commented that, at this rate, 2023 could absolutely become the worst year for US businesses since 2010, a period when 827 companies went bankrupt.

In Europe, according to analysis by Scope Ratings, the number of insolvent companies reached the highest level since 2015 in the second quarter and this number has not shown signs of slowing down in the third quarter. Tougher financing conditions and higher interest rates are forecast to keep many businesses insolvent until the second half of 2024 or early 2025.

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Many risks lie ahead

If pressure continues to increase, some governments will have to impose austerity measures, leading to huge economic losses.

According to analysts, it is likely that the era of higher interest rates for a longer period of time will end on its own by weakening the economy, forcing central banks to cut interest rates without causing Inflation increased sharply.

A brighter scenario is a surge in productivity growth, perhaps thanks to innovative artificial intelligence (AI). This will help increase revenue and profits, thereby making higher interest rates more acceptable to businesses.

However, contrasting with those optimistic expectations is a world stalked by threats to productivity growth. Mr. Donald Trump has vowed to impose new tariffs if he returns to the White House. Governments are increasingly distorting markets with de-globalized industrial policies.

In addition, public spending is increasing in proportion to the economy amid an aging population. The green energy transition and conflicts around the world require more spending on defense, also putting huge pressure on state budgets. Faced with all these problems, anyone betting that the world economy can continue to grow strongly is taking a huge gamble.

Author: Edwin Thinh Vu

Editor: Raouf Boussaoui

10 nob 2023