Monday, June 6, 2016
Boom and bust in global capital and commodity cycles
The global economy is driven by cycles. Normally, the focus is only on the business cycle, but there are also capital flow and commodity cycles that have significant impacts on sovereign risk, currencies, and asset prices. The work of Reinhart, Reinhart and Trebesch, "Global Cycles: Capital flows, Commodities, and Sovereign Defaults, 1815-2015" does the heavy lifting of measuring the ebb and flows of capital around the globe over the last 200 years. Gross capital flows move cyclically with boom lasting on average nine years and busts averaging five years. When there is a trough in the cycle there is a marked increase in sovereign default risk.
The most recent data show that capital flows followed a significant growth cycle through 2011 which was longer than average. This positive flow has been in reversal over the last five years. What has placed an additional real strain on global economies and markets has been the commodity cycle which has also turned down to generate a "double bust".
The coincidence of two cycles each falling together has been a major headwind against the global economy. Clearly, the key negative impact is on emerging markets. Emerging market equities (EEM) peaked before the Great Recession, fell significantly only to have a slightly lower peak in April 2011. The EEM peak of 2011 has not been tested over the last five years.
The capital cycle has been tied to a move to safe assets. It would be hard to imagine a scenario of new highs in EEM until there is a reversal in the cyclical downturn in capital flows and a broad-based turn-around in commodity prices. There has been a positive move in oil and some selected commodities but weak global demand and limited capital flows may continue to holdback emerging markets from further growth and asset appreciation.