What HSBC’s Stephen King Means and Why he is not Entirely Correct


Last week, HSBC chief economist Stephen King reported his take on the global economy to HSBC clients. Instantly – and perhaps due to its dire nature – news media picked up on the report, and have (alongside a swathe of images of big ships) reported how the global economy is the equivalent of the Titanic and – true to the analogy – headed for an iceberg. Many of the reports have pretty much stopped there as far as an actual explanation of what Stephen King meant, so, let’s take a deeper look.

The Analogy

The analogy referenced by Stephen King is based on the idea that normally, when the economy takes a turn for the worse, federal governmental institutions have tools that they can implement in order to counter a recession. These tools are the “lifeboats” of the so-called ship. According to Stephen King, we are six years into a recovery and – as a result – likely closer to the next recession than we are to the last. However, this time around, we don’t have these tools at our disposal.

The primary tool used when an economy dips into recession is interest rates. Pretty much the sole purpose of many of the central banks across the world (the Bank of England, the Federal Reserve) is to use interest rates to maintain a steady inflation level. In a recession, inflation falls to, or falls below, zero, while in times of economic expansion, inflation expands to 2, 3, 4 or 5% in developed economies. When inflation falls and an economy suffers, a central bank will reduce interest rates in order to stimulate borrowing and dis-incentivize saving. Increased borrowing and a reduction in saving results in more spending on both a consumer level and a business level, and with more spending we get more jobs, increase wages and – once again – more spending. In addition, the central bank can introduce more money into an economy (referred to these days as quantitative easing) via a range of mechanisms but most popular at the moment via the purchase of government bonds. An increase in the money supply can also stimulate spending, boost the equities markets and increase perceived wealth. Once again, this can lead to recovery.

As Stephen King has pointed out in his latest report, however, these tools or “lifeboats” are unavailable to us. Interest rates are pretty much zero across the globe (or even negative in some places such as Europe) and government debt is so high in many developed nations that further quantitative easing is not a realistic option. Therefore, when we hit the next recession, we will not have the usual tools available to us to fight it. The recession, therefore, is the iceberg, and the global economy, the Titanic.

Potential Tipping Points

So what could cause us recession? Stephen King highlights four potential causes. First up is the idea that increasing wages in the US will translate to a reduced profit for US corporations, and in turn, negatively impact US GDP. He suggests that this will then lead to a bursting of the stock market bubble and an economic downturn. Second, he theorizes that certain non-bank financial organization such as insurance companies and pension funds will fail to meet their obligations, causing a mass sell-off in liquefiable assets and – again – an economic downturn. Third, we could see a weakening of Chinese economic expansion, leading to a decline in commodity prices and a corresponding increase in US dollar strength. This would make it difficult for outside economies to do business with the US, and impact US GDP. Finally, and perhaps most pertinent, if the Federal Reserve raises interest rates too soon, it could trigger a recession.

A Solution?

So, with all this bad news just round the corner, is Stephen King right and are we headed for a sinking ship situation, or is there something we can do when the recession finally hits? In other words, do we have any lifeboats left?

Well, back in the 30s, during the great depression, the now famous British economist John Maynard Keynes suggested to then president Roosevelt that, through paying men to dig holes in the desert, he could stimulate a recovery. This, of course, was an analogy to illustrate the suggestion that government intervention and funded structural reform could lead to economic activity and national spending increases. Roosevelt took Keynes’ advice and initiated a huge amount of public work, his so-called “new deal”, perhaps the most famous result of which is the Hoover Dam. The increase in employment that came round as a result of the new Deal translated to economic stimulus. In other words, yes we may not have interest rates at our disposal to fend off a recession, but when it comes around, if we can emulate the New Deal policies of the 1930s, we may be able to raise an otherwise sinking ship.

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