Setting the table for a smorgasbord recession.
The last global economic crisis, for all its complex detail, had one big, simple cause: A huge housing and debt bubble had emerged in both the United States and Europe, and it took the world economy down when it deflated.
The previous, milder recession, in 2001, also had a single cause: the bursting of a bubble in technology stocks and investment (remember Pets.com?).
But the slump before that, in 1990-91, was a messier story. It was a smorgasbord recession — a downturn with multiple causes, ranging from the troubles of savings and loan institutions, to a glut of office buildings, to falling military spending at the end of the Cold War.
The best guess is that the next downturn will similarly involve a mix of troubles, rather than one big thing. And over the past few months we’ve started to see how it could happen. It’s by no means certain that a recession is looming, but some of our fears are beginning to come true.
China: Many people, myself included, have been predicting a Chinese crisis for a long time — but it has kept not happening. China’s economy is deeply unbalanced, with too much investment and too little consumer spending; but time and again the government has been able to steer away from the cliff by ramping up construction and ordering banks to make credit ultra-easy.
But has the day of reckoning finally arrived? Given China’s past resilience, it’s hard to feel confident. Still, recent data on Chinese manufacturing look grim.
And trouble in China would have worldwide repercussions. We tend to think of China only as an export juggernaut, but it’s also a huge buyer of goods, especially commodities like soybeans and oil; U.S. farmers and energy producers will be very unhappy if the Chinese economy stalls.
The Global Impact of a Chinese Recession
Most economic forecasts suggest that a recession in China will hurt everyone, but that the pain would be more regionally confined than would be the case for a deep recession in the United States. Unfortunately, that may be wishful thinking.
CAMBRIDGE – When China finally has its inevitable growth recession – which will almost surely be amplified by a financial crisis, given the economy’s massive leverage – how will the rest of world be affected? With US President Donald Trump’s trade war hitting China just as growth was already slowing, this is no idle question.
.. First, the effect on international capital markets could be vastly greater than Chinese capital market linkages would suggest. However jittery global investors may be about prospects for profit growth, a hit to Chinese growth would make things a lot worse. Although it is true that the US is still by far the biggest importer of final consumption goods (a large share of Chinese manufacturing imports are intermediate goods that end up being embodied in exports to the US and Europe), foreign firms nonetheless still enjoy huge profits on sales in China.
Investors today are also concerned about rising interest rates, which not only put a damper on consumption and investment, but also reduce the market value of companies (particularly tech firms) whose valuations depend heavily on profit growth far in the future. A Chinese recession could again make the situation worse.
.. High Asian saving rates over the past two decades have been a significant factor in the low overall level of real (inflation-adjusted) interest rates in both the United States and Europe, thanks to the fact that underdeveloped Asian capital markets simply cannot constructively absorb the surplus savings.
.. instead of leading to lower global real interest rates, a Chinese slowdown that spreads across Asia could paradoxically lead to higher interest rates elsewhere – especially if a second Asian financial crisis leads to a sharp draw-down of central bank reserves. Thus, for global capital markets, a Chinese recession could easily prove to be a double whammy.
.. a significant rise in global interest rates would be much worse. Eurozone leaders, particularly German Chancellor Angela Merkel, get less credit than they deserve for holding together the politically and economically fragile single currency against steep economic and political odds. But their task would have been well-nigh impossible but for the ultra-low global interest rates
.. Today, however, debt levels have risen significantly, and a sharp rise in global real interest rates would almost certainly extend today’s brewing crises beyond the handful of countries (including Argentina and Turkey) that have already been hit.
.. Nor is the US immune. For the moment, the US can finance its trillion-dollar deficits at relatively low cost. But the relatively short-term duration of its borrowing – under four years if one integrates the Treasury and Federal Reserve balance sheets – means that a rise in interest rates would soon cause debt service to crowd out needed expenditures in other areas. At the same time, Trump’s trade war also threatens to undermine the US economy’s dynamism.
.. Its somewhat arbitrary and politically driven nature makes it at least as harmful to US growth as the regulations Trump has so proudly eliminated. Those who assumed that Trump’s stance on trade was mostly campaign bluster should be worried.
.. A recession in China, amplified by a financial crisis, would constitute the third leg of the debt supercycle that began in the US in 2008 and moved to Europe in 2010. Up to this point, the Chinese authorities have done a remarkable job in postponing the inevitable slowdown. Unfortunately, when the downturn arrives, the world is likely to discover that China’s economy matters even more than most people thought.