Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.
NEW YORK – There are three negative supply shocks that could trigger a global recession by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.
The first potential shock stems from the Sino-American trade and currency war, which escalated earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator. The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “Thucydides Trap,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.
The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.
All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains. Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.
Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.
It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.
Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.
Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.
In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.
Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.
In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.
Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.
Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus. But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term. Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.
ABOARD THE U.S.S. ABRAHAM LINCOLN, in the North Arabian Sea — Out here, deterring Iran means avoiding Iran.
The 5,600 men and women aboard this nuclear-powered aircraft carrier do not venture near Iranian waters, despite a warning from President Trump’s national security adviser that the warship is in the Middle East “to send a clear and unmistakable message” to Iran to steer clear of American interests in the region.
Instead, it is the Abraham Lincoln that has steered clear of Iran. In the past four months, the ship has entered neither the Persian Gulf nor the Strait of Hormuz, the crucial oil-tanker highways it is supposed to protect.
“We recognize that tensions are high, and we don’t want to go to war,” said Capt. William Reed, a fighter pilot who commands the ship’s air wing. “We don’t want to escalate things with Iran.”
In short, the Navy has carried out the order of its commander in chief to counter Iran in the Middle East, but in the least provocative way. Just where to station the Lincoln — one of the country’s 11 nuclear-powered aircraft carriers — is a decision made by the Navy’s Fifth Fleet, which has its headquarters in Bahrain. The fear is that sending an aircraft carrier through the narrow Strait of Hormuz, right when Mr. Trump has turned up the heat on Tehran, could provoke exactly the kind of conflict the Pentagon wants to avoid.
“Anytime a carrier moves close to shore, and especially into confined waters, the danger to the ship goes up significantly,” said James G. Stavridis, a retired admiral and former supreme allied commander for the North Atlantic Treaty Organization. “It becomes vulnerable to diesel submarines, shore-launched cruise missiles and swarming tactics by small boats armed with missiles” — all parts of the Iranian arsenal of weaponry and tactical maneuvers.During each of those deployments, the carriers routinely tangled with Iranian fast boats. Both sides constantly watched each other. American naval ships openly roamed the waters along Iran’s 1,100 mile-long southern coastline, their radars trained on the Iranian shore and on Iranian ships leaving their harbors. Iranian fighter jets patrolled the skies, keeping an eye on American combat planes taking off from the Roosevelt every time an Iranian jet came close to the ship.
But these are not normal times. Mr. Trump’s “maximum pressure” campaign against Iran, including his withdrawal from an agreement meant to rein in Tehran’s nuclear ambitions and the imposition of crippling sanctions, has sharply increased tensions between the two adversaries. The Navy has sent smaller warships through the Strait of Hormuz and into the Persian Gulf, but Navy officials say privately that an aircraft carrier could prove too tantalizing a target for Iran to resist.
A Gibraltar court rejected a U.S. attempt to seize an Iranian oil tanker on Sunday, clearing the way for the ship to resume its journey in the Mediterranean under the Iranian flag and with a new name.
The Grace 1 supertanker, renamed the Adrian Darya 1, has been anchored off Gibraltar since it was intercepted by the British navy on July 4 on the grounds that it was carrying oil to Syria in violation of European Union sanctions. Authorities in Gibraltar lifted the detention order last week after Britain, which rules the territory, received assurances from Iran that the tanker would not take its cargo of 2.1 million barrels of oil to Syria.
But late Friday, the United States intervened, issuing a warrant for the seizure of the ship and its cargo, claiming it was violating not only U.S. sanctions against Syria but also those against Iran.
The Gibraltar court ruled that the American sanctions on Iran, which were imposed by President Trump after he walked away from the Iran nuclear deal last year, do not apply in the European Union.
The sanctions violations charged in the U.S. warrant “would not constitute offenses had they occurred in Gibraltar,” the government said in a statement. “There are no equivalent sanctions against Iran in Gibraltar, the UK or the rest of the EU.”
Among the charges laid out in the U.S. warrant is that the tanker was facilitating terrorism because of the involvement in Iran’s oil industry of the Islamic Revolutionary Guard Corps, which is designated a terrorist organization by the United States. The Gibraltar ruling noted that the E.U. does not regard the IRGC as a terrorist organization.
The court’s rejection of the U.S. request raises new questions over where the tanker will go next and whether the United States will attempt to intervene again, perhaps by forcibly intercepting it. No such action has been proposed, but Iranian media speculated that the U.S. Navy, which maintains several bases in the Mediterranean, might attempt to seize the vessel.
Iran’s navy commander, Rear Adm. Hossein Khanzadi, offered to dispatch the Iranian navy to escort the Adrian Darya 1, according to Iran’s Mehr news agency.
The tanker had been set to leave Gibraltar on Friday after the court lifted its detention order, but the captain and five crew members quit, leaving the ship’s owners to recruit replacements.
Photographs posted on social media showed the vessel, painted with its new name and flying the Iranian flag, being readied for departure by men in orange uniforms.
It was unclear whether Iran would release the British tanker seized in the Persian Gulf in apparent retaliation for Britain’s detention of the Grace 1, as the ship was then called.
As tensions with Iran began escalating last month, President Trump made a startling statement: The U.S. shouldn’t be bearing the burden of protecting the flow of oil tankers past Iranian waters and through the Strait of Hormuz, one of the principal assignments the U.S. has accepted for the last four decades.
Instead, he said, China and Japan depend far more on Persian Gulf oil than does the U.S. these days, so they should protect their own ships. “We don’t even need to be there in that the U.S. has just become (by far) the largest producer of Energy anywhere in the world!” the president tweeted.
As tensions mount further, thanks to Iran’s announcement over the weekend that it is breaking the level of uranium enrichmentagreed to in the 2015 deal restraining its nuclear program, Mr. Trump’s pronouncement is more relevant than ever. Iran has made clear in recent weeks that it has two weapons with which to fight back against crippling American economic sanctions: One is to scare the world by reviving its nuclear program. The other is to shake the world economy by blocking the flow of oil tankers carrying oil out through the Strait of Hormuz, a threat illustrated with attacks on a handful of tankers.
In response, Mr. Trump was asking, essentially: Why should we care, if we don’t need your region’s oil as much as we used to? It is a question that seems at once both reckless and perfectly reasonable—one a lot of Americans probably are asking themselves.
Yet the question also serves as notice that political leaders regularly need to remind Americans, and perhaps themselves, why they benefit from assuming the kind of world leadership role that includes protecting the flow of oil out of the Persian Gulf.
The reasons the U.S. should still accept—indeed, should want—this role are both practical and geopolitical. The practical reasons start with the fact that the U.S. economy is still vulnerable to a disruption of oil supplies, from the Persian Gulf or anywhere else.
Oil is the ultimate fungible global product. If the price goes up for somebody because of a supply disruption, it goes up for everybody. The origin of the barrel of oil from which your gallon of gas is derived doesn’t really matter much in determining how much it costs. If there is a global shortfall, everybody pays the price, literally.
In that global marketplace, the Strait of Hormuz isn’t quite as important as it once was, but it is still very important. The U.S. Energy Information Administration reports that 21 million barrels of oil a day flowed through the Strait last year, or about 21% of the world’s total consumption.