The freeze-up in business confidence, caused in part by the trade war, could wind up affecting consumer confidence.
These three things are all true:
- The United States almost certainly isn’t in a recession right now.
- t may well avoid one for the foreseeable future.
- But the chances that the nation will fall into recession have increased sharply in the last two weeks.
That is the unmistakable message that global investors in the bond market are sending. Longer-term interest rates have plunged since the end of July — a shift that historically tends to predict slower growth, interest rate cuts from the Federal Reserve, and a heightened risk that the economy slips into outright contraction.
This is happening in an economy that, by most indicators, is solid. The United States economy is growing at a roughly 2 percent rate and keeps adding jobs at a healthy clip. There is no sign of the kind of huge, obvious bubbles that triggered the last two recessions, the equivalent of dot-com stocks in 2000 or housing in 2007.
So if there’s going to be a recession in 2020 — if the pessimistic signals in the financial markets prove correct — how would it happen? There are plenty of clues, in the details of recent economic reports, in signals from the markets, and in the recent history of recessions and near recessions.
“It is potentially a self-inflicted-wound type of recession,” said Tara Sinclair, an economist who studies business cycles at George Washington University. “But how deep that gash goes depends on many other characteristics of the economy and the policy response thereafter.”
There are parallels to the past. Often, a recession results when some widely held belief about the world turns out to be false. In 2001, it was that a technology boom would fuel the economy and the stock market indefinitely; in 2007, it was that the housing market would never melt down across all regions at once.
This time around, the belief in doubt is that the world will only become more stable and interconnected over time, and that trade, currency and diplomatic relationships can be counted upon.
Recessions result not just when something bad happens in the economy; bad things happen all the time. Recessions occur when those initial shocks are multiplied, in ways that reverberate worldwide. The dot-com crash was accentuated by the Sept. 11 terrorist attacks in 2001 and a rash of corporate scandals. The 2007 housing bust in the United States became a global financial crisis in 2008 only because banks worldwide took huge losses on mortgage debt.
The starting point for the international tensions that could lead to a recession in the United States is business investment spending, especially in the industrial sector. As corporate C.E.O.s look around the world and make their plans for investment and hiring in the year ahead, they aren’t liking what they see.
The economies in China and many of its Asian neighbors are getting weaker, partly as a result of the trade war with the United States. The European economy, which has muddled along for years with low growth, may be tumbling into a recession, and if Britain crashes out of the European Union with no exit deal on Oct. 31, Europe could face still deeper challenges.
Already, a key measure of business capital spending in the United States, “fixed nonresidential investment,” was in negative territory in the second quarter. And in the nation’s factories, the rate of growth has slowed for five consecutive months, according to the Institute for Supply Management’s index. Although this measure still showed growth, the July reading was the weakest since August 2016.
The trade war between China and the United States is a big part of the reason. The conflict has made it difficult for many global firms to plan their operations — and in some cases, it may lead them to sit on their hands rather than invest. The American strategy has been more successful at escalating trade tensions than in resolving them, so companies do not know whether tariffs will go away soon or will be a continuing cost of doing business.
“The president says we’re going to get a great deal and a great deal soon, but he’s been saying that for over a year,” said Phil Levy, a former trade official in the George W. Bush administration and a chief economist at Flexport, a freight forwarder that works with many companies involved in international trade. “You end up paralyzed. You have to make plans, but there is risk all over the place, so businesses get cautious and hold back on investment.”
It’s not just companies directly involved in trade with China that may see reason to hold back on investment. The turmoil in financial markets spurred by the trade war could make businesses of all sorts more cautious.
Still, if the downturn remains confined to business spending, it will be hard — just as a matter of arithmetic — for an overall contraction to result. Consumer spending accounts for more than two-thirds of the American economy, versus about 14 percent for business investment.
So far, American consumers are spending enthusiastically, driving overall growth. But there are a few ways the freeze-up in business confidence could change that.
Turbulence in global markets — and the news reports attached to that turbulence — could reduce consumer confidence, and lead Americans to pull back on their buying. The University of Michigan survey of consumer sentiment fell sharply in its August reading, announced Friday.
Or more directly, if businesses pull back on investment spending, they may also make moves that reduce consumers’ incomes, including layoffs, hiring freezes and cuts to overtime.
If that’s the worst of it — trade wars, slower business spending and weaker overseas economies — the United States could probably weather it without falling into contraction. But there are risks out there that could multiply those shocks.
One is the buildup of corporate debt. Businesses have taken on more debt in an era of low interest rates, which leaves them more vulnerable to failure if the economy were to soften or interest rates were to rise. A pullback because of trade wars could cause a wave of bankruptcies that turns a mild slowdown into something worse.
“A highly leveraged business sector could amplify any economic downturn as companies are forced to lay off workers and cut back on investments,” the Federal Reserve chair, Jerome Powell, said in a May speech.
But the biggest risk multiplier may come out of the policy world. In past recessions, the Fed had plenty of room to cut interest rates as a stimulus measure, and fiscal policymakers have been willing to pour money into weaker economies.
The Fed’s main target interest rate is just over 2 percent now,compared with 5.25 percent heading into the last recession in 2007. Other global central banks have even less wiggle room.
And a polarizing president and a divided Congress are unlikely to find much common ground in stimulating the economy. In early 2008, for example, as a recession took hold, the George W. Bush administration negotiated a $152 billion stimulus package with a Democratic Congress to try to lessen the damage.
It seems unlikely that President Trump, heading into a re-election battle, would find the same harmony with Democrats today.
“You could get a widespread fiscal response to a recession,” said Megan Greene, a senior fellow at Harvard’s Kennedy School. “That would be really nice, but I’d also like a unicorn for my birthday.”
International coordination would be even harder in the current geopolitical moment. In the fall of 2008, finance ministers and central bankers of the Group of 20 major economies released a joint statement pledging to work together to end the financial crisis. With many nations facing inward, it is hard to imagine that today.
How would a 2020 recession happen?
The trade wars and a breakdown in international economic diplomacy
- cause businesses around the world to pull back. This
- leads to further tumbles in markets and job losses, prompting American
- consumers to become more cautious. High
- corporate debt loads create a wave of bankruptcies. And
- central bank policy proves impotent, combined with fiscal policy that is nonexistent.
Chances of a near-term recession are only about one in three, in the view of most forecasters. But if it does develop, the big question will be whether the usual tools to fight it are up to the task.
What Happens in a Recession?
Trump loses, Uber evaporates, the social crisis gets worse.
This column is not in the business of forecasting recessions, based on inverted yield curves or any other form of augury. But when enough credentialed auguries suddenly think one might be possible, it seems prudent to speculate about the consequences if they turn out to be correct. So let’s imagine what might follow if, sometime this winter, our post-2008 economic expansion finally ends.
First, the easy part: Donald Trump loses re-election. It will be ugly and flailing and desperate and — depending on recession-era geopolitics — potentially quite dangerous, but there is no way a president so widely disliked survives the evaporation of his boom. The rules of politics have changed, but they haven’t been suspended. Polarization will keep Trump from being defeated in a landslide, but not from being beaten handily, and in a recession the Democrats can nominate any of their candidates and expect to evict the president with ease.
What comes next? In Washington, the centrists get a surprising opportunity. Blamed and written off by left and right alike, a Trump defeat would give the capital’s dwindling band of dealmakers and moderates another chance to govern — because even if it’s Elizabeth Warren or Bernie Sanders in the White House, it’s still going to be red-state Democrats and blue-state Republicans holding the balance of power in the Senate. The left-wing revolution won’t be canceled, exactly, in those circumstances, but it will be postponed till after 2022 or 2024; in the between-time, the people who once pined after comprehensive immigration reform and deficit commissions may get a (last?) chance to prove their critics wrong.
Meanwhile, the right will have to decide whether it wants to be an opposition or an alternative. With a bad economy and a liberal Democrat in the White House, conservatives could well return to the scripts of the Obama era, rediscovering (with whatever absurd hypocrisy) the perils of deficits and big spending, and defining themselves entirely against whatever bargains the center-left attempts to make. But if the G.O.P. is reduced to a white working-class base at a time of increasing economic pain, there will also be incentives for Trump’s would-be successors to flesh out his populism rather than abandoning it. This will be the ground on which the next Republican civil war gets fought no matter what, but how long a recession lasts and how it gets interpreted will determine whether a serious post-Trump conservative populism is inevitable or stillborn.
Then outside of D.C., the immigration crisis will diminish, while the social crisis gets worse. Notwithstanding the real horrors of gang violence in their native countries, many of the people trying to cross into the United States are clearly making an economic decision when they migrate — which means, in turn, that fewer jobs here will gradually take some pressure off the southern border. But at the same time, the domestic trends that have already worsened despite a strong economy —
- drug overdoses,
- suicide rates,
- middle-aged mortality, the
- slumping birthrate —
are likely to get even grimmer in a contraction. America’s social fabric hasn’t recovered from the rendings that followed 2008; a recession now would tear out the weakest stitching quickly.
Then in the commercial sphere, the venture-capital subsidy to American consumers will dry up. The Atlantic’s Derek Thompson summed up the peculiarities of this subsidy with a recent tweet: “If you work at WeWork, drive home with Uber, and then order food by DoorDash, you’re engaging with three companies that are projected to lose about $13 billion this year.” Those losses are supposed to end with an eventual leap into profitability; in a bad economy, they may end a lot more suddenly than that. Presumably a few of the many money-losing, long-game-playing Silicon Valley companies will survive a recession — but how many? Gather your Uber rides while ye may …
Finally, to end close to home, my profession will be shellacked. As with the social trends noted above, the economic foundation for professional journalism has continued to erode amid relative economic plenty; midsize daily newspapers keep shrinking and closing, web start-ups struggle to find ad revenue, and the business of online subscriptions rewards giants like this newspaper but so far almost nobody else. For many newspapers and webzines struggling to make the economics of the business work, a slump now could be simply fatal. And academia, journalism’s comrade in “careers that made more sense in 1960,” could face its own reckoning, with midsize and small colleges closing and consolidating, like midsize and small newspapers.
So a recessionary America would find the center-left enjoying some kind of power but probably struggling to govern, a right tearing itself apart in civil war, our downscale social crisis worsening, Silicon Valley delivering substantially less than promised, and the institutions that are supposed to inform and educate struggling or in decline.
Having guaranteed Trump’s removal from office, in other words, the recession would also set the stage for Trumpism’s eventual return.
Why We Should Fear Easy Money
Cutting interest rates now could set the stage for a collapse in the financial markets.
To widespread applause in the markets and the news media, from conservatives and liberals alike, the Federal Reserve appears poised to cut interest rates for the first time since the global financial crisis a decade ago. Adjusted for inflation, the Fed’s benchmark rate is now just half a percent and the cost of borrowing has rarely been closer to free, but the clamor for more easy money keeps growing.
Everyone wants the recovery to last and more easy money seems like the obvious way to achieve that goal. With trade wars threatening the global economy, Federal Reserve officials say rate cuts are needed to keep the slowdown from spilling into the United States, and to prevent doggedly low inflation from sliding into outright deflation.
Few words are more dreaded among economists than “deflation.” For centuries, deflation was a common and mostly benign phenomenon, with prices falling because of technological innovations that lowered the cost of producing and distributing goods. But the widespread deflation of the 1930s and the more recent experience of Japan have given the word a uniquely bad name.
After Japan’s housing and stock market bubbles burst in the early 1990s, demand fell and prices started to decline, as heavily indebted consumers began to delay purchases of everything from TV sets to cars, waiting for prices to fall further. The economy slowed to a crawl. Hoping to jar consumers into spending again, the central bank pumped money into the economy, but to no avail. Critics said Japan took action too gradually, and so its economy remained stuck in a deflationary trap for years.
Yet, in this expansion, the United States economy has grown at half the pace of the postwar recoveries. Inflation has failed to rise to the Fed’s target of a sustained 2 percent. Meanwhile, every new hint of easy money inspires fresh optimism in the financial markets, which have swollen to three times the size of the real economy.
In this environment, cutting rates could hasten exactly the outcome that the Fed is trying to avoid. By further driving up the prices of stocks, bonds and real estate, and encouraging risky borrowing, more easy money could set the stage for a collapse in the financial markets. And that could be followed by an economic downturn and falling prices — much as in Japan in the 1990s. The more expensive these financial assets become, the more precarious the situation, and the more difficult it will be to defuse without setting off a downturn.
The key lesson from Japan was that central banks can print all the money they want, but can’t dictate where it will go. Easy credit could not force over-indebted Japanese consumers to borrow and spend, and much of it ended up going to waste, financing “bridges to nowhere” and the rise of debt-laden “zombie companies” that still weigh on the economy.
Today, politicians on the right and left have come to embrace easy money, each camp for its own reasons, both ignoring the risks. President Trump has been pushing the Fed for a large rate cut to help him bring back the postwar miracle growth rates of 3 percent to 4 percent.
At the same time, liberals like Bernie Sanders and Alexandria Ocasio-Cortez are turning to unconventional easy money theories as a way to pay for ambitious social programs. But they might want to take a closer look at who has benefited most after a decade of easy money: the wealthy, monopolies, corporate debtors. Not exactly liberal causes.
By fueling a record bull run in the financial markets, easy money is increasing inequality, since the wealthy own the bulk of stocks and bonds. Research also shows that very low interest rates have helped large corporations increase their dominance across United States industries, squeezing out small companies and start-ups. Once seen as a threat only in Japan, zombie firms — which don’t earn enough profit to cover their interest payments — have been rising in the United States, where they account for one in six publicly traded companies.
All these creatures of easy credit erode the economy’s long-term growth potential by undermining productivity, and raise the risk of a global recession emanating from debt-soaked financial and housing markets. A 2015 study of 17 major economies showed that before World War II, about one in four recessions followed a collapse in stock or home prices (or both). Since the war, that number has jumped to roughly two out of three, including the economic meltdowns in Japan after 1990, Asia after 1998 and the world after 2008.
Recessions tend to be longer and deeper when the preceding boom was fueled by borrowing, because after the boom goes bust, flattened debtors struggle for years to dig out from under their loans. And lately, easy money has been enabling debt binges all over the world, particularly in corporate sectors.
As the Fed prepares to announce a decision this week, growing bipartisan support for a rate cut is fraught with irony. Slashing rates to avoid deflation made sense in the crisis atmosphere of 2008, and cutting again may seem like a logical response to weakening global growth now. But with the price of borrowing already so low, more easy money will raise a more serious threat.
By further lifting stock and bond prices and encouraging people to take on more debt, lowering rates could set the stage for the kind of debt-fueled market collapse that has preceded the economic downturns of recent decades. Our economy is hooked on easy money — and it is a dangerous addiction.