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.
Dr. Doom lives up to his moniker
.. Roubini pointed to the ongoing U.S.-China trade conflict as the likeliest trigger of the next crisis. “There is a cold war between the U.S. and China,” he said. “We have a global rivalry . . . about who is going to be controlling the industries of the future: artificial intelligence, automation, and 5G.”
Because the standoff has evolved into a one about national security and geopolitics, Roubini predicted that “there will be a trade and tech war between the U.S. and China that’s going to get worse.”
Roubini dismissed the trade truce declared by U.S. President Trump and Chinese President Xi Jinpeng over the weekend as mere talk, though stock market investors appeared to think otherwise this week. The S&P 500 index SPX, -0.05% closed at a record high Monday, while the Dow Jones Industrial AverageDJIA, -0.09% and Nasdaq Composite index COMP, -0.11% also gained to be within 1% of their record closes.
The uncertainty that the standoff has created is forcing businesses to delay or cancel plans to make additional investments, Roubini added. “There’s already been, in the data, a collapse in [capital expenditures] and once capex is down, industrial production is down, and then you have the beginning of a global recession that starts in
- tech, then spreads to
- manufacturing, then to
- industry and then it goes to
- services,” he said.
The Sino-American trade dispute will have even further consequences than just triggering the next recession, as it will cause “a complete decoupling of the global economy” as private entities and countries will have to choose whether to do business with China or the U.S., and it will lead to a reconstruction of “the entire global tech supply chain,” which will be a drag on economic growth going forward.
He compared the predicted U.S.-China “cold war” with that between the Soviet Union and the U.S. during the last century, arguing that the coming war will be more disruptive. “This divorce is going to get ugly compared to the divorce with the U.S. and the Soviet Union,” because there was little economic integration between America and Russia prior to the conflict.
Whether or not US President Donald Trump and his Chinese counterpart, Xi Jinping, agree to another truce at the upcoming G20 summit in Osaka, the Sino-American conflict has already entered a dangerous new phase. Though a negotiated settlement or a managed continuation of the status quo are possible, a sharp escalation is now the most likely scenario.NEW YORK – The nascent Sino-American cold war is the key source of uncertainty in today’s global economy. How the conflict plays out will affect consumer and asset markets of all kinds, as well as the trajectory of inflation, monetary policy, and fiscal conditions around the world. Escalation of the tensions between the world’s two largest economies could well produce a global recession and subsequent financial crisis by 2020, even if the US Federal Reserve and other major central banks pursue aggressive monetary easing.Much, therefore, depends on whether the dispute does indeed evolve into a persistent state of economic and political conflict. In the short term, a planned meeting between US President Donald Trump and his Chinese counterpart, Xi Jinping, at the G20 Summit in Osaka on June 28-29 is a key event to watch. A truce could leave tariffs frozen at the current level, while sparing the Chinese technology giant Huawei from the crippling sanctions that Trump has put forward; failure to reach an agreement could set off a progressive escalation, ultimately leading to the balkanization of the entire global economy.
JAW-JAW OR WAR-WAR?
. On the trade front, the US wants China to buy more American goods, reduce tariff and non-tariff barriers, open more financial and service sectors to foreign direct investment, and commit to maintaining currency stability and transparency with respect to foreign-exchange data.
On technology, the US is demanding that China strengthen intellectual-property protections, cease making the transfer of technology to Chinese firms a condition of market entry for US (and other) companies, and crack down on corporate cyber espionage and theft. A temporary deal could include any of the above, with the US offering medium-term (through the end of 2020, and possibly longer) exemptions to Chinese tech firms that use US components, semiconductors, and software. This would leave Huawei severely constrained, but not dead in the water.
The second possibility is a full-scale trade, tech, and cold war within the next 6-12 months. In this scenario, the US and China would adopt rapidly diverging positions after failing to successfully restart negotiations (with or without a truce). The US would follow through with import tariffs – starting at 10% but increasing to 25% – on the remaining $300 billion worth of Chinese goods that have so far been spared. And the Trump administration would pull the trigger on Huawei and other Chinese tech firms, barring them from purchasing components and software from US companies.
China, meanwhile, would take steps to protect its economy through macro-level stimulus, while retaliating against the US through measures that go beyond tariffs (such as expelling American firms). Huawei might survive within the Chinese market, but its growing global business would effectively be crippled, at least for the time being.
Beyond trade and technology, this scenario also implies increased geopolitical and military tensions. The possibility of some type of conflict over the East and South China Seas, Taiwan, North Korea, Xinjiang, Iran, or Hong Kong could not be ruled out.
Finally, in the third scenario, China and the US would fail to reach a deal on trade and technology, but they would forego rapid escalation. Instead of plunging into a total trade and technology war, the two powers might ratchet up their conflict more gradually. The US would impose new tariffs, but keep them at 10%, while renewing only temporarily exemptions that allow Huawei and other Chinese firms to continue purchasing key US-made inputs, while retaining the option of pulling the plug on Huawei at its discretion. Negotiations could continue, but the US would essentially hold a veto over Huawei’s bid to develop 5G and other key technologies of the global economy. Given that Trump could suddenly pull the plug on the company whenever it suits him, China’s leaders would probably abstain from blatant full-scale retaliation, but would still intervene to minimize the economic damage.
THE GOLDILOCKS OPTION…
The third scenario is the most likely for now, because China is playing a waiting game until November 2020, to see if the US elects a more even-keeled president. Even with a truce, therefore, any negotiations that are relaunched after the G20 summit will probably drag on indefinitely, with no real signs of progress. In the meantime, the Trump administration will want to apply additional pressure on China, while keeping its options open. Better, then, to start with a 10% tariff on that remaining $300 billion worth of exports. The US could always hike the rate to 25%, but at the risk of raising the costs of goods that many of Trump’s own lower-income voters rely on.
Where does that leave us? If both Xi and Trump find the third scenario attractive, neither will be willing to meet halfway on a deal. That makes the second scenario – a full-scale trade and technology war – the most likely outcome, given that a controlled escalation is inherently unstable.
As matters stand, the probability of a deal eventually being reached is low (my colleagues and I put it at just 25%). Still, we will know more after the G20 summit later this month. If Trump and Xi fail to broker a truce or a temporary agreement regarding Huawei, the US will probably follow through with 10% tariffs on the remaining $300 billion worth of Chinese exports. We will then be in the initial stages of the third scenario.
On the other hand, if Trump and Xi hold a friendly meeting and agree to a truce, the US will probably withhold new tariffs, and we will be in the early stages of the first scenario. This would make the probability of the two sides reaching a deal slightly higher. But a lurch to the third scenario – a precipitous escalation of the current confrontation – would still be more likely, followed eventually by a descent into a full-scale conflict. Where it will end is anyone’s guess, but an escalating trade and tech war is, in my view, more likely than an eventual deal.
Now that cryptocurrencies such as Bitcoin have plummeted from last year’s absurdly high valuations, the techno-utopian mystique of so-called distributed-ledger technologies should be next. The promise to cure the world’s ills through “decentralization” was just a ruse to separate retail investors from their hard-earned real money.
.. Faced with the public spectacle of a market bloodbath, boosters have fled to the last refuge of the crypto scoundrel: a defense of “blockchain,” the distributed-ledger software underpinning all cryptocurrencies. Blockchain has been heralded as a potential panacea for everything from poverty and famine to cancer. In fact, it is the most overhyped – and least useful – technology in human history.
In practice, blockchain is nothing more than a glorified spreadsheet. But it has also become the byword for a libertarian ideology that treats all governments, central banks, traditional financial institutions, and real-world currencies as evil concentrations of power that must be destroyed. Blockchain fundamentalists’ ideal world is one in which all economic activity and human interactions are subject to anarchist or libertarian decentralization. They would like the entirety of social and political life to end up on public ledgers that are supposedly “permissionless” (accessible to everyone) and “trustless” (not reliant on a credible intermediary such as a bank).
.. Yet far from ushering in a utopia, blockchain has given rise to a familiar form of economic hell. A few self-serving white men (there are hardly any women or minorities in the blockchain universe) pretending to be messiahs for the world’s impoverished, marginalized, and unbanked masses claim to have created billions of dollars of wealth out of nothing. But one need only consider the massive centralization of power among cryptocurrency “miners,” exchanges, developers, and wealth holders to see that blockchain is not about decentralization and democracy; it is about greed.2
For example, a small group of companies – mostly located in such bastions of democracy as Russia, Georgia, and China – control between two-thirds and three-quarters of all crypto-mining activity, and all routinely jack up transaction costs to increase their fat profit margins. Apparently, blockchain fanatics would have us put our faith in an anonymous cartel subject to no rule of law, rather than trust central banks and regulated financial intermediaries.
A similar pattern has emerged in cryptocurrency trading. Fully 99% of all transactions occur on centralized exchanges that are hacked on a regular basis. And, unlike with real money, once your crypto wealth is hacked, it is gone forever.
.. Moreover, the centralization of crypto development – for example, fundamentalists have named Ethereum creator Vitalik Buterin a “benevolent dictator for life” – already has given lie to the claim that “code is law,” as if the software underpinning blockchain applications is immutable. The truth is that the developers have absolute power to act as judge and jury. When something goes wrong in one of their buggy “smart” pseudo-contracts and massive hacking occurs, they simply change the code and “fork” a failing coin into another one by arbitrary fiat, revealing the entire “trustless” enterprise to have been untrustworthy from the start.2
.. Lastly, wealth in the crypto universe is even more concentrated than it is in North Korea. Whereas a Gini coefficient of 1.0 means that a single person controls 100% of a country’s income/wealth, North Korea scores 0.86, the rather unequal United States scores 0.41, and Bitcoin scores an astonishing 0.88.2
As should be clear, the claim of “decentralization” is a myth propagated by the pseudo-billionaires who control this pseudo-industry. Now that the retail investors who were suckered into the crypto market have all lost their shirts, the snake-oil salesmen who remain are sitting on piles of fake wealth that will immediately disappear if they try to liquidate their “assets.”
.. Moreover, in cases where distributed-ledger technologies – so-called enterprise DLT – are actually being used, they have nothing to do with blockchain. They are private, centralized, and recorded on just a few controlled ledgers. They require permission for access, which is granted to qualified individuals. And, perhaps most important, they are based on trusted authorities that have established their credibility over time. All of which is to say, these are “blockchains” in name only.3