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.
President Trump’s plan to slap new tariffs on Mexican imports, weeks after escalating his trade war with China, leaves the United States fighting a multi-front campaign that threatens more instability for manufacturers, consumers and the global economy.
The president’s bombshell announcement that he would impose 5 percent tariffs on Mexican imports, with the possibility of raising them to 25 percent if Mexico doesn’t stop migrants from crossing into the United States, left some economists fearing there were few limits to Trump’s appetite for trade conflict.
“In our view, if the U.S. is willing to impose tariff and non-tariff barriers on China and Mexico, then the bar for tariffs on other important U.S. trading partners, including Europe, may be lower than we previously thought,” Barclays economists said in a research note. “We think trade tensions could escalate further before they de-escalate,” Barclays added.
Adam Posen, president of the Peterson Institute for International Economics, called Trump’s move against Mexico a turning point for financial markets and the U.S. economy.
In global markets Friday, investors spooked by new tariff threats sought safety in German government bonds and the Euro rather than their customary dollar-denominated havens. This “seems to me an indicator that the concerns about the U.S. are rising,” Posen said.
The president’s latest move rocked business leaders who were already scrambling to reshape supply chains to avoid fallout from the U.S. confrontation with China. The added uncertainty may paralyze executives who can’t be sure their next supply chain location will be any safer than their last.
“A lot of companies feeling pressure to get out of China are looking at Mexico if they want to serve the US market, Vietnam if they’re more focused on Asia,” said William Reinsch, a former Commerce Department trade official. “Trump’s action yesterday scrambles all those plans.”
In one example of a company caught in the crossfire, GoPro of San Mateo, Calif., last month announced it would move manufacturing of some of its cameras from China to Mexico, so that it could stop paying tariffs to import them to the United States — tariffs resulting from the U.S. trade war with China. Weeks later, GoPro now faces new tariffs to import those goods from Mexico. The company declined to comment Friday.
As U.S. companies race to find new tariff-free places to manufacture, so far few have reported returning production to the United States, despite the president’s stated aim of using trade policy to help bring jobs back home. Many are still seeking alternative locations overseas, where labor is cheaper.
Trump said he would impose the new tariffs because the Mexican government wasn’t doing enough to stem the flow of migrants, many of whom travel through Mexico from Central America. Some White House officials who support Trump’s approach believe the threat of tariffs is the only way to get the attention of Mexican leaders.
The Mexican government tried to defuse the tension Friday, saying the two sides would meet in Washington on Wednesday for high-level talks.
If no solution is found, Mexico is certain to impose retaliatory tariffs on U.S. goods, with likely targets including U.S. pork, beef, wheat and dairy products, said Former Mexican diplomat Jorge Guajardo.
Some prominent Republicans, including Senate Finance Chairman Charles E. Grassley, raised concerns that the new tariffs could threaten a trade agreement the Trump administration clinched only months ago with Mexico and Canada, to replace the 1994 North American Free Trade Agreement.
Others said the about-face treatment of Mexico would damage Trump’s ability to negotiate trade deals it is pursuing with other partners, including China and Europe.
“You can’t negotiate a trade agreement with someone and then turn around and whack them,” said Douglas Holtz-Eakin, a Republican economist and former Congressional Budget Office director.
In late March, Trump threatened to shut the entire southern border to curb illegal immigration, but backed down a week later after an outcry. That has left some wondering how seriously they should take the latest tariff threat.
If Trump follows through with new tariffs on Mexico, it would hurt U.S. economic growth and increase the possibility of the Federal Reserve reversing course and cutting interest rates this year, economists said.
“The drag to the US economy could be meaningful, especially if the tariffs reach 25%,” the upper limit that Trump has set, Bank of America Merrill Lynch economists wrote Friday. Even if the tariff remains at 5 percent, the effective cost could be higher because many parts cross the border several times as products are assembled, and the tariff must be paid upon each crossing into the United States.
U.S. automakers will be among the principal casualties. Last year, the United States imported roughly $350 billion in merchandise from Mexico, including about $85 billion in vehicles and parts, according to the International Trade Administration.
A full 25 percent tax “would cripple the industry and cause major uncertainty,” according to Deutsche Bank Securities.
“The auto sector – and the 10 million jobs it supports – relies upon the North American supply chain and cross border commerce to remain globally competitive,” said Dave Schwietert, interim president of the Auto Alliance, an industry group. “This is especially true with auto parts which can cross the U.S. border multiple times before final assembly.”
“Widely applied tariffs on goods from Mexico will raise the price of motor vehicle parts, cars, trucks, and commercial vehicles – and consumer goods in general — for American consumers,” the industry group said. “The potential ripple effects of the proposed Mexican tariffs on the U.S. North American and global trade efforts could be devastating.”
Consumers could pay up to $1,300 more per vehicle if the tariffs are implemented, according to Torsten Slok, chief economist for Deutsche Bank Securities.
Retailers, technology companies and textile manufacturers also will be hurt. U.S. mills now ship yarn and fabric to Mexico, where it is turned into apparel and exported back to American retailers. Last year, the U.S. textile industry exported $4.7 billion in yarn and fabrics to Mexico, its largest single market.
“Adding tariffs to Mexican apparel imports, which largely contain U.S. textile inputs, would significantly disrupt this industry and jeopardize jobs on both sides of the border,” said Kim Glas, president of the National Council of Textile Organizations.
The new dispute with Mexico came as the U.S.-China trade conflict continued to deepen.
China on Friday announced it would establish a blacklist of “unreliable” foreign companies and organizations, effectively forcing companies around the world to choose whether they would side with Beijing or Washington.
The new “unreliable entities list” would punish organizations and individuals that harm the interests of Chinese companies, Chinese state media reported, without detailing which companies will be named in the list or what the punishment will entail.
Chinese reports suggested the Commerce Ministry will target foreign companies and groups that abandoned Chinese telecom giant Huawei after the Trump administration added Huawei to a trade blacklist this month, which prohibited the sale of U.S. technology to the Chinese company.
At a time when Western corporations have cut back executive travel to China after authorities detained two Canadians on national security grounds in December, the new blacklist sent another shock wave through the business community.
“I think foreign and especially U.S. firms now have to worry that China is creating a new ‘legal pretext’ to at least impose exit bans on foreign individuals who make this new list, if not worse,” said Bill Bishop, the editor of the Sinocism newsletter, referring to the Chinese practice of not allowing designated foreigners to leave China.
Aside from the new blacklist, China in recently days also escalated threats to stop selling the U.S. so-called rare earths — 17 elements with exotic names like cerium, yttrium and lanthanum that are found in magnets, alloys and fuel cells and are used to make advanced missiles, smartphones and jet engines.
Analysts said it could take years for the United States to ramp up rare-earths production, after its domestic industry practically disappeared in the 1990s. Roughly 80 percent of U.S. imports of the material come from China, according to the United States Geological Survey.
The People’s Daily, the Communist Party’s official mouthpiece, carried a stark warning for the United States this week in an editorial about rare earths: “Don’t say we didn’t warn you.”
That commentary surprised China experts because the People’s Daily, which often signals official positions with subtly codified language, uses that phrase sparingly: It famously appeared before China launched border attacks against India in 1962 and Vietnam in 1979.
That crashing sound you heard in world markets last week wasn’t just a correction. It was the sound of the end of an age.
During the long era of relatively stable international relations that succeeded the Cold War, markets enjoyed an environment uniquely conducive to economic growth.
.. The results were extraordinary. Between 1990 and 2017, world-wide gross domestic product rose from $23.4 trillion to $80.1 trillion, the value of world trade grew even faster, more than a billion people escaped poverty, and infant-mortality rates decreased by more than 50%. The number of people with telephone service grew roughly 10-fold.
This hiatus from history was, by most measures of human flourishing, a glorious era. Now it has come to an end, or at least a pause, and the world is beginning to see what that means.
.. the basic elements of economic globalization appeared firmly in place.
- Russia, the most obvious challenger to the geopolitical order, was an insignificant and diminishing player economically.
- And China, notwithstanding its rapid economic growth and its anxiety about American military power, was unlikely to challenge the economic basis of its own success. Geopolitics might have been back, but that wasn’t an issue for markets.
That complacency was misplaced. The return of geopolitics means the basic framework for economic policy has changed. In periods of great-power rivalry, national leaders must often put geopolitical goals ahead of economic ones. Bismarck’s Germany could have saved money buying armaments from Britain, but building a domestic arms industry was worth the cost. If the U.S. is in a serious strategic competition with China, an American president might well be willing to sacrifice some economic growth to banish China from important supply chains.
,, by invoking “national security,” the Trump administration has found a legal basis, with roots in the Cold War and even earlier, to assert sweeping powers over the nation’s commerce. It has upended a generation of U.S. trade policy in a dramatically short period of time.
.. The new era of geopolitics is unlikely to be an era of small government.
.. The Trump administration is
- reversing some of the regulatory excesses of the Obama era, and
- the president’s judicial appointees are prepared to rein in the administrative state.
.. A recalibration of the U.S.-China relationship was likely inevitable as the world’s oldest civilization became an economic superpower.
Hillary Clinton, who as secretary of state clashed with Mr. Obama over the need for a tougher approach to China, would not be a popular figure in Beijing if she had won the 2016 election.