BY GRACE BLAKELEY
A decade has passed since the start of the Great Recession – the momentous downturn that shook the global economy as none had since the 1930s. In the intervening years, the world has experienced a slow but consistent recovery. Economic dangers, however, are now apparent at every turn: a new global debt crisis, trade wars between great powers and a Chinese slowdown.
The IMF has cut its world growth forecast for 2019 to 3.5 per cent (compared to 3.9 per cent in July 2018), citing lower growth in both advanced and emerging economies and the rising likelihood of a negative economic shock. Some market analysts are now warning of a possible global recession this year – far earlier than most have anticipated. But how much danger are we in? And what would be the economic and political consequences of a new crash?
On the surface, it is unclear what explains the new mood of pessimism. In our interconnected world, global growth is intimately linked to the fortunes of the largest economies, most of which have enjoyed sustained recoveries since the 2008 crisis.
Since 2012, Chinese GDP has grown at an annual rate of 6-8 per cent – weaker than in the pre-crisis period (growth peaked at 14 per cent in 2007) – but still strong enough to support the growth of the Chinese middle class and stimulate the economies of its major trading partners. The US recovery has been slow by historic standards but growth in 2018 (2.9 per cent) was buoyed by Donald Trump’s tax cuts, which dramatically inflated corporate profits. Japan’s growth has been low but stable – unsurprising in view of its rapidly falling population (which declined by 449,000 in 2018). Only the eurozone has continued to struggle, growing by just 1.8 per cent in 2018.
But all is not as it seems. The US recovery has been highly unstable and unequally distributed, with loose monetary policy (interest rates are currently 2 to 2.25 per cent) required to sustain unremarkable growth rates, which have varied by almost five percentage points between the best- and worst-performing states. Real average American wages in 2018 had the same purchasing power as 40 years ago. Meanwhile, corporate debt has reached a record level (45 per cent of GDP) and stock markets still appear overvalued.
China’s growth has been driven almost entirely by its 2009 $586bn stimulus programme – one of the largest in economic history, which included public investment in high speed rail, airports and road upgrades – which has also underpinned growth in economies dependent upon Chinese demand for their exports (such as Germany). Brazil, Russia and South Africa – once heralded as part of the insurgent “Brics” economies – are all growing at annual rates of 1.5 per cent or less, according to recent figures.
Germany avoided recession by the narrowest of margins, with zero growth in the final quarter of 2018, while Italy has returned to negative growth. In the UK growth last year was the weakest since 2012, and output fell by 0.4 per cent in December.
“World growth was buoyant in 2016 and 2017, with more than three-quarters of the world growing at or above trend rates,” Andy Haldane, the Bank of England’s chief economist, told me. “But there was a notable slowing during 2018. Today, more of the world is running below trend than above. This slowing has been strikingly simultaneous across the US, the euro area and China.”
Private debt, meanwhile, has resurged in many countries – notably in China, Australia, Canada and some of the Nordic states – and many emerging markets are now in debt distress (meaning they have defaulted or cannot service their debts).
Without broad, sustainable growth, risks accumulate and uncertainty rises. As Alfie Stirling, chief economist at the New Economics Foundation, told me: “Almost by definition, shocks are caused by uncertainty over events, rather than by events themselves.” The global economy’s problem is less the inevitable downturn in the business cycle but the array of forces that may upset a delicate equilibrium. These can be distilled into five categories: financial instability in China; global monetary tightening (rising interest rates and the end of quantitative easing or QE); the unresolved eurozone crisis; a shock to global trade; and rising private debt in the developed world.
First, China. The myth is that the country has grown rapidly by pursuing a model of export-led growth, based on cheap labour and an undervalued currency. This is the story that the US tells itself in order to justify its trade war with China (the Trump administration has so far imposed $250bn of tariffs on Chinese goods, prompting Beijing to retaliate in kind). But since the 2008 financial crisis, exports have not been the main contributor to Chinese growth.
Instead, growth has been sustained by an extraordinary Keynesian stimulus programme worth almost 20 per cent of GDP. As well as investing heavily in public infrastructure projects, the Chinese government has promoted private lending by state-backed institutions. The corporate debt-to-GDP ratio now stands at 160 per cent, while Chinese households have also hugely increased their borrowing: household debt as a share of GDP reached a record high of 50 per cent in 2017.
This bodes ill for the country’s financial stability. A fall in house prices and mortgage lending could lead property bubbles to implode. Slower growth could also tip highly indebted Chinese corporations into bankruptcy and threaten the solvency of some lenders. Though the state could intervene to rescue them, it has fewer resources to draw on than in 2009.
Any attempt to address the country’s financial bubble means reduced lending, which constrains growth. For decades, the Communist Party has maintained a tacit bargain with the emerging middle class: authoritarian rule in return for annual economic growth of at least 7 per cent. A financial crisis would hurt the government politically but ongoing stagnation could be more dangerous. As French historian Alexis de Tocqueville observed in his classic 1856 work The Old Regime and the Revolution (a text much studied by China’s leaders), revolutions frequently occur when growth falls below rising expectations.
In the trade-off between financial stability and growth, China is likely to continue to favour the latter. And when the bubble does eventually burst, while the Chinese financial system is relatively insulated, some parts of the the world will feel the effects. Indeed, the UK, as host to the Hong Kong and Shanghai Banking Corporation (HSBC), is more exposed than almost any other economy.
But the main impact of any crisis in China would be the global chain reaction it sets off, because it is the engine of growth for so many other economies. Coupled with a US recession – an eventuality that most analysts consider likely over the next three years – events in China could lead to a new global downturn. As Adam Tooze, the economic historian and author of Crashed, told me: “The hopes of the West continue to rest on Beijing pulling off a stunning exercise in macroeconomic juggling while Donald Trump hurls knives at them.”
The second economic trend to worry about is monetary tightening. After the 2008 crash, interest rates were reduced to record lows, while central banks sought to boost demand through QE; $10trn of new money was injected into the global financial system by purchasing government bonds. But this year may herald the end of the post-crash decade of easy money as interest rates are increased across the world and QE is unwound.
Perhaps the most significant consequence would be unmanageable debt in the global south. It is an obvious truth (albeit rarely stated) that the only countries to have experienced acute debt distress are those that borrow in a foreign currency or lack control over their own monetary policy. The former category – mainly emerging economies in south Asia, eastern Europe and Latin America – could be severely affected by monetary tightening as capital flows out of these economies and back to the US (in search of higher returns).
Another consequence will be rising volatility in equity markets (where stocks and shares are exchanged). The market capitalisation to GDP ratio – the total value of all publicly traded stocks relative to GDP – suggests that US stocks remain overvalued, even after a correction in December 2018, and increasing volatility suggests that investors know it. As long as the tune of easy money continues to play, these worries are far from most minds. But when the music stops, equity markets in many developed economies could endure what some would regard as a long overdue correction.
The third cause for concern is the sick man of the world: the eurozone. Growth has long been anaemic in the currency area, with the outlook for Greece and Italy particularly grim. In the absence of control over their monetary policy, there are only two ways for these countries to escape the debt trap: a major state-backed stimulus programme or internal devaluation (through cuts to wages and production costs).
Germany, the eurozone’s hegemon, has a strong preference for the latter. Its economic competitiveness is based on wage repression and a rigid approach to controlling inflation. “If we can do it, why can’t you?” Germany asks. The inconvenient truth, of course, is that the currency union makes this harder for southern European countries and easier for northern ones. The euro makes German exports look cheap, and Greek ones look expensive, acting as a huge economic boost to the former and a constraint on the latter.
The only sustainable – and indeed fair – way to deal with the divergence is to make major fiscal transfers (the redistribution of income and wealth) from north to south. But political reality precludes this solution. The German state, and its allies in northern Europe, would block any continent-wide pro-growth reforms for fear of the inflationary consequences. Germany will also continue to veto anything that resembles debt mutualisation – the sharing of sovereign debt across EU states. As a result, austerity will prevail, stunting the southern European economies’ growth and immiserating their people. Without structural reforms that promote growth in these economies, the disparity between north and south will only further widen. Over the long term, if unaddressed, this surely can only have one outcome: the break-up of the currency union itself.
The fourth ominous storm cloud for the world is the potential for a collapse in global trade because of growing protectionism – most notably in the US and the UK. This follows a decade of slowing global trade and investment flows, which some have termed “slowbalisation”. Trade flows initially recovered healthily from the 2007-08 financial crisis, but have fallen since – from as much as 61 per cent of global GDP in 2011 to 58 per cent today.
But the real indicator of slowbalisation has been falling capital flows (the cross-border movement of money for trade and investment). The period of financial globalisation between 1980 and 2007 saw global cross-border capital flows increase three times faster than trade flows, but between 2007 and 2017, these capital flows fell by 65 per cent. Financial globalisation has proven to be its own undoing. Rising financial instability, culminating in the 2008 crisis and growing inequality in large parts of the global north have led to a backlash against all forms of global economic integration. The fragmentation of globalisation and the subsequent reaction has fuelled the rise of populist movements and the resurgence of the radical left, especially in this country and the US.
Alongside the slowdown in China, the IMF has highlighted a disorderly Brexit as one of the biggest threats to world growth in 2019. The same is true of an escalating trade war between the US and China. Were the US to impose new tariffs on Chinese imports, the slowing Chinese economy would be further harmed, while American growth would also fall, perhaps tipping the country into an early recession. And as the revolt against globalisation spreads, few can predict where the next trade crisis will emerge.
Finally, private debt in the global north continues to pose a threat to financial stability. Steve Keen, an Australian economist, describes private debt as the “elephant in the living room” of the world economy. In the US, corporate debt is at an all-time high of 45 per cent of GDP – higher than during both the dot-com bubble of 2000 and the housing bubble of 2007. Ann Pettifor, a leading heterodox economist, and one of the few to predict the last financial crash, told me that “margin debt” (debt used purely for speculative purposes) has “gone ballistic” on the New York Stock Exchange.
A significant contribution to the financial crisis was the securitisation of US mortgage debt, with ordinary mortgages transformed into complex financial securities used as collateral for further borrowing. After the crisis, the value of this market collapsed, but risk soon spread to new sectors, vindicating US economist Hyman Minsky’s prediction that “that which can be securitised, will be securitised”. In the US last year, the value of securities issued based on car loans, credit card debt, student loans and various other unsecured debt exceeded commercial and residential mortgage-backed securities combined.
Meanwhile, Australia and Canada are experiencing what Tooze calls “unsustainable booms” based on rising property prices that could collapse at any time. When lending conditions tighten, house prices may fall, potentially creating overlapping financial crises in these economies.
While most of these risks are unlikely to trigger a global recession in 2019, the near-term outlook for the world is bleak. Perhaps the greatest cause for concern is that, when the next recession does arrive, as it will, we will be even less prepared than we were in 2008. Monetary policy is already ultra-loose (UK interest rates stand at 0.75 per cent, compared to 5 per cent before the crash) and national debt levels have significantly risen, reducing the space for fiscal stimulus (public spending and tax cuts). The risk is that in the event we hit an iceberg, there aren’t enough lifeboats to go around, as economists are fond of saying.
This reflects a more profound problem. The reason debt levels are still so high and interest rates so low is that the recovery from the financial crisis has been so weak.
GDP levels may have recovered but growth in investment, productivity and wages has been dismal, especially in the US and the UK. More than at any point in previous history, living standards have become detached from employment growth (currently at an all-time high in the UK). If the recovery has been characterised by stagnant wages and productivity, falling investment and rising poverty, what will the next recession look like?
History teaches us that when the status quo only offers stagnation or decline, voters will look for radical alternatives. So far, discontent has been largely channelled into increasing support for the populist right, whose posturing disguises an essential respect for free market capitalism. But as the sheen falls off the likes of Donald Trump and Boris Johnson, defenders of the status quo face a far more worrying prospect: the election of a cohort of leaders who identify as socialists. The next recession may not be as large as 2008, but it could still represent a far greater rupture.