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The global recession of 2020 has been forecast for more than a year by an ever-increasing cohort of economists and market analysts, based on the inversion of the US interest rate hierarchy. Over the summer, financial markets and economic indicators reinforced this pessimistic view. Should we prepare for a recession, even if we do not yet see what could trigger it? The argument put forward by the OECD, the IMF, and even Christine Lagarde during her hearing before the European Parliament, is that if a recession were to occur in the near future, the macroeconomic tools to counter it would not be as efficient as they were in 2009, and, consequently, that we would need to be inventive. Where do we currently stand?
The fall in 10-year interest rates, from 2.0% to 1.5% in the United States and from -0.3% to -0.7% in Germany in July-August, has shown that global investors are preparing for worsening economic conditions by reallocating their investments towards the bonds considered the safest. They see the risk as serious enough to overpay, in the form of negative interest rates, sovereign and corporate bonds for more than €15 trillion. Equity markets, while not falling as sharply as at the end of 2018, have nevertheless seen their volatility soar, which is consistent with the idea of asset reallocation by institutional investors in a world where excess savings have increased even further. Their fate seems once again in the hands of the US Federal Reserve, which will most probably have to give in to President Trump's injunctions, if only to avoid risking a stock market crash.
On the real economy side, industrial business surveys have taken a turn for the worse both in the United States, where the Purchasing Managers Index (PMI) fell below 50, its break-even point, for the first time since August 2016, and in Europe, where the IFO index (which measures the business climate in Germany) for manufacturing industry fell below its historical average for the first time since August 2008, and where industry order books are in free fall.
The global slowdown is therefore very tangible and its cause is clearly identified: the gradual dislocation of trade between the major economic zones.
In China, manufacturing sector growth, traditionally driven by exports, fell below 5%, the lowest level ever recorded in Chinese monthly statistics. The global slowdown is therefore very tangible and its cause is clearly identified: the gradual dislocation of trade between the major economic zones.
World trade has been declining since the end of 2018. After the economic and financial crisis of 2008-2009, the growth rate of trade in manufactured goods stagnated around 2 to 3%, lower than that of the world economy (by about 3.5%), a symptom of "soft globalization". The Chinese recovery in 2017 had revived hopes of moving closer to pre-crisis trends, but it was short-lived and the increase in US tariffs, followed by the intensification of the technological confrontation with China in autumn 2018, led to a contraction in world trade: a positive trend of 2.5% was replaced by an opposite trend of around -1% per year. While transpacific trade is the first casualty of the trade war, the high degree of economic integration of the world economy and, more recently, the downward revision of investment opportunities by companies on both sides of the Atlantic, have in fact affected all trade, across geographies and most product lines.
Fortunately, we are a long way from the collapse that followed the bankruptcy of Lehman Brothers in 2008 (-15% in 6 months). The contraction of international trade nevertheless reveals a gradual dislocation of international economic relations, towards their regionalization - as opposed to the globalization trend that had been the hallmark of the 90’s and 2000’s. However flexible companies may be, the transition to a balkanized world cannot be painless. Indeed, the fragmentation of production chains, which had been the main source of efficiency gains over the past twenty years, is not easily reversible, as we are beginning to realize with regard to digital technologies.
While the global slowdown caused by the US-led trade war is obvious, particularly in Germany, it is difficult to identify what could push the United States, Europe or China into an actual recession. Let us resume our tour of the economic world.
In the United States, the unemployment rate is at its lowest level since the late 1960s at 3.7% and the hourly compensation rate is rising at a 4.4% clip, that is, nearly 2.5% after deducting inflation. Wage growth is sustaining consumer spending, up 2.7% year-on-year in the second quarter. At 8%, the household savings rate is sufficient to absorb an unexpected shock, provided it is considered temporary. However, the decline in profits and the downward revision by companies of their investment plans show that these good figures have a high cycle connotation, and are likely to deteriorate. Besides, the Trump administration is considering reducing employee contributions to support purchasing power, especially if higher import prices as a result of tariff increases continue to fuel inflation, currently running at 2.4%, excluding food and energy. But it is above all the Fed that will provide the support: the decline incorporate investment, the deterioration in cyclical indicators and the fact that bond markets are anticipating at least three additional rate cuts will probably outweigh the acceleration in wage inflation in the deliberations of the FOMC, with or without pressure from the White House.
Germany is more exposed to global trade than the United States, and therefore more affected by the trade war, if only through its 5,000 companies operating in China, which explains the stagnation of its GDP in the second quarter and the warnings from the Bundesbank for the third. However, the domestic economy is in an even better shape than in the United States: at 3.2 per cent, the unemployment rate has never been so low since 1974; it reflects a severe labour shortage, which recent migration flows have only slightly mitigated. There are two German economies, in a way: on the one hand, the manufacturing and services sectors, which are closely intertwined and whose cyclical indicators are correlated, are seriously impacted by the contraction in world trade. On the other hand, retail trade, construction and housing are overheating, with business sentiment indicators at their highest level ever. Wages are rising sharply, at rates ranging from 2.5% in industry to over 4% in construction. Two opposing forces are at work in the German economy: world trade is depressing industry, while the ECB's highly stimulating monetary policy and wage pressures are heating construction and trade white hot. Eventually, the industrial cycle will have the final say, but starting from a situation of full employment and a budget surplus (the two go together), the German economy is strong enough to withstand a global blast, provided it does not turn into a contractionary spiral like in 2008.
Like Germany, China is dependent on world trade, and as the main target of US tariff and non-tariff measures (technology), its export sector is badly hit, as evidenced by the fall in exports (-4% in June) and the sharp slowdown in industrial production, even worse than during the 2008 crisis. However, the domestic economy is not doing so badly. For example, while the profits of state-owned or foreign-owned companies, which are generally export-dependent, fell sharply in the first half of the year (-8% and -7% respectively), those of Chinese private companies increased by 7%. Per capita income increased by 6.5% and per capita consumption by 5.2%, almost equally divided between goods and services. Supported by stimulating monetary and fiscal policies, domestic demand, and households’ demand in particular, remains strong, as in Germany, and for the same reasons.
In summary, economic conditions in the world's major economies have interesting similarities: manufacturing sectors are more or less affected by the contraction in world trade, and domestic sectors are supported by robust domestic demand, particularly households’ demand, thanks to situations of full employment and the support of macroeconomic policies. The worsening of the economic background for manufacturers, which is unlikely to reverse in the short term, is likely to spread to other domestic sectors. In this regard, it is symptomatic that, according to the compilation of opinion polls provided by YouGov, American households have become more pessimistic in recent weeks than in the past three years, despite lower unemployment and accelerating wages.
The most likely outcome is that the global slowdown will worsen in the coming months, and that it will be partially offset by more aggressive fiscal and monetary economic policies. Nonetheless, predicting a global recession is a step too far. Typically, recessions occur once the cycle has passed its peak, under the effect of monetary policies turning restrictive - hence the famous inversion of the yield curve - and/or the violent resolution of financial, housing or oil market imbalances accumulated during the previous cycle.
However, this time, the inversion of the US interest rate hierarchy is not due to monetary tightening, but to the sharp fall in long-term interest rates, itself a sign of expectations of recession, not of an actual recession. Real estate markets as a whole are not showing signs of overheating in advanced economies, with price increases ranging from 1.9% in the United States to 2.5% in the euro zone. Private debt in the United States is under control, at 76% of GDP and falling for households (down from 99% at the 2008 peak) and 74% of GDP for businesses, one of the lowest levels in developed countries.
the global slowdown will worsen in the coming months, and that it will be partially offset by more aggressive fiscal and monetary economic policies.
China has seen the largest increase in private debt since 2008, from 97% to 162% of GDP in 2017 for businesses, and from 19% to 53% of GDP for households. Could a global debt crisis be triggered by China? If capital were free to move freely across Chinese borders, such a crisis would probably have already occurred, causing global financial chaos as a result of capital flight. But this is obviously not the case, and as a result of Xi Jinping's anti-corruption campaign, corporate debt fell to 152% of GDP at the end of 2018. The reduction in the banks' required reserve ratio (RRR) announced on 6 September could halt the deleveraging process, but even if a debt crisis were to start, the Chinese government would intervene immediately, transferring non-performing or impaired assets on government books, taking advantage of a still low public debt, 50% of GDP according to BIS statistics.
Our Cassandras are therefore partly right: the global economy will continue to slow down, due to the dislocation of trade caused by US trade policy and its impact on business investment. But slowdown does not mean recession, in the sense of a lasting contraction in activity and a sharp rise in unemployment. We are obviously not immune to it - from the Straits of Hormuz to the Straits of Taiwan, risks are plenty - and it is true that economic policies have less room for manoeuvre than they had in 2009. However, the global economic backdrop does not show any of the obvious signs of imbalances that have led to past recessions, whether in terms of balances of payments or real estate markets, and, therefore, I do not believe that the extreme pessimism that surrounds us is justified. With one nuance: if all economic actors, starting with business leaders, are convinced that a recession is lurking around the corner, it could well happen, adding self-fulfilling prophecies to the long list of recession triggers.
Copyright : WANG Zhao et MARIO TAMA / AFP
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