It’s not for nothing that economics is known as the dismal science. We are being urged to celebrate synchronised global economic growth again—but it’s not too soon to start thinking about the next recession.
Let’s start with the good news. If the United States expansion keeps going until July 2019, and it will, it will be 121 months old and America’s longest expansion since records began in 1854. The UK’s longest expansion was from the 1991 recession to the 2008 peak, and so we would have to keep ours going for a good few years yet to break that record. Yet, at nine years this summer, it is quite mature compared with most cycles.
Down under in the lucky country, Australia, there hasn’t been a recession for 26 years. On official data, China has never had one in modern times, though it almost certainly came close in both 2008 and again in 2015.
The counterpoint to long expansions, though, is that they do always end, and the fingerprints of central banks and governments are usually found at the scene. For what it’s worth, I think this long-in-the-tooth expansion will keep going through 2019 but there’s a good chance that the next global contraction will occur in 2020. This would be just in time for the US presidential election and most likely hit the UK as we are in the process of leaving the European Union.
The main place to look is the US, where it appears that the Federal Reserve is going to drive a four-by-four kind of monetary policy. Four rate rises this year, and four in 2019, pushing the policy rate up 2 percentage points to about 3.25-3.5 per cent. The likelihood of this happening has been strengthened by the first remarks of new Fed Chair Jerome Powell to Congress, and a recent speech by a highly respected and normally dovish Governor, Lael Brainard. Both opined that some of the economic headwinds the US has faced in recent years have turned into tailwinds, and that the Fed would therefore have to be more vigilant.
The argument runs as follows. Synchronised growth is pulling forward expectations of monetary policy shifts in the US and elsewhere. The US dollar, which rose in trade weighted terms by 25 per cent between 2014-2016, has fallen by 8 per cent in the last year. This adds to US growth and to pressure to offset its impact monetarily. Unemployment is likely to carry on falling to about 3.5 per cent, gradually pushing wage and salary increases higher. Rising oil prices have also helped the US oil industry, business investment has been on a roll, and the Trump/Congressional tax cuts will boost the economy by 0.8 per cent in 2018, and 1.3 per cent in 2019, while pushing the Federal budget deficit up to over 5.5 per cent of GDP.
“Long expansions always end—and the fingerprints of central banks and governments are usually found at the scene”Because a bigger fiscal deficit means lower national savings, the US trade and current account deficits will rise. Trump’s trade measures will make no difference whatsoever except to make allies and adversaries cross.
So, by late 2019 or 2020, the policy environment will have been transformed. Interest rates will have risen further than markets expect, the budgetary impulse in 2020 will suddenly go into reverse, and market valuations will almost certainly be lower. These developments are quite likely to bring the expansion to a close.
The recession will hopefully not be deep or protracted, unless we should become aware of deeper problems in the financial industry, or other factors intervene. But it will undermine and drag down global growth. I am assuming that however Trump, China and the EU choose to play out their trade spats, world trade will weaken for it, but won’t go into free-fall.
Emerging markets (EM) are in the cross-hairs too. EM have been bingeing on debt since 2008, with the outstanding level rising from less than 150 to more than 210 per cent of combined GDP. The surge has been mostly in China, but also in other large economies with fragile external positions, such as Turkey and Brazil. Until now, low US dollar interest rates and now a falling US dollar have made financial conditions and returns attractive. But over the next 12-18 months, we should expect US bond yields to rise further, and in time the US dollar to follow.
If US growth and demand for imports then softens, by 2020, EM will be hit on three fronts. If China continues to clamp down on credit growth and the economy slows a bit more, commodity prices could fall away even sooner, adding a fourth problem. So far, the Chinese authorities seem keen to drive the economy with more brake than accelerator. Economists will be watching for any signs that the government may end up over-tightening policy, or equally mistakenly, easing up prematurely in its addiction to unsustainable growth.
Brexit Britain should be keeping an eagle eye on these developments in the US and beyond. By 2020, if the government’s plans are on schedule, we might be in an extended transition phase (the “kicking-the-can” option), or we could already have left the EU in a hard Brexit, or be in a short transition before one. The latter two possibilities would make for a nasty confidence- and demand-sapping cocktail to add to an already more adverse external environment. The end of the UK expansion would then be happening at a critical junction in the electoral cycle here too.
