The Trump trade war raises the spectre of recession

Muhammad Mahmood | Published: June 22, 2019 21:41:00 | Updated: June 28, 2019 21:36:13

As the risk of a global trade war is rising, that could plunge the global economy, including the US economy, into a recession. With the breakdown of trade talks between the US and China last month the whole global trading system has been thrown into chaos. But it is not China alone, Trump is waging trade war also with the European Union (EU) and many other countries considered to be US allies. Business surveys conducted in the US indicate that business outlook has not been so low since the 2007-08 Global Financial Crisis (GFC). This business pessimism in the US is driven by trade war and recession concerns.

The current acceleration in US economic growth has been propelled by corporate tax cuts (the supply side mantra) and a surge in public spending. But as 2017 corporate tax cuts run its course, the US economy now runs the risk of slowing down. Persistently low inflation enabled the Federal Reserve to maintain a low interest rate regime, easing the cost of servicing public debt and also corporate and household debts. But that may be under threat from Trump's tariff policy as tariff will push up the inflation rate, necessitating an interest rate hike. Even US Commerce Secretary Wilbur Ross conceded that prices in the US will increase as a result of the new China tariffs now put in place by the Trump administration. Such a situation foretells of a rising threat of stagflation where economic slowdown is accompanied by rising inflation.

Meanwhile, the Chief of the International Monetary Fund (IMF), Christine Lagarde  once again repeated her warning of slowdown in global growth arising from the trade war  between the US and China and asked them to moderate their positions. The IMF report published early this month estimated that when all tariffs were taken  into account, that  would cause a 0.5 per cent reduction in global growth. The IMF warning came amid signs of economic slowdown in most of the advanced economies with the consequences for the rest of the world economy.

But the Trump advisers are confident that the relatively buoyant US economy allows the administration to take a much harder line with China than would normally be advisable enabling the US to ride out the storm better than China. That assumption is based on the gut feeling that US will continue to grow until China capitulates. But US tariffs could end that dream. Very similar thing happened in 1929 with Smoot-Hawley Tariff  Act. If the US thinks China will capitulate, they will be waiting forever. In effect China can use it in its favour to reorient its economy to decrease its reliance on exports to the US and seek out economic opportunities in other parts of the world.

The balance of the relationship between the two countries is changing.  China now has more autonomy in safeguarding its national interests than before. China depends on the US for agricultural products and China's enhanced autonomy made it much easier to slap retaliatory tariffs on US products like corn and soy bean. China also has much wider space in pursuing its economic policy. China throughout its economic reform process known as the "open door policy'' pursued an open economic engagement with the West in ways that benefit China. That necessarily presupposes to deal with the Western capitalist economic system, in particular the neoliberal variant of it. China has always dealt and will continue to deal with the West within that context but refuses to internalise that economic system.

The Global Financial Crisis (GFC) created far-reaching consequences for the Chinese economy due to its integration with the rest of the world, in particular the US economy where the crisis originated. China also undertook massive credit expansion like the US but was apparently aware that this could not continue indefinitely. The need for an alternative economic policy to stem the possibility of another financial crisis erupting again and to maintain the economic growth process led China to formulate the "Made in China 2025'' policy. But the US saw it differently as an existential threat to its global economic and military dominance. As a consequence, the trade conflict turned into a much wider conflict with China encompassing economic and security issues as well. The trade conflict with China now has moved to a stage which bears all the hallmarks of a new cold war.

China has, in the meanwhile, launched the New Silk Road Initiative known as the Belt and Road Initiative (BRI), among other policy initiatives, to diversify its markets to reverse the country's dependence on the US market. With expanding market opportunities, China has effectively limited the ability of the US to influence its domestic economic activities or its economic system. China's growing exports to other countries will enable the country to replace whatever they might have lost to the US within a very short period of time. But all these are for some future dates to bear fruits.

But for now the US president, Donald Trump has disrupted global trade and investment flows with his tariffs and restrictions on foreign direct investment (FDI) and technology transfers which could have profound implications for the rest of the world including China. As trade tensions are escalating that in turn are negatively impacting on business confidence and causing supply chain disruptions. As Trump started to impose tariffs on Chinese imports, China also imposed retaliatory tariffs on US goods. Trump  is also  waging trade wars with other countries including many of US allies. His tariffs and restrictions of technology transfers and FDI could morph into a recession. The World Investment Report, 2019 prepared by the United Nations Conference on Trade and Development (UNCTAD) has already indicated that global FDI flows decreased by 13 per cent in 2018 - this was the third consecutive annual decline. This indicates that  post-GFC factors are in play as well.

The process leading to the recession resulting from a trade shock is very simple: higher costs for business triggered by tariffs causing freeze in investment decision; households will be hit by higher prices hurting consumer sentiment, and the trade conflict will also cause disruption in supply chains, that will make firms unable to figure out where to get their inputs from they need. All these chain effects will cause decline in confidence among business executives and consumers leading to scaling back spending, a sure recipe for triggering   a recession. So if the trade war continues, economic growth will continue to decline as costs increase, firms reduce their capital spending and consumer demand slows down.

A spokesperson of the Chinese Ministry of Commerce told  a Beijing press conference that there would be no winner in the trade war which could cause a recession in the US and economies around the world. But such a comment does not deter Trump to make preparation for imposing further 25 per cent tariffs on the remaining untaxed imports from China valued at US$300 billion which is expected to come into effect in July if a last-minute change does not occur from a possible Trump-Xi meeting at the G20 meeting scheduled to be held in Osaka at the end of this month. If Trump goes ahead with his new tariff threats against China and prohibition on component acquisition by Chinese firms such as Huawei, this will further intensify the trade war as China will also retaliate in like manner. This will be sufficient to bring about further global economic slow-own.

The US Federal Reserve is for the moment holding on to the current interest rate range at 2.25-2.5 per cent, but Fed Chairman Jeremy Powel has already indicated that the rate cut was on the table for later this year. The reason he cited were his concerns about the global growth, fall in business confidence and risk sentiment in financial markets. The value of negative-yielding long-term bonds in the US and globally is soaring to trillions of dollars. Trump's war threats against Iran can trigger an oil shock. All these, coupled with the scale of private and public debt, may lead to another financial crisis.

The policy options to deal with the impending crisis have become increasingly limited. The monetary and fiscal intervention in the wake of the GFC can not be used with same effect now because advanced economies are saddled with record levels of public debt than ever before and central banks are sitting on massive balance sheets resulting from successive rounds of quantitative easing (QE). As Trump's trade war with China, the EU and many other countries is causing the global economy to drift towards a global recession and financial crisis. This has also diminished the possibility of the  level of cooperation needed among advanced global economies relative to that which was seen in response to the GFC in 2008. And that will make the crisis far worse than GFC.

Muhammad Mahmood is an independent economic and political analyst.



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