Spectre of recession

The inequality generated by decades of neoliberalism and the resentment it has caused across the world have in recent times led to uncertainties that only intensify the fear of recession.

Published : Aug 28, 2019 07:00 IST

F EAR that the global economy, which has not yet recovered fully from the crisis of 2008, could tip over into yet another recession, is widespread. Growth is decelerating even in the United States, which had experienced reasonable recovery from the 2008 recession with the unemployment rate reportedly at a 50-year low. The two economies—China and Germany—that, along with the U.S., had steadied the boat, have lost momentum. Industrial growth in China is running at a 17-year low. Recently released statistics show that the German economy, which recorded negative growth in the third quarter of 2018 but saw a return to positive territory, has once again contracted, even if by a fraction, in the second quarter (April-June) of 2019. Prospects for the third quarter are gloomy as well.

The performance of these two economies, given their leadership of and integration with global production networks and value chains, affects the rest of the world economy, especially Asia and Europe. For example, depressed Chinese demand is blamed for the fall in Thailand’s second quarter growth rate to the lowest since 2014. Combined gross domestic product (GDP) growth relative to the preceding quarter in the 19 countries of the euro zone fell to 0.2 per cent in the second quarter, from 0.4 per cent in the first three months of 2019.

As a result of all this, scattered talk has given way to widely expressed fears of an impending recession. That fear has already affected financial investment behaviour, with investors dumping stocks and shifting to government bonds, resulting in a slump in stock markets and an inversion of the yield curve. That is, with investor demand pushing up the prices of long-term bonds, the yield on longer-term paper (10-year U.S. Treasury bonds) fell below that on short-term instruments (two-year Treasury bonds), which goes against the conventional expectation that investors willing to wait longer would also expect higher returns. A reversal of that relationship between long and short rates has in the past signalled an impending recession.

The deeper malaise that underlies these recessionary tendencies is the depressed demand that results from the extreme inequality in assets and incomes that has resulted from decades of neoliberal growth across the developed world. Globalisation that moves productive activity to locations with large reserves of cheap labour, depressing wages across countries, large profits for a few from financial speculation, and tax concessions for the rich have combined to accentuate inequality.

Income disparity

While incomes in the top percentile have exploded, those in the middle and lower ranges have tended to stagnate, sapping consumption demand. Growth, therefore, comes to depend on finding ways of stimulating demand that does not depend on current income, but is driven by credit. Prior to the 2008 crisis, a credit boom, fuelled by multiple means of transferring the risks associated with lending out of the hands of the creators of those credit assets, was used to drive growth. That, beyond a point, could not be sustained and ended in the financial crisis and the Great Recession. A similar inability to keep demand going underlies the evidence and the fear that another recession is likely.

NEW SHOCKS

The sense that the global economy is at a recessionary tipping point has also strengthened because of new, and sometimes unexpected, shocks. The first is the far-right political wave across the U.S. and Europe, in which the resentment at the inequality generated by neoliberalism is being tapped with a platform that identifies unfair competition from abroad as the problem. This has taken its sharpest form in the Donald Trump administration’s trade war against China, which it accuses of using multiple means, including currency manipulation, to drive exports to the U.S.

With China and other countries responding or threatening to respond with similar measures, the world is faced with a proliferation of beggar-thy-neighbour policies that could make a bad situation worse. The second, potential shock is a no-deal Brexit, the actual consequences of which for the United Kingdom, Europe and the rest of the world are still a matter of speculation, but cannot be anything but adverse. These uncertainties, by increasing the possibility of a downturn, only intensify the fear of recession.

Yet, there is no appropriate response to that prospect in sight. The post-crisis challenge for capitalism was finding an alternative way of reviving demand depressed by underlying inequality. If past experience offered a lesson, it was that states should step in and lift economies out of recession with their spending. That they did, but for too short a time. With neoliberalism having both shrunk the revenues of the state and identified debt-financed public spending as the problem rather than the solution, this option was shunned. Rather, the effort was to once again drive private demand with credit, through the adoption of “unconventional monetary policies” in the form of near zero interest rates and “quantitative easing”, or getting central banks to hugely increase liquidity in the economy by acquiring and holding large volumes of financial assets. Since those assets are matched by liabilities in the balance sheets of these central banks, and those liabilities are nothing but forms of money, liquidity in the system increases.

Capitalism’s current predicament arises because this policy has not worked, though it has been experimented with for close to a decade and pushed to an extent where interest rates in some countries have turned negative. (That trend was once again headlined when, in mid-August, Jyske Bank in Denmark launched the world’s first negative interest rate mortgage, providing loans to home buyers at a minus 0.5 per cent annual interest rate, which means that the borrower pays back less than she has borrowed.)

However, while the policy has not delivered growth, it has encouraged speculation financed with cheap credit. It has also led to a huge accumulation of corporate debt as firms borrowed not just to invest but mainly to speculate in financial markets and pay off their rich shareholders with costly share buybacks. These trends led to demands that these unconventional policies should be wound down because they were resulting in asset price inflation and financial fragility. But with growth low, the pressure to continue with that policy regime has won out and central banks have renewed their commitment to such a policy regime.

CALL FOR MORE STIMULI

But as the threat of recession looms, erstwhile advocates of fiscal prudence and austerity such as the International Monetary Fund and the Bank of International Settlements are calling for adding fiscal stimuli to the policy mix. German Finance Minister Olaf Scholz has promised to put in place a 50-billion- euro stimulus package if the German economy slips into recession. Financial Times , which normally opposes proactive fiscal policies and calls for fiscal prudence, has editorially noted: “Monetary policy cannot take all the strain, but governments are still slow to shift to fiscal expansion.” Recognising that “this must change”, it argues: “A targeted fiscal stimulus that lifts productivity via growth-enhancing investment should be a priority. Infrastructure upgrades, expanding public housing stocks and targeted tax cuts should all be considered. This is the recipe for a return to more robust growth and inflation.” Meanwhile, a section of the centre-left, such as Alexandria Ocasio-Cortez in the U.S., is making a Green New Deal an important plank of its agenda for renewal.

But, while welcome, such wisdom may prove inadequate and may have come too late. The recession threat is immediate and policy is likely to respond too slowly, if at all. If the recession does set in, this round can be devastating for a number of reasons. First, it is likely to be more synchronised. In the 2008 crisis, countries such as China, Germany and even India were affected less and after a brief downturn bounced back to record robust growth. This time around they are among the countries whose performance could drive the recession.

Second, with private, especially corporate debt, often denominated in foreign currencies in emerging markets, at disconcertingly high levels, a recession would find many debtors defaulting on payments and forced to sell assets. That could result in asset price deflation that could have reverberations elsewhere including in an over-committed financial sector.

Finally, even the relatively weak support that monetary policy can provide has been exhausted, with central bank balance sheets saddled with abnormally large assets, interest rates near or below zero, and speculative positions in a range of financial markets as huge as or bigger than they were in 2007.

In sum, the global economy is muddling along while some global leaders, ranging from Trump in the U.S. to Boris Johnson in the U.K., are messing with already muddied waters. In the circumstances, only a set of freak occurrences can prevent another recession.

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