The law of unintended consequences could lead us into a global recession
Actions have consequences, wanted or not. If there has been one lesson to take from the International Monetary Fund’s annual meetings in Washington this week, that has been it.
A line can be traced from Donald Trump’s trade war with China to the collapse of Neil Woodford’s investment trusts. Another from Beijing’s decade of intellectual property theft to the $19 trillion timebomb of sub-prime corporate debt ticking away under the global economy. Everything is connected. It simply needs the lines of consequence to be drawn.
Let’s start at the end. If the IMF is right, another financial crisis is closer than we think. All it takes is a further escalation in the US-China trade war and a couple of rounds of American tariffs on European goods. The first of those was imposed yesterday on $7.5 billion of EU imports, from aircraft to Scotch whisky, in retaliation for Airbus subsidies. Round two would be an assault on the German car industry, which would tip the country into recession.
Berlin has countermeasures prepared and we know what happens after that. The United States began with tariffs on $10.3 billion of Chinese goods in 2017. They now cover $550 billion and Chinese duty on $185 billion of US goods geos the other way. Between them the US and China have knocked 0.8 per cent off global GDP. That’s $650 billion.
The world economy is now in a “synchronised slowdown”, Kristalina Georgieva, the IMF managing director, said. Growth is weaker than it has been since the 2009 crisis. A recession in Europe’s largest economy combined with a sharper contraction in global trade would drag everywhere down with it.
At that point, much of the corporate debt in advanced economies becomes unserviceable: $19 trillion in all, the IMF reckons. Unregulated shadow banks — insurers, pension funds and hedge funds — own more of it than they should. As borrowers default, the shadow banks would be forced into fire sales, causing a market seizure not unlike that of a decade ago.
Should the worst happen, “an internationally co-ordinated fiscal response may be required”, Gita Gopinath, the IMF’s chief economist, warned. The last co-ordinated response was in 2009, when Gordon Brown “saved the world”, as he put it.
We find ourselves here, teetering on the brink, because of President Trump, because of his trade wars. Three years ago growth was picking up and for once the IMF was upbeat. “Spring is in the air and spring is in the economy,” Christine Lagarde, its managing director, said in April 2017.
With a tailwind of stronger growth, central banks had an opportunity to raise rates, unwind quantitative easing and end more than half a decade of market distortions to bring the world back to normality. It all started so well. By the end of 2018 the US Federal Reserve had raised rates nine times and was expected to increase them a further three times this year. Instead, it has cut them twice and, having unwound some QE, is poised to buy US government debt again to fend off a slowdown.
Talk in Washington this week was that the cycle had peaked, that the economy was on a terminally downward slope and that the chance to normalise rates had slipped away. Both the eurozone and China have eased monetary policy this year, as has the US. Markets reckon that eurozone interest rates, at -0.5 per cent, will be negative until at least 2023. A record $15 trillion stock of negative-yielding corporate and government debt guarantees investors’ losses.
We are back in “lower for longer” territory, where investors have to hunt for yield in dangerous waters: be it in frontier markets such as Mozambique; splicing and dicing structured debt, like the bankers who gave us the financial crisis; or doing a Woodford by buying riskier private equity and venture capital assets that pay a better rate but cannot be liquidated. The conditions are perfect for another sub-prime bubble.
Can all this be laid at Mr Trump’s door? Not if you trace the line still further back, to Beijing’s abuse of the global trading rules with subsidies, dumping and technology theft. When China joined the World Trade Organisation in 2001, it was a $1 trillion upstart economy. It is now a $13.5 trillion superpower to rival the US and no one outside Beijing believes that it should be allowed to game the system any longer.
Mr Trump has been abrasive to China, but we should not fool ourselves into thinking that a Democrat president would roll back the tariffs and restore economic relations. Even within the G20, of which China is a member, Beijing’s trade practices and cybersurveillance have left it isolated. “If Trump had used the G20 instead of tariffs to take on China, it would have been nineteen-to-one against Beijing,” one official said this week.
So this is where we are, eighteen years on from China’s accession to the WTO and one financial crisis later, amid the biggest monetary policy experiment ever undertaken, with investors being robbed blind by assets that pay them a worthless income, a power struggle masquerading as trade wars, a global system that is falling apart and growth stalling. The lines of consequence have converged.
China’s ascendance, which led us inexorably to the tariffs that are warping global supply chains and sapping global growth, was distinct from the financial crisis, which gave us zero interest rates and populist politics. But they are intertwining, with dangerous results.
Because growth is weak, central banks cannot raise rates. Low rates and QE will drive up asset prices. Bubbles are inflating in financial markets and one day they will burst. Policymakers can see it happening and know they will never be forgiven if another crisis strikes on their watch. This time they want to get ahead to turn what would otherwise be a clean-up operation into inoculation.
To do so, the IMF says, they will need to intervene with more regulations, such as higher capital charges on corporate debt and new shadow banking controls. Rather than pull their tentacles out of the system by raising rates and letting markets function freely, the authorities will have to probe deeper and as they do they will create new distortions. Who knows what the consequences might be then.
Philip Aldrick is Economics Editor of The Times
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