Another global recession?
The world is facing a global recession, writes Project Syndicate. Former British Finance Minister Jim O'Neill is confident that the strength of this recession and measures that can minimize its scale and severity will largely depend on the Fed, the Chinese authorities and Putin.
Jim O'Neill
LONDON – At the beginning of the year, I wrote about worries about the prospects of financial markets due to the mass of serious uncertainties that I listed, and many other potential risks that were not yet fully clear at the time. All this was after the beginning of Russia's accumulation of troops on the border with Ukraine, but before the start of the special operation. Now, after Russia unleashed an aggressive war, it was almost completely excluded from the world economy and markets, and energy and food prices jumped sharply.
Meanwhile, the central banks of Western countries have significantly changed their position, finally abandoning the idea that the current inflation is only a temporary phenomenon that will pass by itself. Today, they are deliberately tightening global financial conditions (reducing balance sheets and raising interest rates), which increases cyclical pressure on household incomes and, consequently, on the economy as a whole.
As if all this is no longer enough, the growth of China's economy (it is the second largest in the world and ten times larger than the Russian economy) is deliberately hindered by the state strategy of "zero Covid". It is being implemented against the background of earlier efforts to curb excessively high housing prices, reduce the growth rate of lending and curb some business sectors (starting with the largest technology conglomerates), which, according to the government, hinder the achievement of its new goal – to achieve "more equitable economic growth."
Considering all these events, one might think that we are facing a global recession. And if it starts, it will become strikingly sudden, coming almost immediately after the quarantine-induced mini-recessions of 2020 and 2021. How severe will this downturn be, and are there measures that can prevent it or at least minimize its scale and severity?
In China, the authorities are concerned that a more lenient attitude towards Covid-19 may lead to an increase in the number of infected and overload of the country's urban hospitals. Since we have already seen this in other countries (especially in the UK, where the authorities were forced to impose sudden and very strict quarantines in 2020-2021), it is hardly possible to criticize China for its caution. But, as the data show, the dominant strain of Omicron in the world is so contagious that even quarantines cannot completely stop its spread. In addition, this strain turned out to be less dangerous than the previous ones, so the draconian measures taken are difficult to justify.
China's tough zero Covid strategy is being implemented against the backdrop of an already weakened economy, so it exacerbates its fundamental cyclical weaknesses. The latest trade statistics (for April) show that the volume of Chinese imports remains at an exceptionally low level, and this is one of many signals indicating a weak state of the economy.
The consequences of the problems faced by China are not limited to the economy and markets. The one-party leadership of China has long legitimized its power, ensuring a continuous increase in the standard of living for 1.4 billion residents of the country. But this unspoken pact cannot be easily maintained in an environment where the economy is constantly weak.
Having watched China for more than 30 years, I can name one of the main strengths of its government: it manages risks exceptionally well. In the past, it has dealt with serious potential problems decisively and in a timely manner. But that's not the case today. If the authorities do not quickly change course, then the country's economy and the rest of the world expect much more problems. On the other hand, if the government manages to abandon the "zero Covid" strategy and some of the most draconian measures in economic policy, then the growth rate of the economy may well jump quickly.
As for the rest of the world, apart from China, there are two major factors that will determine the further development of events: the policy of the largest central banks and Vladimir Putin. The intentions of the Russian president today, as well as three months ago, when he launched the invasion, are difficult to predict. Finland and Sweden's sudden support for the idea of joining NATO shows that Putin has made a catastrophic miscalculation. Although he may not end the war, Putin's stupidity may well lead to his removal from power (however, many Kremlinologists consider this unlikely).
In any case, the blow to real incomes (and, consequently, consumer spending) due to rising energy and food prices turned out to be so strong that central banks will have to think hard about their newfound mood for tightening. If the weakening of the economy is necessary in order to control inflation, then perhaps the rise in energy and food prices against the background of tightening financial conditions has already done their job for the central banks.
Yes, of course, if long-term inflation expectations rise and lose their anchor, then the calculations will change significantly. In the United States, where changes in the Fed's policy have a profound impact on the whole world, core inflation, according to the latest indicators of the Consumer Price Index, is still above 6%, while price growth in the service sector has accelerated. As a result, the Federal Reserve may decide that it has no particular reason to turn away from the path of tightening monetary policy, which it so loudly declares.
But the Fed should still think about the fact of a reduction in real (adjusted for inflation) disposable incomes in the United States. Although their decline was not as strong as in Europe, it is significant, and the sharp tightening of financial conditions may have already sown the seeds of a rapidly approaching economic downturn.
So, are we heading into a global recession? The answer will largely depend on the Fed, the Chinese authorities and the unpredictable, isolated mystery man in the Kremlin.
The author is a former chairman of the Asset Management of Goldman Sachs Bank and a former Minister of Finance of the United Kingdom, is a member of the Pan-European Commission on Health and Sustainable Development
