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Underneath the surface of the coming recession

A severe recession has been a long time coming for the advanced countries.

A global recession is all but certain after the US Bureau of Economic Research published data indicating that the world’s largest economy contracted by 4% in the first quarter of 2020. The announcement came weeks after China’s economy, the second largest, was shown to have contracted for the first time in over 30 years, prompting everyone to ask not if there will a global recession, but how bad it is likely to be.

The answer to this question depends on whether you see the coming recession as the result of the COVID-19-induced shock or the consequence of cyclical forces operating in the system. If one opts for the former, as so many have already done, the implication is that the coming recession is likely to be severe, but short-lived, and followed by a spectacular recovery as the global economy returns to normal. An example of this sort of thinking is to be found in the recent IMF report on the state of the global economy. In it, the IMF predicts that there will be two, or possibly three, quarters of contraction in the global economy, followed by a sharp recovery from the fourth quarter onwards, with forecast global growth for 2020 being -3% followed by a +5.8% rate of growth in 2021, and a return to the trend rate thereafter.

If, on the other hand, one sees the coming global crisis as the product of the cyclical movement of the global economy, the IMF’s happy scenario is unlikely to materialize. In the first part of this series on the coming global recession we showed that there were serious problems in the global economy and the US financial system long before the coronavirus was deemed to have hit China. These problems, especially those afflicting the US financial system, pointed to a recession of unprecedented proportions, particularly in the advanced countries. In fact, they pointed to phenomena typically identified with the bottom of long business cycles, a cycle that has hitherto been dominated for the most part by the US.

Increasingly severe crises and recessions

There is now broad agreement among economists that the recession that followed the 2008/9 economic crisis was the worst seen in the advanced countries since the 1940s. What has been missed in most analyses of this recession is that it was in fact the latest in a series of increasingly severe recessions in the economies of the US, Europe, Japan, and other advanced countries since the 1980s.

The periods of expansion following each crisis have witnessed incrementally lower growth, with the period following the 2008/9 crisis being by far the weakest. On several occasions during this period production in the advanced countries as a whole even contracted, as different advanced countries experienced particular weakness at different points in time, viz., the Euro Area in 2012, Japan in 2013, and the US in 2015/6 (as a result of a recession in China).

The increasingly weak recoveries following the various crises experienced by the advanced countries since the 1980s (since the beginning of the long cycle down wave) can also be seen from US employment data. These data show that the period following the 2008/9 crisis is by far the weakest period of post-crisis recovery, even allowing for the dubious nature of the official US employment data (see more below), with US employment taking almost 7 years to returns to its pre-crisis level.

It is the regularity of the crises as well as their increasing severity that contradicts the narrative that these crises were the result of “random shocks”, as proclaimed by the IMF and other leading commentators. Rather, as is becoming increasingly clear, they are the product of the workings of the capitalist system, a system characterised by cycles; long cycles lasting around 60 years comprising a number of shorter, well-documented, cycles lasting 7-11 years.

It is the shorter cycles, also known as Juglar cycles, that explain the regularity of crises and ensuing recessions referred to above. Whether it has been the 1991 oil price hike, the 2001 bursting of the so-called “dot-com” bubble, the 2008/9 collapse of subprime mortgage-backed securities, or the Covid-19 pandemic that we see now― the supposed “random shocks” were not the causes of the crises and recessions that followed but merely their triggers. In each case the Juglar cycle had reached a certain level of maturity such that any “shock” would trigger a major rupture of the economic system.

The increasing severity of each crisis and ensuing recession, as well as the increasing weakness of the recoveries following these ruptures are what is to be expected as the downward phase of the long cycle gathers momentum, and sets the stage for the beginnings of the next long upward wave. Given that it has been the advanced countries with the US at the helm that have dominated the current long cycle, it is the protracted weakening of these economies, particularly that of the US, that best captures the phenomenon of the long cycle down wave.

The world economy’s engine is stalling

Having been the engine of the global economy for almost a century, the US economy is currently the weakest among the advanced countries, despite still being the largest, and notwithstanding popular perceptions. One of the consequences of this growing weakness of the US economy has been the increasing turmoil that has taken place in its financial markets during the bottoms of the recent Juglar cycles. As the issuer of world money and centre of the global financial system, it is not surprising that weakness in the global economy manifests itself first and foremost in the US financial markets.

Witness for example the financial turmoil during the crises of 2001 (the collapse of US equity markets following the bursting of the so-called “dot-com” bubble) and 2008/9 (the collapse of several major US financial institutions following the bursting of the so-called “housing bubble”), as well as the recent extraordinary repo activities of the US Fed referred to in part 1 of this series (suggesting the collapse of one of more major US financial institutions).     

Long before its financial markets took the centre stage, the US was known as the manufacturing hub of the world. The country that produced most of the major innovations that shaped the world we see today is now a mere shadow of the manufacturing powerhouse it was 50 years ago – largely as a result of what has been referred to as the deindustrialization of the US economy. In 1960, at the height of its power, the US accounted for 45% of global GDP and 40% of global manufacturing. These shares are currently down to 25% and 15%, respectively, as a result of a steady erosion of the economy’s competitiveness, that is perhaps most evident from the protracted deterioration in its trade balance.

Having been responsible for the development of such important products as the automobile, computer and smartphone, the dominance of US companies in these sectors is now being eroded― if not displaced―by companies of other countries. And, having dominated the passenger aircraft industry for well over half a century, recent developments suggest this dominance too could be under threat following the recent spectacular collapse of the aircraft-defence manufacturing giant Boeing, following some highly publicised engineering failures in the production of passenger aircrafts.

The curious case of the US unemployment statistics

In a seemingly innocuous statistical change in 1994, the US Bureau of Labor Statistics drastically reduced the number of official unemployed people by reclassifying those who could not find a job within 52 weeks as “discouraged” workers and not unemployed as such. While this has artificially reduced the U-6 measure of unemployment and the most widely used U-3 measure, the latter is further manipulated by excluding those who have not looked for a job in over a month. Perhaps most absurd is that the U-3 measure does not even distinguish between part-time and full-time jobs in its calculation of employed persons, and that a part-time job could mean a person mowing their neighbour’s lawn without even getting paid for it.

The full extent of the statistical manipulations is evident when the unemployment rate is computed with the official methods used before the above redefinitions began in 1994, which is what John Williams of Shadow Government Statistics does. He shows, for example, that the September 2019 unemployment rate using pre-1994 methods was over 20%, while the official U-3 figure registered a record low of 3.5%. The recent rise of the U-3 unemployment rate to a historic high of 14.7% in April  has to be seen in that context, since many of the “newly unemployed”  had likely been de facto out of well-paying work for a long time. But now, even mowing the neighbour’s lawn is not allowed under current lockdown rules.

Ironically, it was Trump himself who strongly criticized official unemployment figures when he was campaigning for the US Presidency, stating: “… Our real unemployment is anywhere from 18 to 20%. Don’t believe the 5.6%. Don’t believe it. That’s right. A lot of people out there can’t get jobs.” There can be little doubt that it is the general sense of despair and resentment caused by these levels of unemployment that were at least in part responsible for Trump’s election in 2016.

World money is a double-edged sword

So what explains the decline of the US economy? Obviously, there is no single reason for it. Some have pointed to the increasing wars the US has gotten involved in and corresponding military expenditures, and others to the growing malaise of corruption. But perhaps the most underrated factor has been the role the US Dollar assumed as world money from around the mid-1950s onwards.

It is the privilege of the country that issues world money that it can command global resources without having to produce anything. That is, it can simply print world money to command global resources whereas other countries need to earn world money by selling goods in the global marketplace to be able to do so. But, as the US has found out, printing world money is a double-edged sword. Being able to print Dollars has gradually eroded the need for US producers to be competitive, as it has become a sort of world-money-sickness effect, akin to the well-known aid-sickness effect. This can only continue as long as the US’s trading partners are willing to subsidise the US consumer in this manner. Commentators are seeing a terminal point for this coming sooner rather than later, with many speculating that the US-Dollar will be replaced as world money by the currency of the country that is currently the world’s largest producer of goods: China.

A new engine for the world economy

The weakening of the advanced country economies, especially the US, has been aggravated by a major shift of global wealth and production that has taken place towards emerging East Asian economies during the last three decades. In 1990, the US, Europe, Japan, and the rest of the advanced country group accounted for 85% of global wealth (as measured by GDP). As of 2018, they accounted for just over 60%, with most of the loss due to the rise of other emerging East Asian economies, i.e., other than Japan. One of the major beneficiaries of this shift in global GDP has been China.

The phenomenon of a global power shift has previously been observed at the bottom of a long cycle. The US supplanted Great Britain as the dominant economic power at the end of the 19th century, just as China is now supplanting the US. In the last cycle, this power shift was consolidated by the economic crisis of the 1930s, and we can expect a similar scenario to happen now. The current ascendency of China may not be fully apparent for some time to come, but current trends make it clear that it is taking place, and that the Chinese economy is rising at possibly a more rapid pace than the US economy did before it displaced the UK as the driving force in the global economy.

To begin with, China has been the largest manufacturer in the world since 2010, and currently accounts for nearly 30% of global manufactured goods, which is almost as much as the US and the Euro Area combined (see chart below). After market reforms in the 1980s, China started out as the world’s workshop; producing for consumers in the advanced countries while also housing their companies that were relocating production for the low labour cost countries. Today, Chinese companies directly compete with those of the advanced countries, producing not just for consumers in the rest of the world but also the domestic market – currently the largest in the world. One example is the global smartphone market. More than 40% of this market is accounted for by Chinese manufacturers, who now dominate the industry’s technological developments. In other markets, such as automobiles and computers, Chinese companies are catching up with their foreign competitors, while in new product markets such as drones (commercial and military) they are already among the dominant players.

In terms of innovations too, China seems to now be taking the lead. In 2017 Chinese companies accounted for the registration of the most number of global patents in technology areas such as artificial intelligence, autonomous driving, and blockchain for the fifth consecutive year. To illustrate the rise of the Chinese entrepreneur, The Economist noted recently that China is now home to more unicorns – start-up companies worth more than $1 billion – than any other country. Significantly, in 2018 China overtook the US as having the most companies on the prestigious Fortune500 list.

The recent US-China trade war provides perhaps the best illustration of the extent of the relative ascendancy of the Chinese economy, and the US’s recognition of this ascendancy, with the initiation of the war by the US being little more than a veiled attempt to slow the Chinese economic juggernaut. Yet, all indications are that the ascendancy of the Chinese economy is now irreversible by anything short of a major military assault on China by the US and its allies. The Lowy Institute recently reported that whereas in 2001 the US was the largest trading partner for over 80% of countries in the world, China is now the largest trading partner of most countries in the world (two-thirds), with about half of all countries trading more than twice as much with China as they do with the US (see chart at bottom).

Delaying the inevitable

We provided a considerable amount of evidence in part 1 of this series to show that, virus or no virus, the advanced countries were headed into a crisis and recession of a magnitude far greater than that experienced in 2008/9. From what was said above, it should be apparent that the coming recession is part and parcel of the cyclical movement of the economic system.

However, it needs adding that it is also partly the result of the policy measures taken by the governments of the advanced countries in response to crises and recessions, particularly those in 2008/9, and quite possibly also in 2001. These measures have worsened the underlying economic and social problems besetting the advanced economies (viz., stagnant investment, low growth, and growing income and wealth disparities). They have done so by preventing the crises and recessions doing what they are supposed to do in capitalist systems, namely to lay the foundations for a renewed expansion of the system, largely because the policies that have been adopted have been at the behest of the rich and powerful.

In 2008, the governments of the US, Japan, the European Union, and China were quick to respond to the developing crisis with massive budget deficits and extraordinary monetary easing. The result was a V-shaped recovery, and a growing arrogance in policy making circles, particularly among central bankers, that they could deal with any developing weakness in their economies by means of increasingly aggressive monetary (and fiscal) . This arrogance has been on display at its most extreme in the wake of the outbreak of the so-called Covid-19 crisis, with monetary authorities in the advanced countries injecting a massive US$ 3 trillion in just 4 weeks and the governments of the world pledging to raise their budget deficits to some 10% of GDP for the current year. Those who belief that the “corona” crisis is the result of another random shock to the system are now trying to battle it with money injections, whereas those who realise that it is part of the cycle know that this just means delaying the inevitable.

These measures will most surely result in rising global stock markets and something of a V-shaped recovery in the global economy, but they will once again impede the sort of “creative destruction” that needs to take place before the up wave of a new long cycle can begin. Instead, the result will be more economic weakness than was seen in the period from 2008/9 to the present, and the build-up of financial bubbles to even more unimaginable levels. Indeed, the most likely immediate result is a “double-dip” recession, since the weakness of the economic system is likely to manifest itself almost immediately.

It is the mistaken view that crises and recessions are the result of “random shocks” that have led to policies being implemented that merely delay the inevitable progression of cyclical movements. Nevertheless, given the increasing bearing that the policy interventions by governments around the world, and especially in the advanced countries, is having on the economic course of the advanced country and global economies, it is important to give some additional consideration to the nature of these policies and their likely future evolution. It is precisely this that we intend to do in part 3.

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