Trade and technology trigger
Michael Roberts warns that the US-China trade war brings with it the threat of another global downturn
Despite all the optimistic talk by Donald Trump about the state of the US economy, the latest data on economic activity and industrial production suggest that America is joining Europe and Japan in a sharp slowdown, as we enter the second half of 2019. And this is at a time when the trade and technology war between the US and China has moved up another gear and so threatens to trigger an outright global recession before the year is out.
JP Morgan economists report that the so-called flash May PMIs (purchasing managers indexes) for the US, Europe and Japan point to a 0.7-point decline, consistent with just 2.5% annual growth in global gross domestic product. PMIs are surveys of company views on their current and future sales and purchases - they have proved to be reasonable guides to actual production. And 2.5% growth globally is considered to be the ‘stall speed’ for the world economy, below which a recession is indicated.
JP Morgan finds that global manufacturing is suffering most - being nearly at 50 in the PMI (anything below 50 means contraction). But services, which constitute 70%-80% of most major economies (at least in the official definition), are also sliding towards the levels of the mini-recession of 2015-16. And, most concerningly, according to JPM, “the global manufacturing and services expectations measures look set to fall roughly two points in May and would push the indexes beneath the lows set in early 2016”.
Like other forecasts, the economic outlook published last week by the Organisation of Economic Cooperation and Development predicts slower growth this year than last in most big economies - in some cases much slower.1 What is more, even in 2020 global growth will not return to the pace it reached in the past few years, it says. Angel Gurría, its secretary-general, stated: “The world economy is in a dangerous place.”
Up to now, it has been in Europe and Japan that signs of a slowdown and even an outright recession were visible. But now the US economy may be joining them. The US manufacturing PMI dropped to 50.6 in May, implying almost stagnation. It was the lowest reading since September 2009, as new orders fell for the first time since August 2009, while output and employment rose less than previously.
The services sector also dropped back and the overall economic indicator showed the weakest expansion in the private sector since May 2016. Then, on May 24, we had actual data for US manufactured durable goods - new orders had fallen by 2.1% compared to a month earlier. Transportation equipment - also down two of the last three months - was a major factor in the decrease. The Atlanta Fed’s ‘GDPNow’ model estimate (a very reliable indicator of future growth) puts US real GDP growth in the second quarter of 2019 at just 1.3%.
When we get to Europe, the latest figure for the continent’s powerhouse, German manufacturing activity, makes particularly dismal reading. May saw a fifth month of contraction in the manufacturing sector, as new orders continued to fall sharply, largely due to lower demand across the car industry and the effects of customer destocking. In addition, the rate of job losses accelerated to the quickest since January 2013.
Even with the services sector holding up, overall activity in Germany looks very weak. And the business morale survey is at its lowest for nearly five years. Activity in the euro zone as a whole is also at a near five-year low.
Japan’s economy is “worsening” for the first time in more than six years, according to one of the government’s main indicators. The index of economic conditions compiled by Japan’s cabinet office fell 0.9% from February to March. That prompted government statisticians to cut their assessment of the economy from “weakening” to “worsening” - the lowest of five levels. The last time the cabinet office used the bottom grade to describe the economy was in January 2013. Barclays economist Kazuma Maeda said that the “mechanical” downgrade in the assessment did not necessarily imply that a downturn was in prospect. But he added: “That said, there is mounting concern about an economic recession.”
Nominal activity growth in Japan, which can be viewed as an up-to-date proxy for nominal GDP, has been falling since the end of 2017, since the decline in real output growth has been greater than the rise in inflation. On the core nominal activity measure, the rate of increase has now dipped to around 0.5%, lower than it was at bottom of the 2016 deflationary shock.
As an aside, it is worth noting that Japan is supposed to be the poster child of Keynesian fiscal and monetary policy. The Bank of Japan has negative interest rates and has bought virtually all government bonds available from the banks, as well as corporate debt and stock, through massive credit injections in the last 10 years. And it has consistently run budget deficits to try and boost the economy; so much so that the government debt-to-GDP is the highest in the world. But nominal GDP growth and prices continue to stagnate.
Those who support ‘modern monetary theory’ should take note.2 Yes, you can have budget deficits permanently and run up public debt without consequences for inflation or even the currency in an economy like Japan. But you cannot get a permanent boost to growth if Japan’s corporations will not invest and neither will the government. Creating money does not necessarily create value. The irony is that prime minister Shinzo Abe plans to raise the sales tax later this year to try and lower the deficits and debt ratios in line with neoliberal policy. The last time he did that, Japan went into recession.
Outside the imperialist blocs, the so-called ‘emerging market’ economies are also slowing. Turkey, Argentina and Pakistan are already in recession, while Brazil and South Africa are on the brink. And capital flows to these economies from the imperialist bloc are drying up, while public-sector investment has nearly ground to a halt.
Net public investment in emerging-market countries has fallen below 1% of GDP for the first time on record, raising fears of widening infrastructure gaps. The share of national output that developing-world governments are spending on investment in assets such as schools, hospitals and transport and power infrastructure, net of depreciation of the existing capital stock, has fallen from 3.3% in 1997 to a low of just 0.9% last year, according to data from the International Monetary Fund. This is well below what the IMF believed as needed to meet basic needs and allow countries to close infrastructure gaps that are slowing the pace of development.
Indeed, if you exclude China, then investment growth is dropping in the rest of the G20 economies. Only the US and India are keeping investment positive. If they should falter, since investment is the driver, a global recession would follow.
If China is stripped out of the data, the weighted average for the rest of the emerging world is 3.9% of GDP, markedly lower than the 4.8% figure seen as recently as 2010. The 49 low-income developing countries - mainly in Africa, but also encompassing the likes of Vietnam, Bangladesh and Moldova - are even more badly placed, with the IMF calculating they need to invest an additional 7.1% of GDP a year until 2030 on roads, electricity and water alone. With health and education added in, this rises to a colossal 15.4% of GDP - or $528 billion - a year.
Low profitability explains above all else why corporate investment has been so weak since 2009.3 What profits have been made have been switched into financial speculation: mergers and acquisitions, share buybacks and dividend payouts. Also, there has been some hoarding of cash by ‘the FAANGs’ (Facebook, Apple, Amazon, Netflix and Google). All this is because the profitability of productive investment remains historically low.
The other key factor in the long depression has been the rise in debt, particularly corporate debt. With profitability low, companies have run up more debt in order to fund projects or speculate. The big companies like Apple or Microsoft can do this because they have cash hoards to fall back on if anything goes wrong; the smaller companies can only manage this debt spiral because interest rates remain at all-time lows and so servicing the debt is still feasible - as long as there is not a downturn in sales and profits.
When fundamentals like profitability and debt turn sour for capital, then anything can trigger a slump. Each crisis has a different trigger or proximate cause. The 1974-75 international recession was triggered by a sharp rise in oil prices and the US abandoning the dollar-gold standard in 1971. The 1980-82 slump was triggered by a housing bubble in Europe and a manufacturing crisis in the major economies. The 1990-92 recession was triggered by the Iraq war and oil prices. The 2001 mild recession was the result of the bursting of the dot.com bubble. And the great recession was started with the collapse of the housing bubble in the US and the ensuing credit crunch, brought on by the international diversification of credit derivatives. But underlying each of these crises was a downward movement in the profitability of productive capital and eventually a slowdown or decline in the mass of profits.4
It now seems possible that brewing trade war between the US and China could be a new trigger for a global recession. Certainly, US investment bank Morgan Stanley has raised such a risk. Its analysts stated:
While a temporary escalation of trade tensions could be navigated without much damage at all, a lasting breakdown would inflict serious pain. If talks stall, no deal is agreed upon and the US imposes 25% tariffs on the remaining circa $300 billion of imports from China, we see the global economy heading towards recession.5
The danger coming from the trade war has also been highlighted. According to the OECD, international trade has slowed abruptly. Its rate of increase has fallen from 5.5% in 2017 to what the OECD thinks will be 2.1% and 3.1% this year and next. That is lower than projected economic growth, meaning trade is shrinking as a share of global economic activity. Since 2009, it had been the slowdown in investment that has led to a dip in trade growth; and the IMF estimated that three-quarters of the trade-growth slowdown could be attributed to weak economic activity, especially in investment. But now the boot seems to be on the other foot.
The OECD numbers on aggregate investment are corroborated by more fine-grained data. Most big US companies’ investment spending, as reported in regulatory filings, has stalled dramatically. A Wall Street Journal investigation of 356 of the S&P 500 companies found that they spent only three percent more on capital in the first quarter year on year (down from a 20% growth rate a year earlier). For the biggest capital spenders, investment fell outright. Trade frictions seem the main cause - directly for businesses particularly reliant on Chinese demand, such as specialised chip producers, as well as indirectly through the increased uncertainty spreading through the economy. Another survey has found that many US companies operating in China are also holding back from investing.
Morgan Stanley also warned not to underestimate the impact of trade tensions in a number of ways. Firstly, the impact on the US corporate sector would be more widespread, as China could put up non-tariff barriers, such as restriction of purchases. Given the global growth slowdown that would follow, profits from firms’ international operations would be hit and companies would not be able to fully pass on the tariff increases to consumers.
What makes it likely that the trade war will not be resolved amicably to avoid a global recession is that the battle between the US and China is not just over ‘unfair trade’: it is much more an attempt by the US to maintain its global technological superiority in the face of China’s fast rise to compete. The attack on Huawei, globally organised by the US, is just a start.
A chain reaction is under way, as a giant industry braces for a violent shock. US investment bank Goldman Sachs has noted that, since 2010, the only place where corporate earnings have expanded is in the US. And this, according to Goldmans, is entirely down to the super-tech companies. Global profits ex technology are only moderately higher than they were prior to the financial crisis, while technology profits have moved sharply upwards (mainly reflecting the impact of large US technology companies).
The growth slowdown is the result of low investment and profitability in most economies and in most sectors. Only the huge tech companies in the US have bucked this trend, helped by a recent profits bonanza from the Trump tax ‘reforms’.6 But now the technology war with China will hit tech profits too - even if the US and China reach a trade deal.
The IMF is very concerned. Its new chief economist, Gita Gopinath, commented:
While the impact on global growth is relatively modest at this time, the latest escalation could significantly dent business and financial market sentiment, disrupt global supply chains and jeopardise the projected recovery in global growth in 2019.
Roberto Azevêdo, director general of the World Trade Organisation, said the US-China trade war was hurting the global economy. The WTO has been bypassed by the US, as the Trump administration aims its attacks directly on China. According to Azevêdo,
$580 billion [£458 billion] of restrictive measures were introduced in the last year - seven times more than the previous year. This is holding back investors, this is holding back consumers and, of course, it is having an impact on the expansion of the global economy. Everyone loses … every single country will lose unless we find a solution for this.7
Michael Roberts blogs at https://thenextrecession.wordpress.com.
See ‘The profit investment nexus’: https://thenextrecession.files.wordpress.com/2019/03/the-profit-investment-nexus.pdf.↩