A new Chinese export — recession risk
Yes” and “China”. His case is plausible. This does not mean we must expect a recession. But people should see such a scenario as plausible.
What might be the effects on the world economy?
A more important channel is commodity trade. Commodity prices have fallen, but are still far from low by historical standards (see chart). Even with prices where they are, commodity exporters are suffering. Among them are countries like Australia, Brazil, Canada, the Gulf States, Kazakhstan, Russia and Venezuela. Meanwhile, net commodity importers, such as India and most European countries, are gaining.
Shocks to trade interact with finance. Many adversely affected companies are highly indebted.
The resulting financial stresses force cutbacks in borrowing and spending upon them, directly weakening economies. Changes in financial conditions exacerbate such pressures. Among the most important are movements in interest and exchange rates and shifts in the perceived soundness of borrowers, including sovereigns. Changes in capital flows and risk premia and shifts in the policies of important central banks exacerbate the stresses. At present, the most important shift would be a decision by the US Federal Reserve to raise interest rates.
How might policymakers respond? China will surely let its currency fall rather than continue to lose reserves, not least because usable reserves are smaller than headline numbers, which include infrastructure investments in Africa and elsewhere that cannot quickly be sold. The policy space of other emerging economies is greater than in the past, but not unlimited. They will be forced to adjust to these shocks rather than resist them.
Meanwhile, the policy choices of high-income countries are restricted: politics has almost universally ruled out fiscal expansion; the intervention rates of central banks are near zero; and, in many high-income economies, private leverage is still quite high. If the slowdown were modest, nothing much might be done. The best response to a big slowdown might be “helicopter money”, created by the central bank to stimulate spending. But its use seems quite unlikely.
The conventional rules.
In brief, a global growth-recession scenario “made in China” is perfectly plausible. If it were to happen, a decision by the Fed to tighten now would come to look downright foolish. We are not talking about the sort of disaster that accompanies a global financial crisis. But the world economy will remain vulnerable to adversity until China has completed its transition to a more balanced pattern of growth, and the high-income economies have recovered from their crises.
That is still far away.