Warnings from the Global Trade Cycle

The global trade cycle is facing major stress in 2019, downward revisions have just begun, and the risk of a major slowdown in world GDP growth cannot be minimized. In a still tightly connected world, no major economy will be an oasis.

Stephen S. Roach  

ship sinking


NEW HAVEN – As the trade cycle turns, so goes the global economy. But there is a new twist. With growth in global trade sharply diminished since the 2008-2009 global financial crisis, an upsurge of protectionism and disrupted global supply chains is all the more problematic. There is a distinct possibility that a turn in an already weakened trade cycle could spark a surprisingly swift deterioration in the global economy.

Early hints of just such an outcome are evident in the January update of the International Monetary Fund’s World Economic Outlook. While the IMF has revised downward its 2019 forecast of world GDP growth by 0.2 percentage points (from 3.7% to 3.5%), it has made just a fractional reduction to its projection of 4% global trade growth. This is certainly puzzling. In a climate of increased tariffs between the US and China, with threats of more to come, and given Brexit-related risks to eurozone trade, there is good reason to look for more significant downward revisions to the global trade outlook.

This would be especially problematic, given that the world economy’s support from global trade is already on shaky ground. Following a crisis-induced plunge of 10.4% in the volume of global trade in 2009 – a modern-day record – recovery has been muted. After a brief two-year rebound in 2010-2011, world trade growth averaged just 3.6% from 2012 to 2018 – about half the 7.1% average annual pace in the 20 years before the crisis.

To be sure, the slowdown in world trade may be traceable to the global economy’s relatively weak post-crisis recovery. But the ratio of growth in global trade relative to growth in world output – an indicator that normalizes for different recovery trajectories – says otherwise. In the two prior expansions – 1985-1990 and 2002-2007 – this ratio averaged 1.6: in other words, once the cyclical noise of post-recession rebounds subsided, growth of global trade was about 60% faster than growth in world GDP. By contrast, in the current expansion, that ratio has averaged just 1.0 over the comparable 2012-2018 period, with global trade having slowed to a pace only equal to the growth of world output.

Debate rages about why growth in global trade has slowed so sharply in recent years. Extensive research published by the IMF in late 2016 attributed the slowdown largely to subdued business capital spending, finding only small effects from protectionism. Yet the world has changed a lot in the subsequent two years. While the capital spending shortfall persists – despite a temporary increase from large corporate tax cuts in countries like the United States – there has been a marked increase in protectionism, with attendant pressures on global supply chains. As a result, a rethinking of the IMF findings is in order.

US President Donald Trump’s administration has obviously taken the lead in moving from trade liberalization and globalization to protectionism and fragmentation. One line in Trump’s inaugural address said it all: “Protection will lead to great prosperity and strength.” Rhetoric quickly gave way to action and was followed in short order by US disengagement from the Trans-Pacific Partnership, replacement of NAFTA with a higher-cost USMCA (United States-Mexico-Canada Agreement), and, of course, a succession of tariff hikes against China. Withdrawal from the Paris climate agreement, threats to pull out of the World Trade Organization, and complaints about NATO participation round out US disengagement from multilateralism and the global trading system that it has long supported.

Against this backdrop, a rapidly unfolding China slowdown is all the more problematic. While recent GDP data point to only a slight deceleration in late 2018 – 6.4% annual growth in the fourth quarter versus 6.5% in the third quarter – monthly data revealed sharp declines in December retail sales of key discretionary consumption items such as automobiles and mobile phones. Reflecting this deterioration in domestic demand, Chinese imports plunged by 7.6% in the 12 months ending in December, a worrisome about-face after a 16.1% gain in 2017. At the same time, China’s exports fell 4.4% in December as tariff-related weakness in US markets finally appears to be taking a meaningful toll.

Needless to say, depending on the outcome of US-China trade negotiations, there could well be more bad news for Chinese exports to the US. Moreover, while China is moving aggressively to counter the cyclical shortfall in domestic activity, it could be several months before its policy moves start to take hold. In the meantime, risks remain very much on the downside for Chinese import demand. That underscores a key risk to the IMF’s latest forecast: China is the world’s largest exporter and second-largest importer. It’s negative impact on an already weakened global trade cycle is only just starting to become apparent.

The disruptive effects of Brexit can only exacerbate this problem. The eurozone, as a whole, ranks right behind China among global exporters and slightly above China as the world’s second largest importer. With exports to the United Kingdom accounting for about 3% of the European Union’s GDP – considerably higher for Belgium, Ireland, and the Netherlands – Brexit-induced frictions to global trade can hardly be taken lightly.

All in all, the global trade cycle is facing major stress in 2019, and markdowns have only just begun. This underscores the risks of a major shortfall in world GDP growth. In a still tightly connected world, no major economy will be an oasis. That includes the US, whose 45th president continues to insist that it’s easy to win a trade war. Maybe not.


Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm's chief economist, is a senior fellow at Yale University's Jackson Institute of Global Affairs and a senior lecturer at Yale's School of Management. He is the author of Unbalanced: The Codependency of America and China.

The Russian Crisis

Vladimir Putin failed to keep his promise to create a modern economy. Now he has to pay the price.

By George Friedman


Russian President Vladimir Putin’s trust rating has fallen to its lowest point in 13 years.

According to a poll conducted by the Russian Public Opinion Research Center, only 33 percent of Russians said they trusted the president. Polls can be unreliable and opinions fickle, but a survey like this in a country like Russia can be an indicator of deep discontent arising from significant social and economic problems.

Hope Fades

Over a quarter of a century ago, the Soviet Union fell because things stopped working. The state was the center of society and managed the economy. After Josef Stalin died, there was a sense of hope in Russian society about the economy – and that hope sustained the government, even when it failed to meet expectations. But by the 1980s, ordinary Russians’ belief that they could provide for their families and that the gulf between them and the nomenklatura (or bureaucratic elite) would diminish had faded. What changed their minds was not envy or anger – Russians had grown to expect a certain level of inequality – but a lack of hope. They had little and were not going to get more. Worst of all, they lacked hope for their children.

This situation was a result of four factors. First, the inherent inefficiency of the Soviet apparatus, which could not build a modern economy. Second, the divergence of available goods, not only to the elite but also to a thriving black market that frequently operated in foreign currencies, which most Russians lacked. Third, the decline of oil prices, which shattered the state budget. And finally, a surge in defense spending, designed to both match U.S. spending and convince Russians that although they might be poor, they still lived in a powerful country.

This was not trivial for a nation that had lived through the German invasion.

In 1991, when the Soviet Union collapsed, there was no revolution. There was simply exhaustion.

The elite were exhausted from trying to push the boulder of the Soviet economy and society up a steep hill. And the people were exhausted from standing in lines for hours to buy basic necessities.

The general sense of failure was apparent not only in faraway capitals but in Russians’ own lives.

The Politburo selected Mikhail Gorbachev to solve these problems. He promised openness and restructuring. But the openness only revealed the catastrophic condition of the economy, and the restructuring, carried out by those who had created the disaster in the first place, didn’t work. All Gorbachev did was legitimize the fears and fatigue that had festered in the Soviet Union and allow them to eat away at what was left.

Boris Yeltsin replaced him but did nothing to solve the lingering economic problems. The Soviet Union was gone, and many took advantage – from Western financiers, consultants and hustlers, to Russians who figured out, frequently with Western advisers, how to divert and appropriate what little wealth Russia had. Privatization requires some concept of the private.

In a country that had lived for generations by the old socialist principle “money is theft,” the oligarchs embraced the concept with a vengeance. Russia’s nomenklatura was just as inefficient as the Soviet Union’s, and, as shown in Kosovo, other nations held it in contempt.

Yeltsin couldn’t last. His replacement was Vladimir Putin, who had roots in the old Soviet Union and in the new Russia. He had been an agent of the KGB, the Soviets’ main security service. (For a country as vast and poorly connected as Russia, a strong central government and secret police have always been key to holding the nation together.) And through his time as deputy to the mayor of St. Petersburg, he was enmeshed with the oligarchs who became the holders of Russia’s wealth.

Putin came to power because of these connections. After Yeltsin, Russians craved a strong leader, and they drew comfort from the fact that Putin had ties to the KGB. They accepted his links to the oligarchs as simply part of how the world works.

Putin’s Promises

Putin promised to make Russia prosperous and respected in the world. To do so, he had to build a modern economy. Russia was highly dependent on the export of raw materials, particularly oil and natural gas. Putin couldn’t control the price of these commodities, so Russia was always vulnerable to fluctuations in global supply and demand. Putin had a choice: allow the economy to deteriorate and the country to descend into chaos, or centralize governance once more. He chose recentralization, concentrating power in Moscow and distributing funds from the state budget to the regions. When oil prices were over $100 per barrel, Putin had an opportunity to make massive investments in new industries. But he was beholden to the oligarchs, and they to him. Any economic reforms could have jeopardized this relationship. It’s not so much that Putin missed the chance to modernize but rather that his path to power prevented it.

Then, in 2014, oil prices plunged. Though they have recovered somewhat from their lowest point, they remain low. Western sanctions have also taken a toll. Until 2018, Russia had two reserve funds, stocked with profits from the oil boom. But following the collapse in energy prices, one fund was depleted, and since January 2018, only the National Wealth Fund remains.

To try to replenish the state budget, Putin decided to reform the pension system. Just seven months after his re-election in March, he signed an unpopular bill into law that will gradually raise the age of retirement for women from 55 to 60 and for men from 60 to 65.

Hence the 33 percent trust rating. That rating is more socially significant in Russia than it would be elsewhere. Putin promised to make Russia a modern, powerful nation. He has failed to deliver on the first point, and his forays in Syria and elsewhere haven’t compensated for deteriorating economic conditions. Older Russians are reminded of what was and what had been abolished; younger Russians are encountering conditions similar to those their grandparents told them of.

There are two possible paths forward. One is the old Russian solution of empowering the secret police to crush the opposition, though it isn’t clear that today’s Federal Security Service, or FSB, has the same power its predecessor organizations had. I suspect that the poisoning of a former Russian spy in Britain is intended in part as a message to the FSB, not only to frighten it but also to tell its agents that they need to uphold the integrity of the Russian nation.

The other path is a re-enactment of the fall of the Soviet Union. Few are eager to relive the 1990s, but collapse is not always the result of a vote. If oil prices remain low, sanctions remain in place, reserves continue to dwindle, and the FSB is more interested in doing business than in sacrificing for the Russian state, then it’s hard to see an alternative scenario.

No foreign power can come to Russia’s aid. Each one demands too much and offers too little.

There’s a fantasy in Russia about an alliance with China, but Moscow is far away from Beijing, and China’s problems at the moment are even more intense. The Kremlin could try engaging in a war to boost morale, but there’s the risk it could lose or that the conflict would last longer than those at the top anticipate.

Russia now faces conditions similar to those it faced in the 1980s: low oil prices and high defense costs. The people aren’t angry, but they are resentful, and in due course they may become simply exhausted, as they were in the 1980s. Russia is vast and needs a strong central government to hold it together, but central governments are not good at managing economies. Thus, the secret police must hold the country together. If it can’t or won’t, then a Gorbachev-type leader may rise up to reform the economy, and a Yeltsin-type leader may follow to preside over the nation’s revolutionizing.

Karl Marx once wrote that history repeats itself, first as tragedy and then as farce. How this maxim may play out in Russia is becoming clearer by the day.


Another tech bubble could be about to burst

We are in the late stages of a credit cycle, with too much money chasing too little value

Rana Foroohar




There were many disconnects between last week’s World Economic Forum and the real world.

One of the most notable was the techno-optimism displayed by many participants, which was in sharp contrast to what the markets themselves are expecting from the technology sector this year.

The coming spate of initial public offerings in particular looks shaky. Uber’s chief executive Dara Khosrowshahi was all over Davos, talking up the company’s forthcoming initial public offering. But the talk had a whiff of desperation. Uber, along with Lyft and a host of other large, still-private tech companies such as Slack and Airbnb, are likely to try to go public sooner rather than later — not only because of worries about a coming recession and volatile markets, but because they have grown so fat on private funding, it is unclear whether the market will be able to sustain their valuations. (Uber’s, for example, is pegged at $100bn.) They want to get their money while the getting is good.

It is a situation that is both similar, and not, to the dotcom boom and bust that occurred at the turn of the century. Back then, I was working in venture capital in London. Companies like the now-defunct, LVMH-backed online retailer boo.com — the pets.com of Europe — were spending millions on glossy ads, and would-be entrepreneurs were trolling for easy money at First Tuesday networking events. Remember those little red-for-investor or green-for-talent lapel dots everyone had to wear?

Then, as now, we were at the late stages of a credit cycle, with too much money chasing too little value. And then, like now, investors were counting on a spate of hot IPOs to pour a little more kerosene on markets that were clearly over-inflated. We all know how that ended, on both sides of the Atlantic.

That is not to say that there wasn’t value created then, as there has been now. For every unsuccessful dog food retailer or expensive T-shirt purveyor that went out of business in the dotcom bust, there were miles of broadband cable laid, which created the infrastructure that companies such as Google now capitalise on. Today, the sharing economy has markets and conveniences where before there were none.

The real difference between the two eras is in the capital markets themselves. Venture money collapsed post-2000, came back up, fell again after the financial crisis, then rebounded to record levels after 2014. The number of new start-ups has proliferated. Yet the number of IPOs has fallen. This is due to a paradox — while technology has made starting a company cheaper, becoming a success is now more expensive. That is because of an arms race to build the next “unicorn” start-up, one with a market capitalisation of over $1bn.

As University of California academics Martin Kenney and John Zysman put it in a forthcoming paper on the shifts in start-up funding, entitled “Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance”, “start-ups are each trying to ignite the winner-take-all dynamics through rapid expansion characterised by breakneck and almost invariably money-losing growth, often with no discernible path to profitability”.

Over the past five or so years, there’s been a massive growth in the number of venture-capital-backed unicorns. Companies such as Uber, Lyft, Spotify, and Dropbox can lose money hand over fist, and yet still continue to grow in valuation. Indeed, it is all part of the new business dynamic.

Low barriers to entry result in many competitors and a race to spend as much as possible to grab market share. Not only do the private companies that emerge from this unproductive cycle become bloated, so too do the venture funds themselves. Billion-dollar venture funds, once unheard of, are now commonplace. Last year, Sequoia raised an $8bn seed fund, and SoftBank a whopping $100bn fund.

Big, of course, begets big. As more and more heavyweight VCs bid up the value of start-ups, others have to follow. It’s up or out. The result has been not only a new bubble in IPO markets, but the undercutting of a host of public companies that actually have to worry about profits. The classic examples would be Uber’s disruption of the taxi industry, or Airbnb’s of hotels.

This may be good for some of the VCs who can use the inflated values of unicorns on their books to raise more money and charge more management fees. But I can’t see how it is good for economic value overall. Massive debt financing of unprofitable firms to create monopolies might benefit some entrepreneurs and investors, but it distorts capital and labour markets and is anti-competitive.

As long as investors are willing to accept growth as a metric for value, the music can keep playing. But as the University of California academics note, “unicorns are mythical beasts”. This year, their financial reality, as well as the sustainability of the current funding model, will be subject to some much-needed testing.

Some of the new crop of hyped-up companies may eventually turn into Cheshire cats, disappearing and leaving behind only the grins of those who got out before the bubble burst.


Where Brexit Goes From Here

London may soon have two options again. This time, it’s no deal or no Brexit.

By Ryan Bridges


Casual observers will be forgiven for assuming British Prime Minister Theresa May’s Brexit deal is dead. It was, after all, historically defeated in the House of Commons just a couple of weeks ago.

May was supposed to consult with her ministers and with party leaders and come back with a new plan. She deftly sidestepped the Commons, however, by revealing Jan. 21 that her plan B was to try plan A again. So her deal lives on, and it still includes the controversial Irish backstop, a provision that would keep the U.K. closely aligned with the EU in the likely event that their future relationship doesn’t obviate the need for a border between Northern Ireland and the Republic of Ireland.

But May’s deal is no closer to passage, and with only 60 days to go until March 29, when the U.K. is to leave the European Union, it would probably be impossible to pass the relevant legislation without delaying the departure date by at least a couple of months. What started two and a half years ago as a binary choice between leave or remain is increasingly looking binary again. This time, it’s between no deal and no Brexit.

A no-deal Brexit means the U.K. would leave the EU, but in doing so, it would terminate 46 years’ worth of agreements with the bloc overnight. A large majority of lawmakers and the public oppose this option because of the economic and potentially social disruption it would cause. The economic cost is difficult to gauge, not only because such calculations are extremely complex but also because much depends on how much pressure the EU decides to apply.

Worst-case scenario, there could be multiday traffic jams at ports and shortages of some medicines, foods and fuel. Socially, there is a low risk of mass protests or even riots and looting – scenarios the government has prepared for by calling up a few hundred army reservists and putting thousands of others on standby. But the direr risk is that violence could erupt again on the Irish border. Irish militants have carried out a few attacks in Londonderry, including a small car bombing, in the past two weeks alone. To those who claim a second referendum or cancellation of Brexit is dangerous because it could ignite mass protests and violence, this is a reminder that going through with Brexit in a disorderly manner could do the very same.

The other option is that the U.K. remains in the EU. One way for it to stay would be to unilaterally revoke Article 50, the provision in the Lisbon Treaty that details how a member state can leave the EU. But such a blatant disregard for the public would upset at least half of the country, so if the government were to cancel Brexit, it would prefer to do so after a second referendum in which “remain” prevails. The problem is there’s not enough time to hold a referendum. London’s only other option is to ask Brussels to extend Article 50.

The U.K. has reportedly been considering as much and putting out feelers to Brussels for weeks. All 27 member states would have to agree to an extension, which would likely prolong the process by two to nine months. The EU has publicly attached all sorts of conditions to an extension – that it be meant to give the U.K. time to ratify the existing agreement, to resume negotiations without some of the U.K.’s original red lines, or to hold a new election or referendum – but ultimately the member states are unlikely to force a crisis right now.

It appears as though May will opt to ask for an extension and kick the can down the road. Her existing deal would probably require serious changes to get through the Commons, and it would almost certainly have to happen with Labour support – May’s functional majority is too small and opposition within her party is too large for any other realistic deal to pass. But it’s unclear why Labour would accept any responsibility for the current and future states of affairs and help May pass her deal, especially when the possibility of canceling Brexit – the preferred outcome of most Labour voters – still exists.

Labour leadership has urged May to eliminate no deal as an option in exchange for cross-party talks. May and her backers have insisted that this is logically impossible, even as lawmakers are crafting legislation that would effectively do just that (by requiring the government to seek an Article 50 extension to prevent leaving without a deal, a process that could be repeated indefinitely; and if that fails, there’s nothing but politics stopping the government from committing to temporarily revoking Article 50).

The problem for May is that the moment she takes no deal off the table, Labour has even less reason to cooperate; the default would then be to remain in the EU, if only through repeated delays. There are no good options for the prime minister, which is why a Brexit delay is the most likely outcome and which may explain why her government doesn’t appear to be putting up much of a fight against lawmakers who are trying to seize more control over the negotiations.

Delaying Brexit will not help settle the terms of the U.K.’s relationship with the EU, but neither will anything else. At the heart of the issue is the balance between national sovereignty and ties, especially economic, with the dominant bloc in the region. The only conceivable way out of the current impasse might be to go back to the British people, whether through another referendum or a general election – and there is a good chance that neither would produce a definitive answer.

Certainly neither would be popular. Brexit took the lid off a very serious and complex division within the United Kingdom about the U.K.’s relationship to the Continent, and deal or no deal, it won’t be settled by the end of March.