From Project Syndicate, by Jim O’Neill – Earlier this year I expressed my concern about the outlook for the financial markets because of all the significant uncertainties I could identify and the many other potential risks that were not yet apparent.
This was after Russia started rallying troops on the Ukrainian border, but before it invaded. Now that Russia has begun its war of aggression, it has been almost completely removed from the international economy and markets, and energy and food prices have skyrocketed.
At the same time, Western central banks have embarked on a major shift in their policy orientations, finally letting go of the idea that current inflation is just a temporary phenomenon that will go away on its own. They are now deliberately tightening global financial conditions (both by easing their balance sheets and raising interest rates), increasing cyclical pressures on household incomes, and thus on the economy as a whole.
As if that wasn’t enough, The Chinese economy – the second largest in the world and ten times larger than Russia’s – has been deliberately held back by the strategy “zero-COVID” from the government† And this is in addition to existing efforts to moderate excessive house prices, curb credit growth and curb industries (starting with large tech conglomerates) that are seen as interfering with the government’s new goal of “fair growth”.
Given these developments, it appears that a global recession is heading our way. If so, it would have been remarkably sudden and so soon after the lockdown-induced mini-recessions of 2020 and 2021. How bad will this downturn be and are there any policies to avoid it, or at least the magnitude and can minimize its severity ?
In China, policymakers fear a more relaxed stance on COVID-19 could drive up infections and overwhelm the country’s urban hospitals† Given that we’ve seen the same streak play out elsewhere – most notably in the UK, which was forced to impose sudden and severe incarcerations in 2020-21 – China can hardly be blamed for having been generally cautious. But there’s some evidence that Omicron (the world’s dominant variety) is so transmissible that even blockages are unlikely to completely stop it. In addition, it appears to be less virulent than previous variants, making a drastic response more difficult to justify.
China’s brutal zero-COVID strategy is contributing to an already weak economy, so it has contributed to underlying cyclical weaknesses. The latest trade data (for April) shows that Chinese imports remain exceptionally weak, which is just one of many signs of a weak economy.
The problems facing China have implications beyond economics and markets. The leadership of China’s only party has long legitimized its power by offering the country’s 1.4 billion people an ever-higher standard of living. But this implicit pact cannot be easily enforced in conditions of continued economic weakness.
After looking at China for over 30 years, I would say that one of the government’s greatest assets has been its exceptionally good risk management. In the past, he has dealt with major potential problems resolutely and in a timely manner. This is not the case today. If he doesn’t change course soon, his economy and the rest of the world will suffer much more. On the other hand, if the government can waive the ” zero-COVID and some of its other more drastic economic repression measures, growth could quickly recover.
As for the rest of the world, two major factors outside of China will determine how things turn out. † main policy of the central bank and Vladimir Putin† The Russian president’s intentions remain as difficult to predict today as they were three months ago when he launched his invasion. The sudden support of Finland and Sweden for NATO membership shows that Putin has made a terrible miscalculation. While he may not end the war, his stupidity could well lead to his ousting from power (although many Kremlinologists consider this unlikely).
Anyway, real incomes – and therefore consumer spending – from rising energy and food prices have been hit so hard that central banks have to think twice about their newfound warmongering. After all, if the way to control inflation is to weaken the economy, rising energy and food prices, coupled with tighter financial conditions, may have already done the job of central banks.
Certainly, if longer-term inflation expectations rise and become unanchored, that would change the calculation significantly. In the United States, where Federal Reserve policy changes have far-reaching global implications, the latest consumer price index shows that core inflation is still above 6%, while headline inflation is accelerating. As such, the Fed may see little reason to abandon the tightening trajectory it has so vocally suggested.
But the Fed would do well to consider the reduction in real (inflation-adjusted) disposable incomes in the United States. While the decline was not as severe as in Europe, it was significant, and the sharp tightening in financial conditions may have soon sowed the seeds of an economic slowdown.
So, are we headed for a global recession? Much will depend on the Fed, the Chinese leadership and the Kremlin’s erratic and isolated encryption.
Jim O’Neill, former Chairman of Goldman Sachs Asset Management and former UK Chancellor of the Exchequer, is a member of the Pan-European Commission on Health and Sustainable Development.
Copyright: Project Syndicate, 2022.