Irony and satire may indeed be dead in the Trump era, but that shouldn’t stop everyone from at least trying to point out instances of both when they invariably pop up.
2017’s “synchronous global growth” story has morphed into a U.S.-centric narrative about late-cycle fiscal stimulus providing enough of a sugar high to ensure that the current expansion has enough momentum to become the longest in recorded history (it’s already the second longest).
There are myriad problems inherent in the current setup, not the least of which is that adding fiscal stimulus to a late-cycle dynamic risks effectively forcing the Phillips curve to not only reassert itself, but to return with a vengeance, raising the risk of a policy mistake from an overzealous Fed.
Assuming you can look past the long-term implications of the anomalous fiscal path the U.S. is currently on, the next question is whether U.S. trade policy will end up negating even the short-term impacts of stimulus. Jitters about trade frictions serving as a drag on global growth are already showing up in emerging markets and Europe. For EM, the trade tensions threaten to exacerbate the pressure exerted by hawkish Fed policy and for Europe, the trade dispute comes on the heels of a sharp Q1 deceleration in economic activity that the ECB hopes will prove transitory in nature.
The question, then, is whether the U.S. is immune. It truly is “America first” in terms of growth and equity market performance, and for those who think the current juxtaposition is sustainable, I would caution that markets are more interconnected than they’ve ever been. Perhaps more importantly, that interconnectedness is mirrored in global supply chains and all other aspects of global trade and commerce.
Desirable or not, “America first” probably isn’t going to end up being a viable strategy precisely because the globalization of markets means negative spillovers are inevitable.
Part and parcel of the populist narrative is a demonization of globalism. Globalization in all its various manifestations has become a casualty of the epochal political shift towards populism. It (globalization) has become a kind of catch-all concept that gets tossed about haphazardly to “explain” everything from stagnant middle-class wages in developed markets to the offshoring of jobs. Because “globalization” is a concept and thus not entirely tangible, multilateral institutions are targeted and painted as the conduits through which deleterious dynamics are channeled.
But the globalization of supply chains and the above-mentioned interconnectedness of markets intuitively means that deglobalization, protectionism and isolationism more generally, simply can’t work.
That’s the setup for a new Goldman note that finds the bank reassessing the subjective odds for a U.S. recession in light of recent events on the trade front. The good news is that according to the bank, the odds of a U.S. recession are ostensibly low:
The current expansion is now the second longest in US history and will become the longest if it survives another year. So far, the odds look good. Our cross-country recession model, which uses economic and financial data from 20 advanced economies to estimate recession odds, puts the probability of recession at under 10% over the next year and just over 20% over the next two years, below the historical average (Exhibit 1).
But that’s not good enough for the cynical among you, now is it? After all, G4 central banks have their sights set on normalization and the looming threat that the Trump administration is looking to rewrite the rules of global trade and commerce is causing a bit of indigestion.
“With monetary and eventually fiscal tightening on the agenda in the years ahead and concern about trade wars and vulnerable foreign economies growing, markets have begun to grumble about the risks further down the road”, Goldman goes on to write, before suggesting that “Recession 2020” is becoming something of a recurring theme.
The Fed has of course begun to warn that the protectionist push poses a risk to domestic investment. Jerome Powell did his best to dodge the issue in an interview with American Public Media’s “Marketplace” program on Thursday, but his comments in Sintra and the June Fed minutes clearly indicate that the FOMC is cognizant of the risks.
Goldman doesn’t find much evidence to support the contention that trade policy risk dampens manufacturing investment. To wit:
We find that while the overall Economic Policy Uncertainty Index—which is not currently elevated—adds predictive information to a standard model of aggregate investment growth, its trade policy component—which is quite elevated—does not.
The bank then goes on to consider whether a slowdown in global growth could spillover into the U.S., and again, the outlook is relatively benign.
“Historically the US has been fairly immune to foreign spillovers”, they write, adding that “according to our analysis of the historical causes of US recessions, it has been about a century since the US last ‘imported’ a recession via weak global demand or financial contagion.”
But – and this is a big “but” – the interconnectedness of global markets means that the risk of financial contagion is now greater. In fact, Goldman posits that the real risk to the U.S. economy from a global slowdown is via financial markets:
The greater synchronization of global equity markets raises the risk that the US could “import” a recession via financial channels in a more adverse scenario. Indeed, this is the most plausible channel through which a trade war or foreign slowdown could tip the US into recession.
Again, there are so many ironies here that it’s difficult to catalogue them all, but one of the more amusing points worth noting is that this seems to suggest that the more China opens its financial markets to outside investment, the more risk there is that episodes like the horrendous crash in 2015 could adversely affect global markets. Anyone who was trading during that period remembers vividly how the devaluation of the yuan ended up catalyzing a modern day “Black Monday” on August 24. Goldman flags that episode as an example of how globalized markets essentially make deglobalization self-defeating (they don’t couch it in those terms, but that’s the idea).
The surprisingly strong reaction of the US equity market to growth fears in China in late 2015 and early 2016 offered a reminder of this trend. Our rule of thumb is that a 10% decline in the US equity market reduces GDP growth by about 0.5pp.
So “yes”, it’s possible that the U.S. could be affected by a global slowdown and/or a concurrent selloff in global financial markets.
If either of those two things are catalyzed by U.S. trade policy, the only thing that will keep everyone from making jokes about the ironic character of the whole self-referential dynamic will be the bad mood that results from losing money.
For Trump, I guess the only question would be this:
If the U.S. “imports” a recession from China’s financial markets, can I slap tariffs on it?