The freeze-up in US business confidence, caused in part by the trade war, could wind up affecting consumer confidence.
These three things are all true: The United States almost certainly isn't in a recession right now. It may well avoid one for the foreseeable future. But the chances that the nation will fall into recession have increased sharply in the last two weeks.
That is the unmistakable message that global investors in the bond market are sending. Longer-term interest rates have plunged since the end of July — a shift that historically tends to predict slower growth, interest rate cuts from the Federal Reserve and a heightened risk that the economy slips into outright contraction.
This is happening in an economy that, by most indicators, is solid. The US economy is growing at a roughly 2 per cent rate and keeps adding jobs at a healthy clip. There is no sign of the kind of huge, obvious bubbles that triggered the last two recessions, the equivalent of dot-com stocks in 2000 or housing in 2007.
So if there's going to be a recession in 2020 — if the pessimistic signals in the financial markets prove correct — how would it happen? There are plenty of clues, in the details of recent economic reports, in signals from the markets and in the recent history of recessions and near recessions.
President Donald Trump's on-again, off-again execution of the trade war with China and other countries has fed uncertainty into businesses' decision-making. Corporate investment spending is softening, despite the big tax cut that Trump said would boost it. And the combination of central banks that are at the outer limits of their ability to stimulate growth, and an inward turn by many countries, could make governments less effective at responding to a downturn.
"It is potentially a self-inflicted-wound type of recession," said Tara Sinclair, an economist who studies business cycles at George Washington University. "But how deep that gash goes depends on many other characteristics of the economy and the policy response thereafter."
There are parallels to the past. Often, a recession results when some widely held belief about the world turns out to be false. In 2001, it was that a technology boom would fuel the economy and the stock market indefinitely; in 2007, it was that the housing market would never melt down across all regions at once.
This time around, the belief in doubt is that the world will only become more stable and interconnected over time, and that trade, currency and diplomatic relationships can be counted upon.
Recessions result not just when something bad happens in the economy; bad things happen all the time. Recessions occur when those initial shocks are multiplied, in ways that reverberate worldwide. The dot-com crash was accentuated by the September 11 terrorist attacks in 2001 and a rash of corporate scandals. The 2007 housing bust in the United States became a global financial crisis in 2008 only because banks worldwide took huge losses on mortgage debt.
The starting point for the international tensions that could lead to a recession in the United States is business investment spending, especially in the industrial sector. As corporate CEOs look around the world and make their plans for investment and hiring in the year ahead, they aren't liking what they see.
The economies in China and many of its Asian neighbours are getting weaker, partly as a result of the trade war with the United States. The European economy, which has muddled along for years with low growth, may be tumbling into a recession, and if Britain crashes out of the European Union with no exit deal October 31, Europe could face still deeper challenges.
Already, a key measure of business capital spending in the United States, "fixed non residential investment," was in negative territory in the second quarter. And in the nation's factories, the rate of growth has slowed for five consecutive months, according to the Institute for Supply Management's index. Although this measure still showed growth, the July reading was the weakest since August 2016.
The trade war between China and the United States is a big part of the reason. The conflict has made it difficult for many global firms to plan their operations — and in some cases, it may lead them to sit on their hands rather than invest. The US strategy has been more successful at escalating trade tensions than in resolving them, so companies do not know whether tariffs will go away soon or will be a continuing cost of doing business.
"The president says we're going to get a great deal and a great deal soon, but he's been saying that for over a year," said Phil Levy, a former trade official in the George W. Bush administration and a chief economist at Flexport, a freight forwarder that works with many companies involved in international trade. "You end up paralysed. You have to make plans, but there is risk all over the place, so businesses get cautious and hold back on investment."
It's not just companies directly involved in trade with China that may see reason to hold back on investment. The turmoil in financial markets spurred by the trade war could make businesses of all sorts more cautious.
Still, if the downturn remains confined to business spending, it will be hard — just as a matter of arithmetic — for an overall contraction to result. Consumer spending accounts for more than two-thirds of the US economy, versus about 14% for business investment.
So far, American consumers are spending enthusiastically, driving overall growth. But there are a few ways the freeze-up in business confidence could change that.
Turbulence in global markets — and the news reports attached to that turbulence — could reduce consumer confidence and lead Americans to pull back on their buying. The University of Michigan survey of consumer sentiment fell sharply in its August reading, announced Friday.
Or more directly, if businesses pull back on investment spending, they may also make moves that reduce consumers' incomes, including layoffs, hiring freezes and cuts to overtime.
If that's the worst of it — trade wars, slower business spending and weaker overseas economies — the United States could probably weather it without falling into contraction. But there are risks out there that could multiply those shocks.
One is the buildup of corporate debt. Businesses have taken on more debt in an era of low interest rates, which leaves them more vulnerable to failure if the economy were to soften or interest rates were to rise. A pullback because of trade wars could cause a wave of bankruptcies that turns a mild slowdown into something worse.
"A highly leveraged business sector could amplify any economic downturn as companies are forced to lay off workers and cut back on investments," the Federal Reserve chair, Jerome Powell, said in a May speech.
But the biggest risk multiplier may come out of the policy world. In past recessions, the Fed had plenty of room to cut interest rates as a stimulus measure, and fiscal policymakers have been willing to pour money into weaker economies.
The Fed's main target interest rate is just over 2% now, compared with 5.25% heading into the last recession in 2007. Other global central banks have even less wiggle room.
And a polarising president and a divided Congress are unlikely to find much common ground in stimulating the economy. In early 2008, for example, as a recession took hold, the George W. Bush administration negotiated a US$152 billion stimulus package with a Democratic Congress to try to lessen the damage.
It seems unlikely that Trump, heading into a re election battle, would find the same harmony with Democrats today.
"You could get a widespread fiscal response to a recession," said Megan Greene, a senior fellow at Harvard's Kennedy School. "That would be really nice, but I'd also like a unicorn for my birthday."
International coordination would be even harder in the current geopolitical moment. In the fall of 2008, finance ministers and central bankers of the Group of 20 major economies released a joint statement pledging to work together to end the financial crisis. With many nations facing inward, it is hard to imagine that today.
How would a 2020 recession happen?
The trade wars and a breakdown in international economic diplomacy cause businesses around the world to pull back. This leads to further tumbles in markets and job losses, prompting American consumers to become more cautious. High corporate debt loads create a wave of bankruptcies. And central bank policy proves impotent, combined with fiscal policy that is nonexistent.
Chances of a near-term recession are only about 1 in 3, in the view of most forecasters. But if it does develop, the big question will be whether the usual tools to fight it are up to the task.
Written by: Neil Irwin
© 2019 THE NEW YORK TIMES