A Possible U.S. Economic Downturn Poses Challenges to the World

Negative growth, abnormal yield curve, loss of confidence among businesses—Is the U.S. economy headed for a recession? Many economists would say “yes.”

The U.S. GDP shrank 0.9 percent at an annualized rate in the April-June period, according to data from the U.S. Department of Commerce. The drop came on the heels of last quarter’s 1.6-percent decline. According to economists, two back-to-back quarterly GDP decreases satisfy the definition of technical recession.

Observers said the U.S. economic contraction is due to its own factors, including improper monetary policies, and its spillover effects will drag down the global economic recovery, posing challenges to emerging economies particularly.

Slowdown

In August, strategists at leading global financial institution Goldman Sachs predicted a 35-percent chance of the U.S. economy entering a recession in the next two years.

Zhong Feiteng, a researcher with the National Institute of International Strategy of the Chinese Academy of Social Sciences, said a technical recession had occurred 10 times in the U.S. since 1949, with each one recognized as a recession—a significant, widespread and prolonged downturn in economic activity—later.

Soaring prices are posing severe challenges. The consumer price index, a main gauge of inflation, rose 9.1 percent in June from a year ago, the largest 12-month increase since November 1981, according to the U.S. Labor Department.

In 2022 alone, the U.S. Federal Reserve (Fed) has already increased its benchmark interest rate four times, from near zero in March to a range of 2.25 to 2.5 percent, to increase borrowing costs and tamp down inflation.

Desmond Lachman, a researcher with the American Enterprise Institute, said he fears that “by continuing to aggressively raise interest rates at a time of incipient domestic economic weakness at home and of a brewing perfect economic storm abroad, the Fed would seem to be inviting a hard U.S. economic landing.”

“We’ll definitely have a recession as the lagged impacts of this major monetary tightening start to kick in,” Stephen Roach, a former chairman of Morgan Stanley Asia, told CNBC on August 30. “They haven’t kicked in at all right now.”

A recession will be long and severe and could bring financial distress across the board, Bloomberg in August cited Nouriel Roubini, an Iranian-American economist who predicted the housing bubble burst in 2008.

Despite the grim outlook, strong U.S. employment seems to indicate more interest rate hikes are possible. Job openings in the U.S. rose to 11.2 million in July from a revised 11 million in June, according to the Labor Department. In response, several Fed officials argued the economy is still able to tolerate higher borrowing costs.

“While economic output contracted for two consecutive quarters, a strong labor market means that currently we are likely not in recession,” Frank Steemers, senior economist at The Conference Board, a nonprofit research organization, shared a different viewpoint. “However, economic activity is expected to further cool toward the end of the year, and it is increasingly likely that the U.S. economy will fall into recession before year-end or in early 2023.”

Steemers’ prediction coincided with a recent survey conducted by the National Association for Business Economics, on August 22, showing that roughly one fifth of panelists believe the country is already in a recession, while 47 percent expect a recession to begin by the end of 2022 or the first quarter of 2023.

The survey showed that some 73 percent of panelists indicate they are “not very confident” or “not at all confident” that the Fed will be able to bring inflation down to its 2-percent goal within the next two years without triggering a recession.

“Employment is always a lagging indicator. And I think it will be very clear by the time when we get to September that the U.S. economy is already in recession,” Jack Rasmus, a professor in the Economics and Politics departments at St. Mary’s College in California, told CCTV.

Spillover effects

Whatever policy the Fed chooses, it’s unlikely to bolster the U.S. real economy, Mei Xinyu, a researcher with the Chinese Academy of International Trade and Economic Cooperation under the Ministry of Commerce, told Global Times. Looking at the bigger picture, the U.S. dollar-based international currency system is becoming increasingly flawed, he added.

The U.S. dollar’s status as the world’s currency was based on the U.S. once-paramount economic productivity. Yet Mei said the Fed’s quantitative easing policy in recent years has decimated the U.S. manufacturing competitiveness, and by doing so undercut the dollar system.

The abrupt tightening of monetary policy after years of easing, along with other factors, is likely to lead to a financial crisis, Mei warned.

The Fed’s policy will inevitably affect international capital flows, raising the cost of financing African countries need to maintain economic activities, thus affecting their recovery from the COVID-19 pandemic, Charles Onunaiju, Director of the Abuja-based Center for China Studies in Nigeria, told Xinhua News Agency.

The long-term U.S. dollar hegemony has made African economies tie their key economic fundamentals and foreign trade to the currency, he said, adding this means the U.S. could transfer inflationary pressure to these countries through its domestic monetary policy.

“One of the challenges that economies in Nigeria, and Africa at large, face is inflationary pressure… They are all imported inflationary pressures arising from the hegemony of the dollar as a major currency of exchange,” Onunaiju said.

According to Malhar Nabar, a division chief with the IMF’s Research Department, emerging economies that have borrowed heavily in U.S. dollars could find themselves in a difficult position. He told Xinhua that for those who are already mired in debt if they cannot meet debt service obligations, that will create wider problems.

The volatile international situation plus energy and food crises have already led to social and political instability in some developing countries, Zhong echoed, adding that debt problems in some of them may even deteriorate and result in social disorder—a vicious cycle.

Risk-averse sentiment will rise in the face of a U.S. economic slowdown, or recession, Josua Pardede, chief economist at Indonesia’s Permata Bank, told Xinhua, adding such sentiment will lead to capital outflows from the financial market, particularly in the bond market.

The shock in the U.S. economy will drag down the global economy, and global trade volume will also decline, he said, adding that the export performance of Indonesia and some other developing countries will go down given the U.S. is their main trading partner.

The spillover effects also include stock market volatility, currency depreciation, rising cost of imported raw materials and other challenges for many emerging markets, according to experts.

All countries, including China, should remain highly vigilant to the potential impacts on their exports due to U.S. economic recession and possible capital outflows as the Fed has reaffirmed plans for an aggressive interest rate policy, said Yu Xiang, a research fellow with the Center for International Security and Strategy at Tsinghua University.