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Adam Triggs
Signals that predict US recessions are far from perfect. But what is striking is just how many of them are now flashing red. The next US recession is a question of when, not if. Across the indicators, a recession around 2020 is more likely than not. This will have big implications for Asia’s economies. They’d best get ready now.
In 1966, economist Paul Samuelson mocked that the stock market had forecast ‘nine of the last five recessions’. Not much has changed since then. Economists still disagree on what drives the boom-bust business cycle in the US economy. Many rule-of-thumb ‘recession predictors’ have been identified as a result.
At least five of these predictors are currently flashing red. One of them is the US business cycle. The US economy has never gone longer than a decade without a recession, a milestone which is fast approaching.
Another is the stance of the US Federal Reserve. Four of the last five episodes of Fed rate rises have been followed by a recession. With the latest episode already underway, investors expect at least four more rate rises before December 2019. Possibly there’ll have to be more given US President Donald Trump’s pro-cyclical fiscal stimulus — the sugar hit when the economy is already overheating.
Term-spreads are another predictor flashing red. A flattening yield curve — when short and long-term interest rates start converging — has predicted every US recession in the last 60 years.
Another recession predictor is how much spare capacity there is in the economy. The last 10 US recessions were preceded by a closing of the output gap. The US output gap is now near zero, employment is heading beyond full employment and, while inflation and wages are moving slowly, they are beginning to shift.
There are other forces, most coming from Trump, which also warn of a slowing US economy. The stimulus effects of his tax cuts will subside in 2019 and 2020, with no evidence that they have delivered the promised increase in sustained growth through an uptick in investment and productivity.
Trump’s trade war, a tax on US businesses and consumers, is dragging on growth in unpredictable ways because of cross-border supply chains. On current trends, US GDP growth is forecast to fall by one-third by 2020 according to the International Monetary Fund (IMF), leaving a much smaller buffer for shocks.
Others already forecast a US recession around 2020, including Bank of America Merrill Lynch, The Economist Intelligence Unit and two-thirds of the economists surveyed by the National Association for Business Economists.
A slow-down in the US economy will have significant implications for Asia. The IMF estimates that a 1 percentage point decrease in US growth typically reduces growth in the emerging markets by 0.6 of a percentage point. A more complicated story may emerge this time around.
The big increase in trade among Asia’s economies has led some to believe that Asia is less reliant on the big industrial economies. The opposite is true. Asia’s intra-regional trade is driven in large part by cross-border production chains that are linked to demand from the major industrial economies. Asia’s trade dependence on the United States has in fact increased, not decreased, according to IMF analysis.
Increased reliance on international wholesale funding has made Asian banks more exposed to the process of global deleveraging. Hélène Rey of the London Business School shows that the global economy remains as influenced as ever by the stance of US monetary policy, evidenced by the recent impact of Fed rate rises on Asia’s economies.
The biggest concern isn’t the fire. It is the lack of water with which to put it out. Historically, the US Federal Reserve has needed to cut interest rates by 5 percentage points to support the US economy during a downturn. It currently has less than half that with which to stimulate the economy. Corporate and household balance sheets are similarly weak.
Fiscal stimulus is possible. Trump is clearly not averse to it. But any package must now be negotiated through a Democratic House of Representatives and a Republican Senate by an ideologically untethered President. All have very different views on what stimulus should look like. Many Republicans prefer none. While they agree on the merits of infrastructure investment, it is unlikely to come fast enough to provide the necessary short-term stimulus.
In the absence of fiscal stimulus, the US Federal Reserve will return to quantitative easing (the purchase of securities with newly created central bank reserves to depress long-term interest rates) or some other form of unconventional monetary policy.
Even this has political risks. The Fed’s balance sheet is 20 per cent of GDP. Quantitative easing (let alone measures like helicopter money) is looked at suspiciously by many in the US Congress, on both the right and the left. The Fed may find its independence under further attack, particularly if it is accused of causing the recession — as ‘Trump logic’ will certainly try to do.
The only certainty is volatility, particularly for Asia. The last round of quantitative easing saw money flood into Asia in search of high yields. The dollar-denominated debt of emerging-market firms other than banks quadrupled. Conversely, if risks increase, capital flowing back into the United States will drive the dollar up, causing more stress for emerging markets already struggling with their dollar-denominated debt stocks.
Asia’s economies might welcome the increase in investment from a fresh round of quantitative easing. But it would also wreak havoc for their exchange rates, equities and bond markets. It would make macro-financial management even more difficult in economies trying to reform their weak financial systems.
Asia best build its domestic buffers now before the next storm hits.

Adam Triggs is Director of Research at the Asian Bureau of Economic Research, Crawford School of Public Policy, Australian National University