We are suffering from a crisis of confidence. In a drastic reversal of fortunes, the global economy has weakened significantly during the past 18 months following the synchronised global boom of 2017.
A cocktail of mostly political risks is badly hurting sentiment in financial markets and among businesses. This dampens appetites for risk and investment.
Initially, the softness was focused in export-orientated Europe and East Asia, where US President Donald Trump’s trade wars, the slowdown in China and intensifying Brexit uncertainties weakened demand for exports of investment goods. Now, the softness is finally spreading to US manufacturing as the fiscal stimulus of 2017/18 wears off.
When broad economic fundamentals are healthy, a correction in one sector should not tip the whole economy into a recession.
In the exceptional times when that happens, the other parts of the economy are typically primed for a downturn anyway – usually because they had built up unsustainable excesses beforehand.
The current correction is nothing like the broad-based slump of 2008/9 that followed the extreme excesses in US, UK and Spanish debt and real estate. In major parts of the world today there are no such dangerous excesses.
The situation also differs from the moderate global downturn of late 2015 and early 2016. Four years ago the problem was mostly due to economic issues – the sharp drop in US energy investment after a plunge in the oil price and the economic downturn in China. This time, the weakness reflects bad policy choices.
The key risk today is that, if the political risks persist, the slide in production and trade will continue until, eventually, the domestic parts of major economies like consumption and services begin to weaken badly, too.
So far, this is only happening a little. In the eurozone and the UK, we find some signs that the rot has started to affect parts of the service sector and the labour market.
Central banks are doing their bit to contain the risk of a full-blown downturn. However, policy rates are so low across the Western world that further rate cuts cannot raise consumer spending or business investment much.
Nonetheless, central banks still play a vital role in containing risk. Supplying liquidity on good terms will help mitigate the situation and prevent issues in financial markets and – from there – the real economy.
But to stave off the risk of recession, trade and production need to recover soon. For that, we need the risks to fade and for confidence to recover. That largely depends on the upcoming political choices.
First, will Trump escalate trade tensions with China or will he seek a partial deal ahead of the 2020 presidential elections?
Second, will China clamp down heavy-handedly on the pro-democracy demonstrations in Hong Kong, thereby stoking West-East tensions further?
Third, will the UK perform a dramatic act of political and economic self-harm and crash out of the EU without a deal?
If the answer to each of these questions is no, then the global economy can begin to improve by the turn of the year and strengthen into next spring. However, if the risks materialise, the world economy could gradually descend into a full-blown recession.
With luck, this will not happen. But the string of negative political surprises over recent years suggests that we would be foolish to be too relaxed about the economic outlook just yet.
Kallum Pickering is senior economist at Berenberg Bank