The Fed, trade wars and recession

World stock markets took another tumble on the news that the US Federal Reserve under its new chair, Jerome Powell, had raised its policy interest rate and that President Trump had upped the stakes on an international trade war by adding to the already announced tariffs on imported steel and aluminium, a new range of tariffs on imported Chinese goods.  With China likely to retaliate, the risks are rising of a new recession triggered by rising borrowing costs on debt and falling exports globally.

The Trump administration announced plans on Thursday to impose tariffs on up to $60bn in annual imports from China, raising fears of a trade war between the world’s two largest economies and sending US stocks sharply lower.

The Fed’s ‘policy’ interest rate sets the floor for all borrowing costs in the US and even internationally in many countries.  It is now at 1.75%, a level not seen since 2005.  And the Fed’s policy committee (FOMC) signalled that it intended to raise its rate at least twice more this year and even more in 2019 and 2020, to double the rate to 3.5%.  Powell commented that “the economy was healthier than it had been in ten years” (i.e. at the beginning of the Great Recession in 2008).

The long depression, characterised by weak economic growth (the slowest recovery from a slump in the post-war period), low investment rates and profitability in the capitalist sector, appeared to be over.  And this justified further interest rate hikes to “normalise” the economy.  In addition, the recent corporate tax cuts and other measures by President Trump would lead to a sharp boost to consumer and investment demand “for at least, say, the next three years”.  The US economy was now primed to grow at 3% a year at minimum, suggested Powell.

In previous posts, I have argued that if the cost of borrowing rose while profits and profitability in the corporate sector turned down, then the Fed could provoke a new recession, as happened in 1937 during the Great Depression of the 1930s, when the US monetary authority thought the depression was over.  But profitability then had not made a recovery and increased borrowing costs only squeezed earnings for investment and so pushed the economy back again.  The risk is that this could happen again now.

The Fed does not look at profitability as an indicator of the health of the US capital; instead its mandate is employment and inflation.  On these indicators, employment continues to rise, with the official unemployment rate right down to pre-crisis levels; and inflation remains relatively subdued.  So all appears well.  And if the Fed did look at profitability, it might still argue that things are ok there too.  But that is not entirely correct.  As I argued in previous posts, the overall trend in US corporate profits has been down for over two years. And this is particularly the case for non-financial profits, the key sector for driving productive investment.

Indeed, although the first three months of 2018 are not yet over, various economic indicators forecast that US economic growth, far from accelerating towards 3% a year, has slowed to under 2% from 2.5% at the end of 2017.

Sure, that could just be a first quarter downward slip, as has happened in previous years.  After all, the Fed has raised its forecast for the whole of 2018 to 2.7% and 2.4% for 2019 – not 3%, but a bit better than previous years since 2008.

Actually, despite Trump’s boasts and Powell’s expectations, the US economy is stubbornly stuck in the 2% range of economic expansion.  And the Fed economists have been notoriously wrong in their forecasts of economic growth, inflation and employment.  The real pick-up since trough in the Kitchin short-term growth cycle of 2015-6 has been outside the US; in Europe and to some extent Japan and Asia.  Real GDP growth in Europe is currently higher than in the US.

Most significant has been a profit recovery. JP Morgan economists recently looked at global corporate profits, which in past posts I have measured as making a mild recovery.  Measuring profits as earnings from the top quoted companies in various stock exchanges (by no means a perfect measure as JPM admits), the JPM economists recorded a significant jump in profits across most areas of the capitalist world after a recession-like contraction through mid-2016”.

And where does this jump in profits come from? Mainly the energy sector, as oil prices recovered from the deep lows of the 2015-6; and from the financial sector, as stock and bond markets boomed.  In contrast, healthcare, IT and telecoms profits slowed.  And it came regionally in the advanced economies, while the emerging economies made only modest moves up. Within the advanced capitalist economies, it was profits in Europe and Japan that shot up – areas where the corporate sector had been in the doldrums or worse until recently.

None of this may last.  ‘High frequency’ indicators of economic activity, called the purchasing managers indexes (PMIs), have been at very high levels.  Anything over 50 implies that an economy is expanding and anything over 60 means very strong growth of up to 4% a year rate.  The US ‘composite’ PMI stands at 54 – not bad, but hardly exciting.  The Eurozone’s is higher at 55 but coming down.  Japan is around 52 and China is 53.

Indeed, figures for retail sales (consumer spending), employment and GDP growth suggest a ‘topping out’ of the recent acceleration since 2016.  And now the major capitalist economies face a double whammy of rising borrowing costs and the prospect of an international trade war – just as trade was picking up from the doldrums of the long depression.

A key measure of US borrowing costs, the spread between the US three-month Libor rate and the Overnight Index Swap rate, has reached its highest level since 2009.  And we already know that corporate debt in the US, Japan and Europe, is at record highs relative to GDP.

The hoped-for end to the long depression may be wishful thinking.



11 Responses to “The Fed, trade wars and recession”

  1. Arthur Says:

    “President Trump had upped the stakes on an international trade war by adding to the already announced tariffs on imported steel and aluminium, a new range of tariffs on imported Chinese goods.”

    That is only correct as concerns China (which only provides a tiny portion of steel imports to U.S. – not sure exactly – 2%?). So the announcement was of some future intention to add various perhaps less insignificant tariffs to an insignificant tariff on Chinese steel.

    I am not familiar with US trade policy details, but I have been following US politics. To me it is far more interesting that this unexciting announcement largely buried interest in a far more significant announcement – a “temporary” withdrawal of steel tariffs from EU, Brazil and other countries during “negotiations”. On top of the previously announced withdrawal for Canada, Mexico and Brazil this now excludes all the main importers of US steel including the indirect sources of reexported Chinese steel. So immediately after failing to avoid losing the Pennsylvania election for which a dramatic announcement of steel tariffs was rushed through, those tariffs have been made as harmless as possible while still adding to the general noise. The important but successfully buried announcement was a retreat on tariffs, not an addition. This should at least be mentioned.

    My view is that Trump will keep pushing this stuff, but avoiding real damage from it until Democrats have also fully committed to it as the unions and Bernie Sanders wing show every inclination to do and as they already did running a protectionist in Pennsylvania.

  2. Arthur Says:

    Whoops. Meant to write previously announced “Canada, Mexico and Australia”.

  3. Boffy Says:

    “With China likely to retaliate, the risks are rising of a new recession triggered by rising borrowing costs on debt and falling exports globally.”

    What another one???!

    • michael roberts Says:

      “Recessions tend to come, on average, every five years (though lately, some have taken longer than that to develop). Since 1854, according to the National Bureau of Economic Research, the United States has had 33 recessions, and it has already been 105 months since the last one.” Robert Shiller

      • Arthur Says:

        Shiller quote is misleading – NBER chronology since 1854 does suggest average trough to trough close to 5 years. Better to look closely at more recent experience than nineteenth century:

        For modern period 1945 to 2009 average 69.5 months – closer to 6 years. Last trough was 2009Q2 about 9 years already so lots of anticipation as “overdue already”.

        But previous three were 91, 128, 100 and months and 28 respectively. It just isn’t predictable and the dates are announced retrospectively as they have not been able to do reasonably accurate forecasts.

        Need some underlying theory. If the GFC was a classical crisis it should have actually RESOLVED some of the contradictions and disproportions paving the way for prosperity and a boom before another crash. I gather that is not what most observers are seeing. I am not competent to be sure but it looks to me like the extreme measures taken to avoid a full scale crash with Quantiative Easing etc were SUCCESSFUL in postponing a full crash and consequently in postponing any subsequent cycle. But if so, as Maksakovsky argued, we should expect the next crash to be more intense when it does come as the disproportions will have continued to get worse.

        I don’t see any basis on which anybody could predict how soon a postponed crisis would break out. I certainly could not, and anybody who could would be able to make a very large fortune on the futures markets. But for what it is worth the US looks like building up exactly the sort of huge deficits that have historically been used to postpone crisis. I see no reason to assume that this won’t have the intended effect of postponing crisis until after the 2020 elections.

  4. MaoTseFunkadelic Says:

    Hi Michael (and other readers), this is rather tangential to your current post, but I wanted to ask your opinion on a rather abstract line of idle (amateur) thinking when pondering the UBI.

    The basic question is: has anyone considered a form of UB that doesnt rely on redistributing surplus appropriated by the state, but rather a UBI premised on the final value of consumer goods produced?

    In other words, if a $1 billion of goods and services were produced, the population would receive an equal share of $1 billion in their bank accounts. Higher productivity would only result in higher ‘baseline’ consumption for population, including for those made redundant. Those whose labour is still required, would still be incentivised by the prospect of higher consumption through their wages for their labour-power. All the better if the workplace is democratized (i.e workers become the owners of their enterprises).

    Is this a ludicrous idea from a Marxist perspective? I only have a basic understanding of Vol I., and passing second-hand knowledge of the contents of Vol II. and III.

  5. Socialism In One Bedroom Says:

    Michael, will you and your bloodhound Arthur be celebrating Israels duck shoot of the Palestinians over this Easter holiday?

    Just wondered what the official Marxist position is?

    • michael roberts Says:

      This blog is about Marxist economics and does not deal with revolutionary politics and class struggle except occasionally. However, just to make it clear, I fully support the rights of Palestinians to an independent state (preferably based on socialism) and totally condemn the continual reactionary militarist actions of the Israeli state which acts a client state of imperialism in the region. I have no idea what Arthur’s position is as half the time I do not understand what he says.

  6. Nadim Mahjoub Says:

    Hi Michael
    Just searched for Russia in your posts, using the search engine. Interestingly, I cannot find a single blog about Russia, a very important cluntry. According to the IMF, the Russian economy is et to be the 6th in 2010 in terms of GDP. There are two interesting pieces recently on Russia, one today on the BBC and another long one by Thimothy Snyder on the Guardian Long Read. Neither of course speaks about ‘imperialism’ although Snyder’s one speaks about American capitalism a bit. It would be useful if you write something from your perspective.

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