The economy is at risk of recession due to a force hiding in plain sight

Last week brought back the scale of the intertwined crises plaguing the global economy, adding to fears of recession, job losses, hunger and plunging stock markets.

At the root of this torment is a force so primal that it is no longer worth mentioning – the pestilence. This power is far from exhausted, confronting policymakers with dangerous opacity. Their policy tools are better suited to typical deflation situations, not a rare combination of waning economic growth and rising prices.

Major economies, including the United States and France, reported their latest inflation data, revealing that prices for a wide range of goods rose faster in June than at any time in four decades.

These shocking numbers have raised the possibility that central banks will move more aggressively to raise interest rates as a way to slow price increases – a path that is expected to cost jobs, hit financial markets and threaten poor countries with debt crises.

On Friday, China reported that its economy, the world’s second largest, grew just 0.4 percent from April to June compared to the same period last year. This performance – which has been astonishingly poor by the standards of recent decades – threatens the prospects for dozens of countries that trade heavily with China, including the United States. It reinforced the realization that the global economy had lost a vital driver.

The specter of slowing economic growth coupled with rising prices revived even a scary word that was a regular part of slang in the 1970s, the last time the world experienced similar problems: stagflation.

Most of the challenges ripping apart the global economy have been triggered by the world’s response to the spread of Covid-19 and its attendant economic shock, though exacerbated by the recent turmoil – Russia’s disastrous attack on Ukraine, which has waned. Supplying food, fertilizer and energy.

Julia Coronado, an economist at the University of Texas at Austin, said last week during a discussion held by the Brookings Institution in Washington. “The pandemic has disrupted almost everything in our lives, and then we move on to that war in Ukraine.”

It was the pandemic that prompted governments to impose lockdowns to curb its spread, crippling factories from China to Germany to Mexico. Confined at home, people demanded record amounts of goods — exercise equipment, kitchen utensils, and electronics — they overwhelmed the ability to make and ship them, creating a major disruption to the supply chain.

The resulting scarcity of products led to higher prices. Companies in highly concentrated industries from meat production to shipping have exploited their market dominance to generate record profits.

The pandemic has prompted governments from the United States to Europe to unleash trillions of dollars in emergency spending to reduce unemployment and bankruptcy. Many economists now argue that they have done too much, spurring purchasing power to the point of stoking inflation, while the Federal Reserve has waited too long to raise interest rates.

Now, central banks like the Federal Reserve are playing catch-up and have moved aggressively, raising interest rates at a brisk pace to try to stamp out inflation, even as it fuels fears that it could lead to a recession.

Given the mix of conflicting indicators present in the US economy, it is difficult to predict the severity of any slowdown. The unemployment rate – 3.6 percent in June – hit its lowest level in nearly half a century.

But concern about price hikes and the recent slowdown in spending by US consumers reinforced fears of a downturn. Last week, the International Monetary Fund cited weak consumer spending in lowering its forecast for economic growth this year in the United States, from 2.9 percent to 2.3 percent. And the Fund warned that avoiding a recession would be an “increasingly challenging”.

The epidemic is also at the center of explaining an alarming economic slowdown in China, which is likely to increase shortages of industrial goods while curbing appetite for exports worldwide, from auto parts made in Thailand to soybeans harvested in Brazil.

China’s no-coronavirus policy has been accompanied by Orwellian lockdowns that have restricted business and life in general. The government is expressing determination in maintaining the lockdowns, which now affect 247 million people in 31 cities and produce a combined $4.3 trillion in annual economic activity, according to a recent estimate from Nomura, the Japanese securities firm.

But Beijing’s persistence – its desire to continue to overcome economic damage and public anger – is one of the most important variables in a world filled with uncertainty.

The Russian offensive in Ukraine amplified the unrest. International sanctions have restricted sales of Russia’s vast reserves of oil and natural gas in a bid to pressure the country’s powerful leader, Vladimir Putin, to back down. The blow to global supplies caused energy prices to soar.

The price of a barrel of Brent crude oil rose by about a third in the first three months after the invasion, although recent weeks have seen a reversal of the assumption that weak economic growth will translate into lower demand.

Germany, Europe’s largest economy, depends on Russia for nearly a third of its natural gas needs. When a major pipeline carrying gas from Russia to Germany sharply cut supplies last month, it raised fears that Berlin could soon ration energy consumption. This will have a chilling effect on German industry just as it deals with supply chain problems and lost exports to China.

If Germany loses full access to Russian gas – an imminent possibility – it will almost certainly fall into recession, economists say. The same fate threatens the continent.

“For Europe, the risk of a recession is real,” Oxford Economics, a British research firm, declared in a report last week.

For the European Central Bank – which then meets on Thursday with plenty of jitters in the markets – the prospect of a deflation further complicates a host of already painful decisions.

Typically, a central bank dealing with an economy sliding into a recession lowers interest rates to make credit more available, stimulating borrowing, spending and hiring. But Europe is not only facing weak growth, but also rising prices, which usually calls for higher interest rates to eliminate spending.

A rate hike would support the euro, which has shed more than 10 percent of its value against the dollar this year. This has increased the cost of Europe’s imports, another driver of inflation.

Complicating matters further, the usual central bank toolkit is not designed for this situation. Balancing job protection and stifling inflation is hard enough in the simplest of times. In this case, price hikes are a global phenomenon, amplified by a war hitherto prevented by sanctions and diplomacy, along with the mother of all supply chain entanglements.

Neither the Fed nor the European Central Bank has leverage to withdraw these measures from Mr. Putin. Neither has a way to rid itself of the backlog of container ships clogging ports from the United States to Europe to China.

“Everyone who follows the economic situation at the moment, including central banks, we don’t have a clear answer on how to deal with this situation,” said Kjersti Haugland, chief economist at DNB Markets, an investment bank in Norway. “You have a lot of things happening at the same time.”

The greatest risk is the impact on poor and middle-income countries, particularly those with large debt burdens, such as Pakistan, Ghana and El Salvador.

As central banks tighten credit in rich nations, they have spurred investors to abandon developing countries, where the risks are greater, and instead turn to hard assets such as US and German government bonds, now paying slightly higher interest rates.

This cash outflow has increased borrowing costs for countries from sub-Saharan Africa to South Asia. Their governments face pressure to cut spending as they send debt payments to creditors in New York, London and Beijing – even as poverty increases.

The influx of money drove down the value of currencies from South Africa to Indonesia to Thailand, forcing households and businesses to pay more for key imports such as food and fuel.

The war in Ukraine doubled all these risks.

Russia and Ukraine are major exporters of grain and fertilizer. From Egypt to Laos, countries that traditionally depended on their supplies of wheat have suffered from the rising costs of staples such as bread.

The United Nations World Food Program announced this month that the number of people considered “acute food insecure” has doubled worldwide since the pandemic began, rising to 276 million from 135 million.

Among the biggest variables that will determine what comes next is the one that has caused all the problems – the pandemic.

The return of colder weather in northern countries may lead to another wave of infections, especially given the unbalanced distribution of Covid vaccines, which has left many people vulnerable, threatening the emergence of new variants.

As long as Covid-19 remains a threat, it will discourage some people from working in offices and eating in nearby restaurants. Some will discourage taking planes, sleeping in hotel rooms, or sitting in theaters.

Since a public health catastrophe first seized the world over two years ago, it has been self-evident that the ultimate threat to the economy is the pandemic itself. Even as policymakers now focus on inflation, malnutrition, recession, and an endless war on the horizon, this observation holds the currency.

“We are still struggling with the pandemic,” said Ms Hoagland, chief economist at DNB Markets. “We can’t afford to just look away as a risk factor.”

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