The world is edging towards a recession once again. The yield curve, which shows the return on US government debt, has inverted for the first time since 2007 – meaning short-term bonds pay out more than long-term bonds. An inverted yield curve has augured every major recession for the last half century.
The global economic indicators are not good. In the US, business investment is falling as the effect of its stimulus programme fades and concerns grow over the trade war with China. The eurozone is feeling the squeeze as demand from China and US slows. Germany has fallen into negative growth and the Bundesbank has said the country is probably heading for a recession. Uncertainty around Brexit is constraining business investment in the UK, while the overall growth of the economy has disappointed financial analysts for several quarters now.
Recessions usually happen every ten to 15 years – business confidence drops, investment declines, employment stalls and demand shrinks. Eleven years on from the crisis of 2008, we are entering a co-ordinated global slowdown.
The next recession is unlikely to be a repeat of the accelerated crash that defined 2008-2010. While there are risks to financial stability – Chinese shadow banking, frothy US equity markets, and a fragile southern European banking system – none of these will impact the real economy in the way the collapse of Lehman Brothers did.
But policymakers should not be complacent – the next crisis will be long, slow and deep.
The Office for National Statistics has said that employment in the UK is rising and the labour market is robust. But the average British worker still earns less than they did in 2007, while the average US employee has the same purchasing power as in 1978. In place of rising wages, consumption in both countries is being driven by growing household debt, and unsecured debt in the UK is now the highest it has ever been.
The global economy is facing a debt overhang (around $246trn) many times larger than that which preceded the financial crisis. Total global debt is three times the size of global GDP, and corporate debt, particularly in the US and the UK, has ballooned because of low interest rates. Household debt in Australia, New Zealand, Canada and the Nordic countries is far higher than it was in 2008.
With incomes low, savings drained and debt levels high, a turn in the business cycle will mean great financial hardship for families throughout the global North.
Independent central banks are supposed to adjust interest rates in order to mitigate the ups and downs of the business cycle. High interest rates make borrowing more expensive, constraining spending and investment, while low interest rates do the opposite. But with interest rates hovering around zero in most advanced economies, central banks will have little room for manoeuvre come the next recession.
In the wake of the 2008 crisis, central banks used “unconventional” methods to boost output. The US, UK, Europe and Japan implemented huge quantitative easing programmes (QE), allowing central banks to create money and buy up government bonds, and so encouraging investors to invest their money in the real economy. But much of this investment has ended up in stock markets, corporate debt and real estate, increasing wealth inequality and exacerbating financial instability.
Fiscal policy is also unlikely to contain the impact of the next recession. The so-called automatic stabilisers that usually ease the rate of economic slowdowns will be less effective than they were in 2008. When an economy enters recession, the government takes less in tax revenue and distributes more in social security payments, which should lessen the shock of a downturn. But a decade of cuts to welfare and public spending, combined with tax cuts, have blunted the effectiveness of these stabilisers.
The ten years since the financial crisis have been a lost decade for wages, investment and productivity.
Many people are no better off today than they were in 2007, and they do not expect their lot to improve. If the political turmoil of the last decade has resulted from economic stagnation, there is no telling what chaos might be unleashed when stagnation turns into decline.
This article appears in the 21 Aug 2019 issue of the New Statesman, The great university con