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What Past Global Recessions Can Teach Us About the Next One


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  • The global economy is looking at a very tough year
  • Recession is not certain, but it may now be difficult to avoid
  • What can past recessions teach us about what may be coming?

The global economy is ‘perilously close’ to falling into recession according to the World Bank’s latest forecast.

It now predicts world economic growth of 1.7% this year, a steep climbdown indeed from the 3% hoped for back in June. As for why, well, take your gloomy pick. Top of the list we find Russia’s invasion of Ukraine, of course. But inflation, higher interest rates, Covid-related supply chain problems and a dialing-back of the globalization trend previously dominant for decades all feature malevolently.

If the World Bank is proved correct, we’re staring down the barrel of the feeblest global growth since 1991, apart from 2009 and 2020. And those are years with world recessions of their own to their names, thanks – respectively – to a global financial crisis and Covid.

Moreover, if 2023 joins the list, it will also be the first time since the 1930s that there’ll have been two world recessions in a single decade. The 1920s may have roared. On current evidence the 2020s will be lucky to get away with merely whimpering. Barclays Capital analysts are reportedly warning that 2023 will see the worst global economic conditions in forty years.

DEVELOPED MARKET SLOWDOWN IS AN OMINOUS SIGN

Worryingly, we have seen growth in the world’s richest economies slow down sharply. It was around 2.5% overall in 2022. This year it may limp in at 0.5%. Maybe. For more than twenty years, crashes like that have foreshadowed a global recession.

But how exactly are these recessions defined, and what if anything can we learn from those which have gone before?

For the purposes of this article, we’ll focus on recession in the modern, industrial era. Doubtless historians have made elegant, educated guesses as to the global hit forced on humanity by ice ages, the Fall of Rome, and any number of historically distant calamities. We’ll leave those to them.

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WHAT EXACTLY IS A GLOBAL RECESSION?

The generally accepted definition of a national recession hinges on those ‘two successive quarters of negative growth’ that are so terrifying to politicians everywhere. Unfortunately, a global recession can’t be quite so narrowly defined, or indeed so readily felt. It’s likely that few economic agents in a country hit by recession will be totally immune from it. However, a global recession won’t hit all countries equally, and a national recession need not happen when a global one does. For example, five acknowledged global recessions since 1950 had an echo in the United States. But the US also had an extra one in the same period.

So, how do we define a global recession?

Well, the International Monetary Fund has said in the past that an annual world-total Gross Domestic Product (GDP) growth rate of less than 3% would qualify. Perhaps a more nuanced definition, and perhaps a more widely accepted one, is a period in which world per-capita GDP is seen to decline.

By this measure there have been 14 global recessions since 1870, and five since the end of World War 2 in 1945. As for what we might learn, well, the most recent – those of 2009 and 2020 – had their roots in very specific “one-off” causes. The first was triggered by the collapse of the US subprime mortgage markets. The subsequent banking Armageddon came about thanks to a long and catastrophic under-estimation of financial risk which too many in the sector were, wrongly, incentivized to permit. The second was a direct result of the astonishingly rapid spread of Covid-19 and the measures taken worldwide to defeat the virus.

 

Still, all global recessions have their specific, proximate causes. These are extremely difficult to predict before the fact, making overall lessons commensurately tough to draw. The world recessions of 1975 and 1979 were triggered by oil price shocks, and high energy costs were still ravaging the global economy into 1982 when another recession hit. 1991’s version had its roots in a US credit crunch, the first Gulf War and the disintegration of the Soviet Union.

That said, many of them are started by price rises, whether they are caused by an increase in the cost of an essential commodity or for some other reason. In developed, monetarist economies, a rise in inflation is almost bound to lead to higher borrowing costs. Central banks are, after all, mandated to keep inflation in check. The problem is that, while that very system involves slowing the economy, when recession threatens, the trick of containing price growth without inflicting much more severe economic damage than necessary becomes far harder.

A very long period of docile inflation and essentially negligible borrowing costs has served to blunt memories of how difficult that balance is to strike. And that’s a shame because the chances of fighting inflation and avoiding at very least a string of damaging national recessions seems to be fading.

CENTRAL BANKS WALK A DANGEROUS LINE

Politicians from the Eurozone, UK and US are already pleading with central banks to go easy on the pace of interest rate rises, as thought that hadn’t occurred to the central banks themselves. However, while inflation remains above target as it does, independent monetary authorities will argue that they are mandated to ignore these pleas and keep borrowing costs high.

And there are at least six factors common to all global recessions. We see both rising unemployment and decreasing wages. That’s a toxic combination for both wage earners and politicians, so political instability tends to rise. In the financial world, investment gets deferred or abandoned entirely while asset prices deteriorate, weakening even if they don’t fall sharply. Default rates rise, hollowing out weaker financial sectors and hitting even the strongest. Credit becomes extremely hard to get. This last factor is likely to be a huge problem for a generation of market participants who don’t recall it being anything other than easy.

So, is there any light in all this darkness? Well, one small crumb of comfort can be found in the fact that, while the world may be close to recession, it’s not there yet. While there seems little chance of peace in Ukraine anytime soon, the situation there is fluid and a meaningful cessation of hostilities would surely do much to take the edge of current, gloomy forecasts.

Even if it doesn’t, recessions do tend to be mercifully short-lived things compared to phases of expansion. The average length of one is about eleven months.

It just seems a lot longer.

 

--By David Cottle For DailyFX | Feb 17, 2023

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