The growing threat of a global recession

A recession in Europe is almost inevitable if the war in Ukraine escalates, and Germany, which has been fiercely resisting calls to pull the plug on Russian oil and gas, finally relents. China is finding it increasingly difficult to sustain positive growth in the face of draconian Covid-19 lockdowns, which have already brought Shanghai to a screeching halt and now threaten Beijing. In fact, the Chinese economy may already be in recession. And with US consumer prices currently increasing at their fastest rate in 40 years, prospects for a soft landing for prices without a big hit to growth look increasingly remote.

Private and official economic forecasts have recently started to highlight growing regional risks, but perhaps understate the extent to which they multiply each other. Widespread lockdowns in China, for example, will wreak havoc with global supply chains in the short run, raising inflation in the US and lowering demand in Europe. Normally, these problems might be attenuated by lower commodity prices. But with no clear end in sight in Ukraine, global food and energy prices are likely to remain high in any scenario.

A recession in the US, especially if triggered by a cycle of interest-rate hikes by the Federal Reserve, would curtail global import demand and trigger chaos in financial markets. And although recessions in Europe normally radiate globally mainly through reduced demand, a war-induced slowdown could radically shake business confidence and financial markets worldwide.

A recession in Europe is almost inevitable if the war in Ukraine escalates, and Germany, which has been fiercely resisting calls to pull the plug on Russian oil and gas, finally relents

How likely is each of these events? China’s growth trajectory has long been slowing, with only a combination of luck and mostly competent macroeconomic management preventing a severe downturn. But no amount of careful macroeconomic stewardship can save the day if the Chinese leadership has made the wrong call on Covid-19.

Most Asian countries have now exited zero-Covid strategies and are moving on to regimes that manage Covid-19 as an endemic threat, but do not treat it as a pandemic. Not China. There, the government is spending massive sums to convert empty downtown office buildings into quarantine centers.

Perhaps the new quarantine centers are a brilliant idea, providing a way to redirect China’s bloated construction sector toward more socially useful activities than piling more new projects on top of years of overbuilding (something that the International Monetary Fund economist Yuanchen Yang and I warned of in 2020). Perhaps China’s leaders know something their Western counterparts don’t about the urgency of preparing for the next pandemic, in which case the quarantine centers could look positively visionary. More likely, however, China is tilting at windmills in trying to tame the increasingly contagious virus, in which case the centers will prove to be a vast waste of resources, and the lockdowns futile.

The risk of a US recession has surely skyrocketed, with the main uncertainties now being its timing and severity. The sanguine view that inflation will decline significantly on its own, and that the Fed will therefore not have to raise interest rates too much, is looking more dubious by the day. With savings having soared during the pandemic, the more likely scenario is that consumer demand will remain strong, while supply-chain problems become even worse.

True, the US government appears to be scaling down its stimulus policies, but that will increase recession concerns even if it helps mitigate inflation somewhat. And if stimulus programs continue full throttle – and, in an election year, why would they not? – it will make the Fed’s job even tougher.

As for Europe, blowback from economic slowdowns in China and the US would have threatened its growth even without the war in Ukraine. But the war has greatly amplified Europe’s risks and vulnerabilities. Growth is already weak. If Russian President Vladimir Putin resorts to using chemical or tactical nuclear weapons, Europe will be forced to cut the cord decisively, with uncertain consequences for both its economy and the risk of further escalation, which might mean imposing sanctions on China as well. Meanwhile, European governments are under considerable pressure to increase significantly their spending on national defense.

Clearly, emerging markets and poorer developing economies will suffer mightily in the event of a global recession. Even energy and food-exporting countries, which until now have benefited economically from the war because of high prices, would likely have problems.

With luck, the risk of a synchronized global downturn will recede by late 2022. But for the moment, the odds of recession in Europe, the US and China are significant and increasing, and a collapse in one region will raise the odds of collapse in the others. Record-high inflation does not make things any easier. I am not sure politicians and policymakers are up to the task they may soon confront.