26 May 2019 — Michael Roberts
Despite all the optimistic talk by President Trump about the state of the US economy, the latest data on economic activity and industrial production suggest that America is joining Europe and Japan in a sharp slowdown as we enter the second half of 2019. And this is at a time when the trade and technology war between the US and China has moved up another gear and so threatens to trigger an outright global recession before the year is out.
JP Morgan economists report that the so-called flash May PMIs for the US, Europe and Japan G-3 point to a 0.7-pt decline, consistent with just 2.5% annual growth in global GDP. Purchasing Managers Indexes (PMIs) are surveys of company views on their current and future sales and purchases. They have proved to be reasonable guides to actual production. And 2.5% growth globally is considered to be the ‘stall speed’ for the world economy, below which a recession is indicated.
JP Morgan find that global manufacturing is suffering most – being nearly at 50 in the PMI (anything below 50 means contraction). But services, which constitute 70-80% of most major economies (at least in the official definition), are also sliding towards the levels of the mini-recession of 2015-6.
Like other forecasters, the OECD’s Economic Outlook, published last week, predicts slower growth this year than last in most big economies — in some cases much slower. What is more, even in 2020, global growth will not return to the pace it reached in the past few years, it says. Angel Gurría, its secretary-general, said: “The world economy is in a dangerous place.”
Up to now, it has been in Europe and Japan that signs of a slowdown and even an outright recession were visible. But now the US economy may be joining them. The US Manufacturing PMI dropped to 50.6 in May, implying almost stagnation. It was the lowest reading since September 2009 as new orders fell for the first time since August 2009 while output and employment rose less.
US Manufacturing PMI
The services sector also dropped back. The overall economic indicator showed the weakest expansion in the private sector since May 2016. Then on Friday, we had actual data for US manufactured durable goods. In May new orders fell 2.1% from a month earlier in April 2019. Transportation equipment, also down two of the last three months, drove the decrease. The Atlanta Fed’s GDPNow model estimate (a very reliable indicator of future growth) puts US real GDP growth in the second quarter of 2019 at just 1.3%.
When we get to Europe, the latest figure for Europe’s powerhouse, German manufacturing activity, makes particularly dismal reading. The May reading pointed to a fifth month of contraction in the manufacturing sector, as new orders continued to fall sharply largely due to lower demand across the car industry and the effects of customer destocking. In addition, the rate of job losses accelerated to the quickest since January 2013.
German manufacturing PMI
Even with the services sector holding up, overall activity in Germany looks very weak. And the business morale survey is at its lowest for nearly five years. Activity in the Eurozone as a whole is also at a near five-year low.
Eurozone composite PMI
Japan’s economy is “worsening” for the first time in more than six years, according to one of the government’s main indicators. The index of economic conditions compiled by Japan’s Cabinet Office fell 0.9% from February to March. That prompted government statisticians to cut their assessment of the economy from “weakening” to “worsening” — the lowest of five levels. The last time the Cabinet Office used the bottom grade to describe the economy was in January 2013. Barclays economist Kazuma Maeda said that the “mechanical” downgrade in the assessment did not necessarily imply that a downturn was in prospect. But he added: “That said, there is mounting concern about an economic recession”
Nominal activity growth in Japan, which can be viewed as an up-to-date proxy for nominal GDP, has been falling since the end of 2017, since the decline in real output growth has been greater than the rise in inflation. On the core nominal activity measure, the rate of increase has now dipped to around 0.5 per cent, lower than it was at bottom of the 2016 deflationary shock.
As an aside, it is worth noting that Japan is supposed to be the poster child of Keynesian fiscal and monetary policy. The Bank of Japan has negative interest rates and has bought virtually all government bonds available from the banks, as well corporate debt and stock, through massive credit injections in the last ten years. And it has consistently run budget deficits to try and boost the economy; so much so that the government debt to GDP is the highest in the world. But nominal GDP growth and prices continue to stagnate.
Those who support Modern Monetary Theory should take note. Yes, you can run budget deficits permanently and run up public debt without consequences for inflation or even the currency in an economy like Japan. But you cannot get a permanent boost to growth if Japan’s corporations won’t invest or the government won’t either. Creating money does not necessarily create value. The irony is that Prime Minister Abe plans to raise the sales tax later this year to try and lower the deficits and debt ratios in line with neo-liberal policy. The last time he did that, Japan went into recession.
Outside the imperialist blocs, the so-called ‘emerging market’ economies are also slowing. Turkey, Argentina, Pakistan are already in recession. Brazil and South Africa are on the brink. And capital flows to these economies from the imperialist bloc are drying up, while public sector investment has nearly ground to a halt.
Net public investment in emerging market countries has fallen below 1% of GDP for the first time on record, raising fears of widening infrastructure gaps. The share of national output developing world governments are spending on investment in assets such as schools, hospitals and transport and power infrastructure, net of depreciation of the existing capital stock, has fallen from 3.3 per cent in 1997 to a low of just 0.9 per cent last year, according to data from the IMF. This is well below what the IMF believed was needed to meet basic needs and allow countries to close infrastructure gaps that are slowing the pace of development.
Indeed, if you exclude China, then investment growth is dropping in the rest of the G20 economies. Only the US and India are keeping investment positive. If they should falter, as investment is the driver, a global recession would follow.
If China is stripped out of the data, the weighted average for the rest of the emerging world is 3.9 per cent of GDP, markedly lower than the 4.8 per cent figure seen as recently as 2010. The 49 low-income developing countries, mainly in Africa but also encompassing the likes of Vietnam, Bangladesh and Moldova, are even more badly placed, with the IMF calculating they need to invest an additional 7.1 per cent of GDP a year until 2030 on roads, electricity and water alone. With health and education added in, this rises to a colossal 15.4 per cent of GDP, or $528bn, a year.
Low profitability explains above all else why corporate investment has been so weak since 2009. What profits have been made have been switched into financial speculation: mergers and acquisitions, share buybacks and dividend payouts. Also, there has been some hoarding of cash by the FAANGS. All this is because the profitability of productive investment remains historically low.
The other key factor in the long depression has been the rise in debt, particularly corporate debt. With profitability low, companies have run up more debt in order to fund projects or speculate. The big companies like Apple or Microsoft can do this because they have cash hoards to fall back on if anything goes wrong; the smaller companies can only manage this debt spiral because interest rates remain at all-time lows and so servicing the debt is still feasible – as long as there is not a downturn in sales and profits.
When fundamentals like profitability and debt turn sour for capital, then anything can trigger a slump. Each crisis has a different trigger or proximate cause. The 1974-5 international recession was triggered by a sharp rise in oil prices and the US coming of the dollar-gold standard. The 1980-82 slump was triggered by a housing bubble in Europe and a manufacturing crisis in major economies. The 1990-2 recession was triggered by the Iraq war and oil prices. The 2001 mild recession was the result of the bursting of the dot.com bubble. And the Great Recession was started with the collapse of the housing bubble in the US and ensuing credit crunch brought on by the international diversification of credit derivatives. But underlying each of these crises was a downward movement in the profitability of productive capital and eventually a slowdown or decline in the mass of profits. (The profit investment nexus).
It now seems possible that brewing trade war between the US and China could be a new trigger for a global recession. Certainly, US investment bank, Morgan Stanley has raised such a risk. “While a temporary escalation of trade tensions could be navigated without much damage at all, a lasting breakdown would inflict serious pain. If talks stall, no deal is agreed upon and the U.S. imposes 25% tariffs on the remaining circa $300 billion of imports from China, we see the global economy heading towards recession,” the bank’s analysts said in a note.
The OECD also highlighted the danger coming from the trade war. According to the OECD, international trade has slowed abruptly. Its rate of increase has fallen from 5.5 per cent in 2017 to what the OECD thinks will be 2.1 per cent and 3.1 per cent this year and next respectively. That is lower than projected economic growth, meaning trade is shrinking as a share of global economic activity. Since 2009, it had been the slowdown in investment growth that has led to a slowdown in trade growth; and the IMF estimated that three-quarters of the trade growth slowdown could be attributed to weak economic activity, especially in investment. But now the boot seems to be on the other foot.
The OECD numbers on aggregate investment are corroborated by more fine-grained data. Most big US companies’ investment spending, as reported in regulatory filings, has stalled dramatically. A Wall Street Journal investigation of 356 of the S&P 500 companies found that they spent only 3 per cent more on capital in the first quarter year on year; down from a 20 per cent growth rate a year earlier. For the biggest capital spenders, investment fell outright. Trade frictions seem the main cause — directly for businesses particularly reliant on Chinese demand, such as specialised chip producers, as well as indirectly through the increased uncertainty spreading through the economy. Another survey has found that many US companies operating in China are also holding off on investing.
Morgan Stanley also warned not underestimate the impact of trade tensions in a number of ways. Firstly, the impact on the U.S. corporate sector would be more widespread as China could put up non-tariff barriers such as restriction of purchases. Given the global growth slowdown that would follow, profits from firms’ international operations would be hit and companies would not be able to fully pass through the tariff increases to consumers.
What makes it likely that the trade war will not be resolved amicably to avoid a global recession is that the battle between the US and China is not just over ‘unfair trade’, it is much more an attempt by the US to maintain its global technological superiority in the face of China’s fast rise to compete. The attack on Huawei, globally organised by the US, is just a start.
A chain reaction is under way as a giant industry braces for a violent shock. US Investment bank Goldman Sachs has noted that, since 2010, the only place where corporate earnings have expanded is in the US. And this, according to Goldmans, is entirely down to the super-tech companies. Global profits ex technology are only moderately higher than they were prior to the financial crisis, while technology profits have moved sharply upwards (mainly reflecting the impact of large US technology companies).
The growth slowdown is being driven by low investment and profitability in most economies and in most sectors. Only the huge tech companies in the US have bucked this trend, helped by a recent profits bonanza from the Trump tax ‘reforms’. But now the technology war with China will hit tech profits too – even if the US and China reach a trade deal.
The IMF is very concerned. New IMF chief economist, Gita Gopinath, commented. “While the impact on global growth is relatively modest at this time, the latest escalation could significantly dent business and financial market sentiment, disrupt global supply chains, and jeopardise the projected recovery in global growth in 2019.” Roberto Azevêdo, director general of the World Trade Organization, said the US-China trade war was hurting the global economy. The WTO has been bypassed by the US as the Trump administration aims its attacks directly on China. Azevêdo said that: “$580bn [£458bn] of restrictive measures were introduced in the last year, seven times more than the previous year. This is holding back investors, this is holding back consumers, and of course it is having an impact on the expansion of the global economy. Everyone loses … every single country will lose unless we find a solution for this.”