It would appear that it is now longer a question of if global recession is on the cards, but simply a matter of when.
Concerns about a global recession have been on the increase, and with good reason, as the economic downturn looks increasingly similar to the high inflation of the late seventies and the big oil shock of the early eighties.
According to the International Monetary Fund, there is no official definition of recession, but it is generally recognised that the term refers to a period of decline in economic activity. Most commentators and analysts use, as a practical definition of a recession, two consecutive quarters of decline in a country’s real (inflation-adjusted) gross domestic product (GDP).
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A global recession will mean a squeeze on living standards unlike anything anyone has seen for a while.
“Real incomes are falling in a way they have not done since the second half of the seventies or the early eighties,” Keith Wade, chief economist at global asset manager Schroders, says.
In the 1970s, meat prices increased by 25% in one year alone, while milk and dairy prices shot up almost 22%. Driven by war, loose monetary policy, and energy supply problems, inflation in the seventies topped out at 22%.
“At the moment an oil shock is playing a part in the squeeze on incomes, with energy prices in most parts of the world up more than 40%.
“However, it is broader than that because we also see food prices increase, inflating at high single and low double-digit numbers. On top of this, we also see the prices of quite a range of goods increasing.”
Wade points out that, compared to our recent history, when inflation has been around 1,5% to 2%, it is quite a big increase. Households are therefore feeling that squeeze across the board.
“If it feels like things are bad, it is because they are.”
The misery index, an economic indicator that helps determine how the average citizen is doing economically, is now in the highest 20% of readings in almost 50 years.
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Wade says we are effectively at the early stages of an economic slowdown and the signs are already there in the housing market, where the effect of high mortgage rates is beginning to slow down the housing market.
Retailers are trying to make cuts as they go along by introducing cheaper lines of products to ensure that people can continue to spend, even if it is not quite so much, he says. He points out that people will adjust their spending behaviour.
“We will likely start to see much more in the way of evidence of weaker consumer spending coming through, particularly on retail sales. This will be the second sector to drop after the housing market slows down.”
Can central bankers do anything? “Central bank policymakers have fallen behind the curve, but there has been a lot of uncertainty and I think central bankers felt that they did not want to tighten too early because it could really crunch the economy if they got it wrong.”
Wade says if the central banks reacted earlier, we might not have seen inflation or wages increase as much and we could have had a more gradual slowdown. However, now we are looking at something a bit more aggressive in the way of a sharper slowdown as a result.
“Central bankers have been quick to blame outside influences for the cost-of-living crisis, such as the war in Ukraine. I do not believe it Is outside central bankers’ power to ease soaring costs. About 80% of the consumer price index (CPI) is not oil or food. What a central bank should be doing is targeting the rest of the basket that is not food or oil and tightening policy to bring inflation down to offset increases in oil and food.”
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Governments can help by taking actions that might be unpopular with voters, such as raising taxes, freezing income bands, and tightening the purse strings, but there is not much else beyond that.
In the 1970s, they tried all kinds of income and pricing policies and none of them really worked. Therefore, it is really down to the central banks to do the right thing.
Wade says the probability of a global recession towards the end of this year or early next year is quite high, probably in the order of 35%. “However, different regions have different risks. While everybody has a measure of inflation risk, particularly the US and Europe, China, as an example, has a big problem in the form of its zero-Covid policy.”
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While China had to shut down a lot of the economy to implement that policy, Schroder’s assumption is that China can emerge from that later this year.
Authorities have succeeded in bringing Covid under control, but they are still putting numerous measures in place so there is still quite a way to go, Wade says. In the meantime, economic activity is very weak and China is not currently contributing much to global growth.
In Europe the question is not only how to bring inflation under control, but also what to do about Russian energy.
“There has been talk of an oil embargo for the last few weeks and I believe they will gradually introduce one. This will put a lot of pressure on European industry and households as parts of Europe depend on Russian energy.”
Germany and Italy, for example, get a quarter of their energy from Russia and therefore an embargo could cause quite a sharp slowdown in economic activity.
Wade also notes that investors are not yet starting to price in a recession, although they have started to think pretty seriously about it, which is why we have seen weakness in equities and parts of the credit markets.