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Explained: Why the US-China trade war might lead to a global recession

The Indian Express logo The Indian Express 6 days ago Udit Misra
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Researchers at Morgan Stanley, a leading investment bank, have alerted that if US and China continue to heap increasing tariff and non-tariff barriers over the next four to six months, the global economic growth rate to fall to a seven-year low of 2.8 per cent, and worse still, the world economy could enter a recession within the next three quarters (that is, 9 months).

The last massive downward spiral in the global economy happened in the wake of the great financial crisis of 2008 and continued till 2010.

What is a global recession?

In an economy, a recession happens when output declines for two successive quarters (that is, six months). However, for a global recession, institutions such as the International Monetary Fund tend to look at more than just a weakness in the economic growth rate; instead, they look at a widespread impact in terms of the impact on employment or demand for oil etc. The long-term global growth average is 3.5 per cent. The recession threshold is 2.5 per cent.

What has triggered the alarm?

On August 1, trade tensions between the two biggest economies of the world escalated further when the US announced that it would impose 10 per cent tariff on imports from China. These measures are to come in to effect on September 1.

In retaliation, China threatened to take countermeasures. The US has also declared China a currency manipulator . In other words, the US accuses China of deliberately weakening the yuan to make Chinese exports to the US more attractive and undercut the effect of increased tariffs that the US is employing.

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The renewed trade tensions threaten to derail the already struggling global economy. For instance, the global manufacturing Purchasing Managers Index and new orders sub-index have contracted for the second consecutive month in July; they are already at a seven-year low. Further, the global capital expenditure cycle has ground to a halt ; since that start fo 2018, there s been a sharp fall-off in nominal capital goods imports growth.

Central banks around the world are cutting interest rate in a bid to shore up global economic activity. To some extent, that cheap money policy is countering the adverse impacts of trade wars and all-round global uncertainty, thanks to Brexit and geopolitical tensions in West Asia, and between the US and North Korea.

How do higher tariffs affect growth?

According to Morgan Stanley, two-thirds of the goods being lined up for increased tariffs are consumer goods. Higher tariffs are not only likely to douse demand but, most crucially, hit business confidence. The apprehension is that the latest US tariffs and similar countermeasures by China could start a negative cycle wherein businesses do not feel confident to invest more, given the lower demand for consumer goods. Reduced capital investment would reflect in fewer jobs, which, in turn, will show up in reduced wages and eventually lower aggregate demand in the world.

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What makes this scenario tricky is that fact that monetary policy is already loose. Ideally, the global economy should not risk reaching a recession at a time when the monetary levers may not have a lot to offer. In fact, at present, the trade tensions and uncertainty is negating the positives that a cheap money policy could provide to the world economy.

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