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A new winter for the global economy? Geopolitical and financial risks

Rome, 16/01/2019, Breakfast Talk

The US economy continues to show signs of very strong and wide-based growth, although a few indicators suggest possible problems going forward. A relatively optimistic view points to the fact that there are no significant financial imbalances – especially since companies are doing well. Historically, unless the real estate sector is directly involved in a crisis of confidence, even significant equity market corrections do not cause recessions. The housing market has indeed slowed, but only to the degree that this was expected, and current prices appear to be sustainable.

The other major precursor of previous recessions has been a FED tightening, and there is currently no sign of this, at least in the short term.

Looking at potential external factors affecting American growth rates, a spillover from a major slowdown or recession in the rest of the world – for instance from emerging markets or from Europe –  is also very unlikely to have massive repercussions on the US economy overall.

According to estimates that are shared by several experts, likely growth will be 2.5% over the next two years, which means that the ongoing growth streak will continue well into the next presidential campaign.

On the more sceptical side of the debate, there are serious concerns with the financial sector, including corporate debt – despite the strength of the real economy. In addition, a number of structural problems inherited by the Trump Administration have not really been addressed, particularly law quality employment in many sectors of the economy, relatively low productivity growth, infrastructure weaknesses.

As to China-US trade tensions, there is broad agreement among analysts that the most worrisome issue is the indirect repercussions of existing and future differences – both on the US economy, at least potentially, and on global growth.

The challenge will be to accommodate the rise of China in smart ways, since the influence the US – and even the most advanced economies collectively – can now have on such a large economy is limited. A serious problem with Trump’s approach is that there is no clear path to “victory” in the oingoin negotiations with Beijing and few clear benchmarks to evaluate the outcomes of such negotiations. There is a very wide consensus across the US (including among Democrats and large sections of the business community) on the need to stand up to China in various key sectors. In particular, the hi tech competition is fierce and will certainly not subside. Beyond some tactical and temporary de-escalation, it’s hard to envisage a broad-based arrangement, given that the Chinese push for higher end products, innovation and top level education simply cannot be stopped.

As a consequence of these structural factors, the political space for the President to declare victory after a partial trade deal in very limited, and the tensions will probably continue between ups and downs.

In this context, and assuming a continuation of current trade policies by Washington, global trade volumes will not necessarily change much, but as patterns do change the overall benefits from trade may be negatively affected. And the intrusion of security considerations may often damage economic and market-based decisions. We might say that the quality of global integration is on a declining trajectory.

As US-China tensions are not resolved, options for Europe include an attempt to gain short or medium term advantages – at US expense – but strategic considerations will sharply constrain such a course. In any case, more discussions with Beijing will be held with a view to managing the economic relationship in a tougher global context, and this may impact American calculations at some point. The worst dilemma for Europe would be to be forced to choose between the traditional Transatlantic partnership and a deeper relationship with China.

A more general point about Europe was made: it is hard to say what “grand strategy” (as a coherent combination of economic and security interests) the EU is willing and able to pursue, given its decisionmaking weaknesses and differences among its key members. In light of  a gradual US retrenchment from some geopolitical settings and multilateral organizations, the long term question about relations with Russia will probably return with more urgency, and the Middle East region may become even more unstable. However, no major geopolitical change seems imminent from a European standpoint, in part exactly because major policy innovation is extremely difficult for the EU as a whole.