Date: Thursday, January 12, 2023
Not for nothing has this been dubbed the “dangerous decade.” Already, a global pandemic, Russia’s invasion of Ukraine and the return of inflation have shaken the 21st century global economy to its core.
After the shocks of 2022, a recession for large parts of the world in 2023 seems a safe bet. Tougher to gauge, and more frightening, is the long-term impact of money itself being repriced and the assumptions that underlie more than 30 years of global economic history being overturned.
Plentiful cheap labor, low energy and transportation costs and a generally peaceful era for geopolitics all helped turbocharge the globalization of supply chains and drive economic growth around the world in the decades after 1990. Whenever one of those pillars wobbled, there was cheap money to keep the party going, especially in the years after the 2008 financial crisis. The three major central banks—in the US, the euro zone and Japan—have kept their key interest rates below 5% since 2001. For most of the past 10 years, rates have been close to zero and certainly well below the rate of inflation.
In less than three years, each of those supporting pillars of globalization has been knocked away. Workers are scarce and increasingly expensive in the US, Europe and the UK. Oil prices have more than tripled since 2020, and the global cost of energy jumped 50% in 2022 alone.
War has come to Europe with Russia’s invasion of Ukraine, and President Vladimir Putin and President Xi Jinping are openly challenging the post-Cold War order and Western liberal values. In response, the major powers have declared war on Russia’s economy—and the US has begun openly pursuing policies designed to slow China’s rise.
In October 2021 some listeners found it jarring when US Secretary of Commerce Gina Raimondo talked in an interview about denying China advanced tech. Now US export controls on advanced semiconductor technology aimed at China are a reality, with the Netherlands and Japan being urged to follow suit and the number of blacklisted Chinese entities growing all the time. Global businesses are left wondering whether—and how—intricate supply chains that took decades to build must be remade.
The most disturbing consequence of all these shocks was the return of inflation. Central banks that ignored the first embers shifted forcefully into firefighting last year, unleashing the fastest, most synchronized tightening of monetary policy in two generations.
More than 90 central banks raised interest rates in the spring and summer of 2022, at least half of them by three quarters of a percentage point in a single bound. This had an equally dramatic effect on long-term borrowing costs for businesses, consumers and governments.
At the start of 2022, the yield on the 10-year benchmark US government bond was around 1.5%, and the market was expecting the federal fund rates to stay below 1%. Instead it ended the year above 4%, with 10-year yields expected to be not far short of that level throughout 2023.
It’s not only the size of the shift that’s historic but also the pace. In the UK, the rate on a five-year fixed-rate mortgage tripled, from 2% to 6%, in barely two months—this, after more than two decades during which households, businesses and investors got used to the idea that interest rates could always go lower.
One pressing question for 2023 is how the jump in the cost of borrowing will affect business investment, consumer spending and government budgets. The second key issue is how corporations will react to a world in which the tide of history now seems to be running against them.
We know that home prices are taking a hit as property gets repriced in many countries to reflect higher mortgage costs. According to Bloomberg Economics, UK house prices are now 20% higher than fundamentals would suggest. The figure for the US is 10%. The adjustment is already under way in many countries. Hong Kong may lose its title as the most expensive property market in the world.
Is it possible for economies to continue to grow while interest rates and joblessness are going up and both real incomes and house prices are going down? We are about to find out. We have seen “soft landings” in the US occasionally. But those involved slowing the economy to a more sustainable growth rate, not slamming on the brakes hard enough to drive the unemployment rate up.
The financial crises in Mexico and Asian emerging-market economies after the US started increasing interest rates in the mid-1990s showed that even a soft landing in the US can bring other parts of the world down with a bump, especially when it’s accompanied by a soaring dollar. Europe and the UK are already in recession. Globally, Bloomberg Economics is forecasting growth of 2.4% for 2023. Excluding the crisis years of 2009 and 2020, that’s the slowest rate since 1993.
To sum up: There’s no more free money; macroeconomic policymakers are being tested; and the basic geopolitical assumptions underpinning more than 30 years of global economic integration are being thrown into the air.
If the long-term relationship between economic activity and inflation in developed economies has also shifted permanently, these trends may well get worse. Interest rates would go higher, for longer, as central banks work out what’s going on and households start to expect inflation to stick around. Economies would face deeper recessions that are harder to escape from. Politicians struggling with limited options would be more likely to fall back on short-term isolationist solutions.
A gloomy outlook indeed. But just as the world was transformed by unexpected events in 2022, the next 12 months could see it remade again.
With its strong labor market and still healthy consumer balance sheets, the US could narrowly avoid recession or only see a brief contraction in output. Europe’s relatively mild winter could continue, leaving it plenty of gas to get to summer. Households facing the worst squeeze in living standards since the 1970s might just catch a break.
Emerging-market economies, as a group, could defy history and avoid big capital outflows and a string of crises. Bloomberg Economics’ chief emerging-market economist Ziad Daoud reckons the risk of widespread defaults due to higher global borrowing costs is much lower now than it was in the 1980s, and the most vulnerable countries account for a much smaller share of the global economy.
The most important piece of this brighter alternative future is now the most uncertain: China. Ditching Covid Zero policies abruptly in the final weeks of 2022 shocked observers inside and outside the country and sent infection rates soaring. Nobody knows how this will play out.
The messy pivot could have unpredictable policy consequences, given how much Xi had invested personally in protecting the population from the virus. But it could well bolster economic growth in the second half of the year, once infection rates level off. That, in turn, could drive energy prices up, making it harder to tame inflation in the US and Europe. Bloomberg Economics believes that faster reopening could push China’s 2023 GDP growth to 5.1% and add about 1 percentage point to global inflation relative to a repeat of the 3% expansion China managed in 2022. An upside scenario of 6.3% growth could push up global inflation by as much as 1.7 percentage points.
Could global growth also surprise on the upside? Dreams of a widespread productivity dividend from Covid-19—thanks to remote work and faster adoption of automation—seem a bit fanciful now. But short-term supply chain pressures are a fraction of what they were a year ago. For all the talk of deglobalization, the drivers that looked set to transform the world economy a few years ago—the digitalization of global services, for example, the transition to a net-zero economy and the rise of automation—have not gone away.
Beneath the surface, these trends mostly still point toward more integrated markets—even if politicians in the US and China are resolutely marching the other way. The microeconomic story of 2023 will be how businesses attempt to square that circle, nearshoring and diversifying suppliers to insure against supply chain disruptions, and lobbying and resisting, where they can, government efforts to create splits between trading partners.
Despite the aggressive posturing, many businesses and investors seem to be betting that globalization—in some form—is here to stay and that the short-term costs of a true unraveling will be too high for politicians to withstand. That hope may also prove fanciful, given the cold wind blowing through geopolitics. But if central banks can bring inflation under control in 12 months’ time, almost anything is possible—and just about everything will be easier.