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STATE OF PLAY

The economic threats that loom over 2020

Julien Posture for Quartz
  • Gwynn Guilford
By Gwynn Guilford

Reporter

Published This article is more than 2 years old.

2019 was a dramatic year, full of manufacturing slumps, yield-curve inversions, and other possible harbingers of impending recession. And yet the curtain closed on 2019 with the global economy seeming, somewhat improbably, pretty much okay. Will 2020 be equally dramatic? Will it, too, have an upbeat ending?

Three out of four economists, according to one survey, predict a recession in the US by the end of 2021 and, although predicting recessions is nearly impossible, it’s not hard to spot the imbalances that have built up that are due for an adjustment. If there’s an underlying theme it’s that, a decade since the financial crisis, the structure of the global economy has changed in ways we still don’t understand. Ultra-loose monetary policy has boosted asset prices and put people back to work, but productivity growth and business investment have not kept pace. Globalization has woven together supply chains and financial markets but not trade politics.

In this field guide we’re tackling the biggest risks to the global economy in 2020. We can’t tell you whether there’ll be a recession this year–although we asked some forecasters to try. What we can tell you is that if there is a recession this year, there’s a good chance it will involve one of these major vulnerabilities in the world economy.

Table of contents

A short recap of markets in 2019 | Weak corporate profits in the US | US corporate debt | Emerging market debt | Strong dollar, weak dollar | Trade war | Fragile global supply chains | Everything rests on consumers | China slowdown | Other emerging-market weakness | Central bank overreliance | Inflation risk | Can we trust the data? | Wildcards | The roots of uncertainty

A short recap of the markets in 2019

2019 year began amid a financial market freakout that prompted the Federal Reserve to halt its years-long effort to “normalize monetary policy. A manufacturing slowdown that began in China in 2018 hit the US and the global economy in 2019. Meanwhile, the US-China trade war, which looked set to be resolved early in the year, deteriorated dramatically throughout the late spring and summer, sending markets swooning. The Fed began cutting rates. That fanned recession fears and talk of “late cycle” excesses, and investors recoiled in horror as the dreaded yield curve inverted in August 2019. In September, mayhem in the US repo market squeezed interbank credit, tightening financial conditions. Then came a series of reprieves. In a bid to manage the repo mess, the Fed began buying Treasury bills and, in October, slashed interest rates for a third time. Markets calmed. The US and China hastily patched things up at the end of the year. Consumer confidence and labor markets held up throughout the year and, come late December, recession fears had receded enough that 2019 was dismissed as a “mid-cycle pause.” Markets closed out the year in full-on boom mode. The question is how long that can last—and what excesses build up in the meantime.

What follows is the shortlist of economic vulnerabilities in 2020.

Weak corporate profits in the US

Here’s a glaring disconnect: despite the Fed’s indication that it will hold steady in 2020, financial markets are betting on one rate cut this year. This dissonance may reflect a looming vulnerability: the weakening of corporate profits. At the same time, the outlook for GDP—which typically tracks corporate revenue—doesn’t look overly rosy. Even if recession fears have faded since 2019, that’s more down to the removal of risks than it is an underlying revving-up of growth.

This economic reality stands at odds with the soaring stock markets. If profits keep weakening, at some point, a reckoning is inevitable, argue analysts at Societe Generale. “Companies are already paring investment, but so far have held off on cutting employment,” they say, adding that “when companies finally resort to reducing labor in order to cut costs, a recession is likely.” (It’s for this reason that SG predicts a mild US recession in mid-2020.) One factor that could amplify a downturn is the level of corporate debt.

US corporate debt

One of the defining features of the post-crisis economy is the continued reliance on monetary stimulus (more on that later). The point is to encourage borrowing by driving investors into riskier investments. But more than a decade past the crisis, the pace of economic activity has failed to keep up with growth in debt. And, generally speaking, the more debt in an economy, the more vulnerable it is to shocks.

Debt can exacerbate a drop in demand as firms and individuals curb spending en masse to pay down their debts—a phenomenon that economist Richard Koo dubbed a “balance-sheet recession.” These dynamics make it harder for central banks to stimulate the economy, since people with too much debt have little ability or willingness to borrow more. When the comedown finally arrives, however, excessive leverage makes contractions longer and more painful.

The good news is that the global economy is far less vulnerable to a balance-sheet recession than it was in, say, 2007. This is mainly due to wide-scale deleveraging among households since the financial crisis. Corporate borrowing, however, has swelled to unsustainable proportions.

Debt in itself isn’t automatically a worry. The degree of fragility it creates depends a lot on how credit is being invested and the terms of borrowing—and how those make repayment more or less likely over time. On that score, US corporate debt is looking increasingly shaky. Credit spreads have been unusually narrow (meaning, riskier companies can borrow at rates only a little bit higher than financially sound firms).

That’s been great for firms since corporate bonds tend to be a key source of working capital. But it doesn’t seem all that sustainable. Indeed, as Gaurav Saroliya of Oxford Economics notes, corporate debt is rising faster than profits. One problem is likely that corporate borrowing hasn’t been matched by productivity-juicing investments likely to boost profitability.

So, what have companies been doing with their cheap credit? In the US, firms have been borrowing heavily to fund share buybacks. Since 2010, S&P 500 companies repurchased shares equal to 22% of the index’s market capitalization, according to SG analysts. This is in part because of tax incentives, they note. Since interest payments are tax deductible, debt-financed buybacks let firms boost their earnings per share, raising share prices. But “tax efficiency” is only part of the story here. The larger context is the search for yield, explains Vincent Deluard, strategist at INTL FCStone Financial Inc. “[I]nvestors want to buy debt, not stocks. But corporate managers get paid if stocks’ prices go up,” writes Deluard in a recent note. “Buybacks are the magic wand that turns investors’ preference for debt into rising stock prices.”

This drives home the point about debt and fragility. “On a superficial level, investors feel safer as their portfolios show a large, ‘conservative allocation’ to bonds,” says Deluard. “But the system as a whole gets structurally riskier as leverage rises. There is a smaller and smaller cushion of equity to protect bond investors from losses.” The feedback loops are tightening, since falling yields boost the relative value—and hence attractiveness—of stocks.

For now, though the high-yield default rate climbed steadily throughout 2019, it’s comfortably below historical danger zones, according to John Lonski, chief economist at Moody’s Capital Markets Research. Still, bond prices show that investors expect the default rate to recede throughout 2020—optimism that is hard to square with shrinking corporate profits. The risk is that something happens to cause investors to suddenly worry about those companies’ creditworthiness. The interaction between equities, defaults, and the larger economy can be self-reinforcing. But causality is hazy here. Slowing profit growth could spur defaults that, at a certain level, could induce a stock market drop or even a recession.

It’s not just a US problem. Thanks in part to this desperate search for yield, the value of global bonds is now closing in on $120 trillion, according to the Institute of International Finance. Emerging markets account for a quarter of that, up from a tenth pre-crisis.

Emerging market debt

Emerging-market debt has doubled since 2010, hitting $72 trillion in 2019, according to IIF—a surge powered mainly by corporate borrowing (in advanced economies, governments have driven the increase in debt). Foreign currency-denominated debt leapt to $8.3 trillion, more than twice what it was a decade ago. The maturity profile of that borrowing could prove dicey too: in 2020, some $820 billion in emerging-market foreign currency debt will come due, according to IIF.

A looming concern is the broad slowing of growth in emerging markets. A more sober reckoning of their economic performance—or, as we’ll explore more below, a tightening of advanced-market financial conditions or an economic shock—might trigger a reversal in capital inflows that could, in turn, hobble economic and financial stability.

Much of the vulnerability comes, just as in the US, from corporate debt. In Chile, for example, corporate debt is already well beyond advanced economy levels and growing fast: non-financial corporate debt, as a share of GDP, surged to 103% in Q3 2019, up from 96% just a year earlier, according to IIF.

Household debt is also a problem. Greater financial liberalization means that emerging markets are increasingly vulnerable to the sort of household balance-sheet imbalances that in the past have typically afflicted advanced economies. Household debt levels, as a share of GDP, leapt sharply in Russia, South Korea, Chile, Lebanon, Hong Kong, and China last year. This type of borrowing could wind up exacerbating a downturn if income growth stalls or drops, by forcing families to pay off debt instead of consuming, or if falling housing prices leave households underwater.

In some cases, sovereign debt is a potential problem area, too. For instance, South Africa’s deteriorating economy puts its sovereign credit rating at risk of being downgraded to “junk“—which could force divestment from bond indexes and trigger a wider selloff—noted Jaques Nel, economist at Oxford Economics, in a recent note.

Strong dollar, weak dollar

And then there’s the dollar, the value of which could be decisive in determining economic fortunes in 2020. The dollar’s status as the main reserve currency makes the US the de facto provider of safe assets for the world. The greenback is even more dominant in FX markets, involved in nearly 90% of all currency trades. It’s also the main currency used in trade invoicing, accounting for about 80% of bank trade financing. Around 85% of the increase in foreign currency borrowing in emerging markets since 2010 was in dollars.

A strengthening dollar—in tandem with the forces that drive its appreciation—tends to pressure emerging markets to raise interest rates in a bid to prevent capital from flowing out. That’s one reason why, in general, a weak dollar tends to be good for global growth. It tends to make borrowing cheaper and servicing dollar-denominated foreign debt more manageable. Extra dollar liquidity keeps financial conditions everywhere looser.

Since 2014, the dollar has risen sharply—by more than 25%—against the currencies of its major trading partners (except for a brief reversal in 2017). The good news for 2020 is that the dollar weakened broadly after the announcement of the “Phase One” trade deal with China late last year, as risk appetite revived and investors shifted out of safe assets—a trend that many expect to continue. Besides tariffs, other factors that may have been propping up the dollar are likely to recede in 2020—notably, the impact of Trump’s tax cuts, the US economy’s outperformance, and geopolitical uncertainty.

Trade war

One of the more unnerving headlines of 2019 was the onslaught of a manufacturing recession . After falling throughout the first half of the year, in August the US ISM manufacturing index signaled contraction, and has since slipped to levels last seen in 2009. (The services index, however, has held up.) That’s a vulnerability exacerbated by feeble business investment. In the US, after picking up slightly in 2018, equipment investment slumped throughout 2019, despite the sharp easing of financial conditions throughout 2019. Even though business investment drives a relatively small share of US GDP, its recovery may be crucial to sustaining growth. For one thing, it will help buoy productivity growth and, therefore, boost profit. A more important factor will likely be the continued demand for labor, which feeds into consumer demand.

The proximate culprit is obvious enough. Investors, the media, and pretty much everyone else spent the last two years barraged by the drama of trade wars—new tariffs, threatened tariffs, retaliatory tariffs, removed tariffs, new revelations about the impact of tariffs. The cumulative effect was uncertainty, which took a particularly big toll on businesses. Surveys suggest that slumping business spending is in some part due to uncertainty about the future of global supply chains. A spate of recent research indicates that tariffs on China and other nations have hurt margins for US companies. At the same time, investment levels have lagged corporate profits, suggesting that trade-related uncertainty has indeed led companies to put spending projects on hold, says Capital Economics analyst Andrew Hunger.

It’s quite possible, therefore, that the Phase One agreement between the US and China will revive investment, helped along to some degree by the signing of the new North American trade deal, the US-Mexico-Canada Agreement. At a global level, the reduced risk of a no-deal Brexit seems to have quelled uncertainty too.

However, the economic impact of the Phase One deal is far from certain. Under the agreement, the US will reduce tariff rates on $120 billion of Chinese goods—but only from 15% to 7.5%. It’s hard to anticipate how much this will relieve margins for US importers.

Another point of concern involves China’s commitment to import $200 billion worth of certain US goods and services over the next two years. Those targets will be hard to fulfill, argues Chad Bown, trade economist at the Peterson Institute for International Economics. (However, the structure of the deal means any shortfall won’t become clear until after the presidential election in November.) Another worry is that the purchase pledge induces China to simply shift the composition of its imports. “For example, China could purchase more American soybeans by cutting back on imports of oilseeds from Brazil,” says Bown. “At the same time, Beijing may choose to import significantly less of the tens of billions of dollars of American exports that are not covered by the legal agreement. In the end, mismanaging trade could hurt unwitting American companies as well as [other] countries.”

The deal also resolved little of the underlying conflict between the US and China, which centers on technology policy. Investment restrictions and export bans, which proved economically disruptive in 2019, could easily flare up again this year. On top of that, with its China relations temporarily on the back burner, the Trump administration is now turning its attention to Europe. With disputes ranging from auto and aircraft production and monetary policy to antitrust and climate change, new sources of potential uncertainty abound.

In that sense, one vulnerability may be the broad-based assumption—reflected in bullish investor sentiment—that the apparent detente in Trump’s trade wars will rev up trade enough to power global growth. After all, even if US-China relations warm and Brexit goes smoothly, that will have mainly resolved newly created conflicts and won’t meaningfully improve the stability of global supply chains.

The focus on protectionist hectoring may also mask a much more fundamental vulnerability tied to global trade: deglobalization. Far from being a new phenomenon, the decline in world exports as a share of global GDP began around 2011, back when Trump was still a reality TV star. Although recent politics have exacerbated that decline, other forces set it in motion.

Fragile global supply chains

Even as exports have declined as a share of GDP, interconnectedness has created  its own vulnerabilities, according to intriguing new research. What if the global economy has become too connected? It used to be that a couple countries could periodically fall into recession but could count on the health of other nations to keep demand for their exports steady. As countries’ manufacturing sectors swing in and out of recession in sync with one another, the global economy as a whole loses resilience.

The buildup of intricate trade networks boosted global growth in the mid-2000s. However, it’s possible those loose credit resulted in overextended value chains that now link the fortunes of companies and markets around the planet. This is the dark side of globalization:the collective sensitivity to financial market shocks and monetary policies that might appear at first to affect only the US.

This situation may be the consequence of loose monetary policy and a weak dollar. Analysis led by Hyun Song Shin of the BIS has found a negative relationship between the expansion of global trade and the value of the greenback. That is, when the dollar strengthens, trade—as measured by world goods exports as a share of global GDP—tends to contract, and vice versa. This is because the majority of the world’s trade invoicing is in dollars. When the dollar is weak—which often occurs when monetary policy is loose—trade picks up, buoyed by dollar-denominated lending. A pullback in dollar lending, on the other hand, accompanies a strong greenback.

The relationship isn’t necessarily causal, emphasizes Shin. However, the research challenges deep-seated assumptions about global economic dynamics based on textbook logic. Goods trade, that most concrete of economic activities, is much more closely intertwined with the economy’s most abstract enterprise, finance, than was once assumed. We may still not fully appreciate how problems that infect financial channels can spread to the rest of what we think of as the “real economy.”

The research also raises disquieting questions about the global economy’s structure. “Manufacturing and finance could, in fact, be so closely related that we may even entertain the notion of ‘bubbles’ in global value chain activity, just as there are in asset markets,” said Shin in a speech in May 2019. He added: “[T]he reversal of the 2017 mini-boom in manufacturing should give policymakers pause for thought as to what constitutes a durable impetus to global growth. Even when the growth spurt comes from trade and manufacturing, it may not be strong enough to bear the full burden of sustaining global growth.”

Everything rests on consumers

Strong consumer demand and booming labor markets hint that growth will keep chugging along. This year, American consumers will be even more critical since government spending—a boost that powered growth in 2018 and 2019—continues to shrink.

But all this pressure on consumers raises its own questions. For one, dependence on consumers means business spending that drives jobs growth, as well as steadily rising wages, is especially important. For another, the hyper-financialization of the economy, which has only intensified since the global financial crisis, means that consumers’ willingness to spend hinges on market conditions. Household net worth depends more than ever on asset prices—suggesting that a significant enough blow to portfolios could translate into less consumer spending, turning an otherwise ordinary correction into something worse.

This leaves the global economy vulnerable to shocks, geopolitical or otherwise, that abruptly dampen consumers’ confidence. On that score, the apparent resolution of the US-China trade spat should lower the risk of recession; though upbeat overall, consumers have been reacting somewhat to news of escalating trade conflict.

China slowdown

China looms large over the global economy, including its domestic vulnerabilities. Warring with Trump over trade has hurt growth. Manufacturing investment drives around 11% of China’s GDP, according to Nomura analysis, and exports account for about 13%. Though estimates of magnitude are all over the map, the country is very definitely slowing.

In some ways, years of credit-fueled stimulus have finally caught up with the China miracle. Topped-out housing prices, fast-rising household debt, and ebbing wage growth are combining to eat into Chinese consumers’ disposable income. The country’s industrial sector is still suffering from significant pockets of overcapacity. And corporate debt levels remain high. Worse, heavily indebted local governments are facing a sharp drop in land-sale revenue—factors that will make it hard to sustain infrastructure investment, a key factor for growth. Xi Jinping’s financial de-risking campaign has been fairly successful, but it nonetheless entails growing risk of financial strain, bank failure, and credit crunches. All of these factors make it much harder for Beijing to stimulate by easing credit, as it has so often and so massively in the past.

The pace of China’s slowdown will, naturally, reverberate everywhere. China’s effort to shrink industrial overcapacity starting in 2018 is what triggered the manufacturing slump, according to Conference Board economists. Neither that effort nor Trump’s trade war, however, have unseated it as the center of global manufacturing. It’s the world’s biggest consumer of almost every commodity you can name. The disproportionate influence China exerts on all kinds of commodities markets, trade, and even financial flows makes the rest of the world vulnerable to whatever ails China.

A slowing China isn’t necessarily a bad thing—or it wouldn’t be if it were due to a rebalancing of its economy toward consumer spending and away from external demand. But there are few signs that things are headed that way. One indicator of the excessive supply that it contributes to the global economy is the gap between the growth in imports and GDP, as Brad Setser, economist at CFR, points out. Last year, the value of foreign goods and services China purchased shrank 2%, according to IMF estimates—even as the economy grew about 6%. In that sense, though the oft-mentioned risk of a “Chinese hard landing” is an obvious vulnerability, China’s drag on demand remains a persistent obstacle to more balanced global growth.

Other emerging-market weakness

Recent optimism about emerging markets reflects the shifting of investors toward riskier investments. But as with China, it masks some real underlying problems. Last year, growth slowed sharply in India, Russia, Mexico, and a slew of countries in southeast Asia and central and eastern Europe, according to the IMF’s latest World Economic Outlook report. The Middle East is a distinct source of vulnerability. Saudi Arabia’s already battered economy will struggle with lower oil output growth this year. And while Iran faces the heating-up of conflict with the US, social unrest will likely continue to roil Iraq and Lebanon. In Latin America, meanwhile, Chile faces disruption from popular uprisings, and Mexico’s economy is struggling with slumping investment.

Continued monetary easing in the US and other advanced economies has taken the pressure off for now for the reasons discussed above. But that will stoke vulnerabilities all the more. Take, for example, South Africa. The country is likely already in a recession, which could trigger a downgrade of its sovereign bonds. But as has already happened in Brazil and Turkey, foreign investors are likely to see this as an opportunity. “We think investors will view South Africa’s debt as some of the best ‘junk’ out there and, given low yields and inflated asset prices in much of the developed world, will remain attractive,” says Oxford Economics’ Nel in a recent note. “We expect a temporary overreaction by the rand and a mild increase in government borrowing costs, but no capital exodus.”

Central bank overreliance

It’s become a truism by now, but perhaps the most fundamental imbalance besetting the global economy right now lies in the traditional levers of economic policy: monetary policy is gravely overburdened, and fiscal policy has been neglected.

Major governments relied heavily on monetary policy to stave off depression after the 2007-8 financial crisis and the euro crisis. Central banks’ response included a range of unconventional measures, including large-scale asset purchases (“quantitative easing”) and negative rates. At the same time, they shunned the more direct jolt of fiscal spending. (The US and China are the chief exceptions. However, the US’s fiscal package was smaller than many economists think it ought to have been and was followed by a stretch of austerity in the early 2010s. China’s massive stimulus, meanwhile, was executed mainly through forced bank lending and wound up fueling asset-price bubbles.)

The idea was to stimulate risk-taking not just through traditional channels—by making it cheaper for banks to loan, and thereby, for businesses and individuals to borrow and refinance—but by boosting prices of stocks, bonds, and housing. This was supposed to spur business investment and prop up consumer confidence.

Dramatic action to prevent deflation was likely called for, though the economic impact of these policies remains unclear. Whatever the necessity, there are risks to this approach. By trying to juice demand through asset-price inflation, unconventional monetary policy likely encouraged speculation that now could imperil financial stability. It has contributed to worsening wealth inequality. In most places where central banks employed negative rates (notably Japan) damage to the banking sector is increasingly apparent.

The dynamic is perniciously self-reinforcing. To prevent bad economic news from triggering a stock market selloff—which, in turn, could induce or accelerate a slowdown—the Fed essentially has been forced to ease. The most upbeat indicator of the moment, the buoyant stock market, results from these dynamics—the intertwining of bond and equity markets that build off central bank policy to mutually reinforce rising valuations. As theory has it, the value of stocks and bonds reflect investors’ bets on the growth potential of economic activity. When the outlook is good, stocks are up, and bond yields rise too. At the moment, however, stock market highs reflect unvarnished optimism, while super-low rates suggest a far glummer outlook.

What might explain this discrepancy? As Anatole Kaletsky of Gavekal points out, bond values no longer reflect risks of recession or inflation—at least not directly. Instead, in the last five or so years, speculation has hinged not on activity undertaken by businesses so much as that by central bankers. And central banker priorities have changed a lot since the financial crisis.

Since former Fed chair Paul Volcker’s victory over prices in the early 1980s, central bankers spent the 1990s and early 2000s as anti-inflation crusaders. Lately, though, central bankers seem to have accepted that inflation is persistently—perhaps even permanently—subdued, argues Kaletsky. And chronic deflation will ultimately wind up hurting the financial system in ways that are little understood but seem extremely hard to reverse (see: Japan). So instead of hiking rates to keep prices in check, they’ve been easing to whip price growth higher—in some cases, pushing nominal rates negative. The crusade is no longer against the business cycle, in other words; it’s against deflation.

Of course, central bankers wield tremendous influence over the “risk-free” assets—bonds issued by governments like the US, Japan, and Europe—upon which the entire market is based. That flows into an asset-market feedback loop: By pushing down rates and driving up bond prices, central banks wind up boosting stock valuations. And that dynamic, in turn, puts even more of a burden on central bankers to keep markets liquid.

This dynamic is clear in the otherworldly boom in negative-yielding bonds that took hold in 2019, which now total around $11 trillion (down from a peak of $17 trillion last summer). Why would anyone pay for bonds that literally promise to lose money? In part because negative rates in Europe mean bonds might lose less money than cash. But the bigger factor is speculation, the cynical gamble that rates will fall even further. The implied bet is that the economy will weaken even more, forcing more central bank action.

This isn’t to say the Fed and other central banks have chosen unwisely. Politics have scuttled the critical economic management tool of public spending and fiscal stimulus, leaving monetary policy to do all the work. (One might argue that Trump took  this gambit to its extreme and made it explicit; after launching a trade war that threatened global demand, and therefore, the US economy, the president called repeatedly for the Fed to cut rates, even urging the embrace of negative rates.) Unless that changes, central bankers will be left using increasingly counterproductive tools to resuscitate growth.

What might force a reckoning,? Among possible triggers, Nomura names the “dawning on markets that central banks can no longer come to the rescue in the next economic downturn.” It’s hard to imagine what event might lead to such a collective “dawning”; the Fed’s diminished capacity to cut rates is already quite obvious by historical standards. Three rate cuts in 2019 left rates at a target range of 1.5-1.75%. By comparison, in the past three recessions, the Fed has cut by an average of around 500 basis points.

But the real “sledgehammer,” as Nomura analysts put it, would be central banks sharply hiking rates. If inflation suddenly jumped enough to threaten their national economy, they might be forced to. The major potential causes there include a freak event that drove up oil prices or, perhaps, labor market tightness finally giving way to inflation.

Inflation risk

When it comes to price dynamics, it’s as hard as ever to get a handle on what’s going on. From one vantage, the $11 trillion of negative-yielding debt out there is just a signal that persistent and unshakeable deflationary pressures are at work. The recovery’s eerie longevity reflects this deeper weakness, too. But economists also make the case that, in the US at least, the recovery is mature. Businesses say they’re struggling to find workers, wage growth is solid, and unemployment is super low. Household balance sheets are in great shape. Consumer confidence was barely ruffled by the dramas of 2019. All that should be inflationary. And that’s not even counting other factors that should have driven up prices in 2018 and 2019, including tariffs and the fiscal double-whammy of tax cuts and a big spending bill. No one quite understands what’s going on, and even if higher inflation isn’t likely it still could be possible.

Can we trust the data?

Technology, globalization, demographic change, and other factors alter the structure of the economy in ways that make it hard for indicators to keep up. As a result, our data might not be telling us what we think it is.

Employment data is a prime example. While headline unemployment rates are at nearly unprecedented lows, it’s not hard to find signs of slack. That may be because data on labor markets don’t necessarily reflect people’s working lives with the precision they used to.

The unemployment rate used to reliably reflect the potential for employment of an economy’s workers. No longer. Since 2018, the unemployment rate has hit the lowest levels in more than 40 years. Yet wages, though rising, have climbed much more slowly than economic theory would predict. Sluggish wage growth suggests that there might be hidden “slack”—the “reserve army of labor,” as Karl Marx memorably put it, whose existence reduced worker bargaining power.

Increasingly, economists look to the labor force participation rate—the measure of people with a job or looking for one as a share of the population—to get a sense of how much labor slack remains. In 2019, the participation rate among Americans aged 25 to 54—what economists call “prime-age” workers—closed in on pre-crisis levels but was still below its peak in the late 1990s. Among prime-age men, it still hasn’t recovered. Another problem with the unemployment rate is that it measures the total number of jobs, but can’t capture the quality of that employment, in terms of the hours and pay. Meanwhile, analysis by the IIF suggests that the euro zone is still well below full employment.

But it’s also unclear how much the apparent “slack” represents people truly eligible or willing to work. In an analysis of long-term joblessness, Marianna Kudlyak, economist at the San Francisco Fed, recently noted that those currently out of the labor force have a lower likelihood of eventually becoming employed, compared with the same group in 1999. That hints that the labor market might be tighter than participation rates suggest. Technological and social changes also might be making the official data less accurate. For instance, economists hotly debate the degree to which unofficial work in the gig economy—particularly drivers for ride-hailing apps like Uber and Lyft—might mean more people are gainfully employed than the data imply. Or it’s possible that rampant opioid use in the US is keeping people out of work because of addiction or due to widespread on-the-job drug testing.

Still, the apparently tight labor market is not showing up in prices so far. Though labor costs are rising, the pace is slow, notes Bruce Kasman, economist at JP Morgan. And after a decade of deleveraging, household balance sheets seem to be in solid shape. “The more striking thing is that, though margins are compressing we don’t have that overextension in the economy—in housing or [consumer] spending activity,” he says. “So it’s not delivering the things that tend to trigger Fed tightening. The implications are this expansion is not looking as mature as it might seem given the 3.5% unemployment rate and the 11-year expansion.”

While economists debate the magnitude, they generally agree that key forces suppressing price growth over the last few decades are the ways technology and globalization have changed the global economy’s structure. (Demographic factors are another oft-cited factor.) How long these will continue to weigh on prices is far less clear. Globalization has stalled. Gains from automation and the information technology revolution may have run their course.

Wildcards

Of course, the global economy is always vulnerable to economic shocks. While those are, by definition, unpredictable, some possible themes are identifiable. For instance, the spread of coronavirus in China will disrupt growth in the first quarter, according to Julian Evans-Pritchard of Capital Economics. With the scale of China’s public health crisis still unclear, it’s impossible to guess how severe and long-lasting those effects might be. During the 2003 SARS epidemic, passenger traffic fell by half and retail sales growth plummeted, shaving as much as 3.5 percentage points of Q2 2003 GDP growth, according to Capital Economics’ estimates. “We had already been expecting growth to slow from 5.7% Q4 to 5.3% in Q1, as measured by the CAP. This would be the sharpest quarterly slowdown since the environmental crackdown during the winter of 2017,” says Pritchard in a recent note. “The coronavirus makes a pronounced slowdown even more likely and if the disease is not brought under control quickly, then even our downbeat forecasts may turn out to be too high.”

There’s always the possibility that a natural disaster or geopolitical turmoil will trigger price spikes in energy or food. For instance, in September, an attack on oil facilities in Saudi Arabia drove oil prices up nearly 15%, the biggest one-day spike in almost 20 years. Though prices calmed within days, the episode is a reminder of the potential for such disruption.

There’s also the risk of below-the-surface financial disruptions. A swift Fed intervention calmed tumult in the repo market in September, containing its potential to tighten financial conditions. But analysts expect the Fed to wean the market off that support at some point in the coming year, likely in the first half. Another possible source of havoc is the shift away from LIBOR, the benchmark used to set the risk-free rate of bonds, which will be retired in the next two years. The leading alternatives split between a dollar- and pound-based benchmark. That could make the transition bumpier than anticipated.

Finally, the US election may prove to be a source of fresh panic. Wall Street heads have warned that the nomination of a more left-leaning Democratic candidate—i.e. Elizabeth Warren or Bernie Sanders—would freak out investors. The Eurasia Group named perceived illegitimacy of the general election outcome as its top risk for 2020, due to polarization and the high likelihood of foreign election interference. Even without such drama, to the extent that the election heightens uncertainty it could further dampen investment.

The roots of uncertainty

There is a deeper uncertainty pervading all of this: it’s increasingly hard to find a framework that describes the evolving path of the US and global economies. The mainstream conversation still hews to the business cycle interpretation, by which the economy travels through expansions and short-ish contractions, with monetary and fiscal policy offsetting the chief source of disruption, inflation.

But whether because of technology, central banking, or other factors, key relationships underlying the economy’s structure have changed dramatically in just a decade, denting the “business cycle” notion’s explanatory power. Other “cycles” have filled the void; none, however, satisfy. The US, China, and global manufacturing activity have been undergoing what some investment-bank analysts have taken to calling “mini-cycles”—one- or two-year slowdowns that reverse before they morph into actual recessions. Investors also look to corporate-profit cycles and earnings cycles.

Recent research suggests a global financial cycle might be an increasingly pertinent framework for capturing how financial excess tends to result in the deep contractions and long, slow recoveries that have defined this era. (The 2001 recession is the last proper example of a business-cycle recession; the Great Recession obviously falls in the financial-cycle recession category.) A driving factor is the degree to which finance has saturated global economic activity, giving rise to credit booms and deflationary busts.

We’re still no closer to predicting recessions before they happen. In part, that’s because of how little we understand about the way the global economy functions. At the turn of the century, macroeconomists felt they’d gotten a handle on the workings of the business cycle–just in time for the financial crisis to expose the limits of their knowledge. Plenty has changed since then, and our understanding of the new world economy has not yet caught up.

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