Fra BNP Paribas:
Ongoing trade tensions are unlikely to lead to a scenario like the Great Depression, which
was mainly caused by a banking crisis that led to liquidity drain.
Because the current global recovery is already mature, however, we think that if the trade wards drag on, the world economy might go into recession.
One cause for concern is that renewed monetary easing by the world’s central banks could rekindle fears of competitive currency devaluations.
The trade war is escalating. If it drags on, how much damage might it do to the global
economy? Could declining trade plunge the world into a spiral of economic contraction?
In our view, the likelihood of a Great Depression-like scenario is small, but a global recession, while not the most likely scenario, is possible. Our report Global: Trading blows (dated 18 July) attaches a 20% probability to a global recession scenario, in which President Donald Trump would impose more tariffs on Chinese imports than currently proposed, along with car tariffs and significantly tighter capital restrictions on investment in the US.
Any fears of a spiral of economic contraction probably arise from analogies between the current situation and the 1930s. The Smoot-Hawley Tariff Act adopted in 1930 by the US government prompted other nations to impose retaliatory tariffs, which made exporting difficult, resulting in the suppression of aggregate demand and the deterioration of income.
Trading partners’ exports were suppressed, setting off a chain reaction that brought a spiral of export reduction and stagnating aggregate demand. While an explanation along these lines is partially correct, it would be an exaggeration to say that trade wars caused the Great Depression.
The primary cause of US economy’s collapse at that time was the onset of the financial and
banking crisis, which sapped both investment and consumption. With liquidity contracting, as the banking crisis spread throughout the US, domestic demand continued to shrink, causing imports to plummet (the banking crisis also flared in Europe).
The deposit insurance system was born in the aftermath of the economic havoc wrought by this banking crisis. An export slump due to high tariffs was a factor for stagnant aggregate demand, but domestic factors were the main cause of the tanking US GDP. The breakdown of trade financing, a natural consequence of the banking crisis, also contributed to the drop in imports.
That said, with the current global recovery already in its tenth year, the cycle is quite mature. Even before the trade war intensifies, we have seen negative effects arising from the maturing of the global recovery, such as capital outflows from emerging market economies. Widening credit spreads are also starting to filter through to sectors of the US economy.
Financial imbalances might be building in some areas due to prolonged loose monetary conditions. If trade wars are added to the picture, we cannot rule out a global recession kicking in earlier than expected. If businesses deem uncertainties to have increased as a result of sudden changes in the rules of global trade, investment could be curbed, with the result that economic growth will decline the world over and the negative trade multiplier will also kick in via tanking imports.
In that event, the fallout could be especially strong on Japan and Germany, as the production of capital goods is a forte of both nations. Meanwhile, trade protectionism now comes at a clearly higher cost than before. Prior to the IT revolution in the 1990s, supply chains were largely national, but production has now become internationally fragmented, with the creation of highly advanced global supply chains.
Imposing high tariffs would not only hurt domestic consumers, who must pay more for imported goods, but also do great damage to domestic businesses through their global supply chains.
