Spectre of 2023 global recession looms

Spectre of 2023 global recession looms

Vehicles queue to refuel at a Bangchak petrol station in Bangkok. The cabinet agreed on Tuesday to cut the excise tax on diesel by 5 baht per litre for two months until July 20 to tame inflation. (Photo: Sarot Meksophawannakul)

In economics, there is no such thing as a surprise. Major economic events like rising inflation, interest rate hikes, currency depreciation, even economic recession can be detected as far as a year ahead.

Take the recent spike in global inflation as an example. The rapid price rise of world commodities began a year before Russia’s invasion of Ukraine on Feb 24. The rise in a broad range of commodity prices reflected the recovery in demand after the outbreak of Covid-19 and deteriorating supply due to a lack of investment to expand and maintain supply chains during the Covid years.

Here are some examples of commodity price hikes from January 2021 to January 2022, basically a month before Russia invaded: crude oil climbed 57%, phosphate (a key ingredient for fertiliser) jumped 104%, soybeans rose 34%, wheat was up 29%, chicken meat soared 59%, and beef jumped 34%.

Therefore, with or without the Russia-Ukraine conflict, inflation was going to be a serious concern this year and the Fed (US central bank) should have raised its interest rates to subdue inflationary pressure in the fourth quarter of 2021, rather than waiting until this March. However, the war undeniably worsened the situation with commodity prices, particularly in the energy field, which prompted the Fed to raise rates twice by 75 basis points. More rate hikes are to be expected.

A rate of inflation beyond 2% indicates a demand-supply imbalance which needs to be immediately corrected. Corrective measures, aimed at slowing down consumption, traditionally include government spending cuts and central banks raising interest rates. In most cases, governments would be reluctant to cut spending while consumers (voters) are suffering from high prices. Therefore, central banks would have to raise interest rates higher than they theoretically should. This has proven true during previous global recessions.

Attempts to curb consumption demand, which normally accounts for half of GDP, would naturally slow down economic growth, or might even push the economy into recession. Let’s look at the past four global recessions to determine their causes and the policy responses from central banks.

The first modern-day recession, as qualified by the World Bank, was the oil embargo that sparked the 1973-1975 recession. In 1973, Arab members of the Organization of the Petroleum Exporting Countries (Opec) cut production in protest against Western countries supporting Israel in the Yom Kippur War with Egypt and Syria, which caused oil prices to shoot up fourfold. The global oil price kept rising until it peaked in March 1974 at 61.15 dollars per barrel. Mind you, that price is equivalent to US$300 in today’s money. With such an extraordinary high oil price, US inflation hit 12.34% that year. The Fed responded by raising the Fed Funds Rate to 9.95%. High energy prices, coupled with high interest rates, pushed the world economy into a recession.

An energy crisis was once again the culprit in the early 1980s. During the Iranian revolution of 1978-79, Iran’s oil production was severely disrupted, which lowered its production by 4.8 million barrels per day. The world oil price rose quickly, reaching US$140.98/barrel in April 1980, causing US inflation to reach 12.52%. Paul Volcker, who was then chairman of the Fed, raised interest rates to 15.45%. It proved a very effective move as world inflation plummeted from just over 12% in 1980 to below 6% in 1986. The price? The world economy fell into another recession.

On Aug 2, 1990, Iraqi invaded Kuwait. The United Nations reacted by putting an embargo on trade with both Iraq and Kuwait. Not surprisingly, the global oil price shot up once again, peaking at US$86.09/barrel. Things were not as bad this time round, though, because Saudi Arabia increased its oil production by 3 million barrels per day to make up for the loss from Iraq’s output.

However, higher oil prices still caused inflation to surge to 6.11% in the United States. Since inflation did not hit double digits this time, the Fed merely raised its interest rate to 8.1%. Nonetheless the combination of high oil price and rising interest rates again sent the world spiraling into recession.

The fourth crisis was not oil-driven, but marked by the collapse of the sub-prime mortgage market in America in 2008. However, I want to note that the global oil price did rise to US$189.94/barrel in June 2008, just three months before Lehman Brothers filed for bankruptcy. Have high oil prices always preceded an economic crisis? Answering that would require further studies about the relationship between oil prices and global recessions. But the data does show the world was experiencing inflation of 8.95% in 2008.

It is not difficult to draw similarities between today’s situation and the economic environment of past global recessions. First, world oil price have risen 79.4% compared to the same period last year, climbing up to US$113.2/barrel (WTI crude, as of May 18). Second, inflation rates are reaching historically high levels around the world. Third, the Fed, slow as it is, raised its Fed Fund Rates twice in March and May 2022, and has pledged to raise them much more.

The problem is we are not at the end of the story. Oil prices have significant potential for more upside, particularly when demand from China resumes after the internal Covid outbreaks have been brought under control. Moreover, China can probably pump prime its economy to restore growth momentum. That could have a substantial impact on world commodity prices. Don’t forget, China has 1.4 billion resource-hungry consumers.

Since inflation, currently at 8.3% in the United States, remains unabated, higher interest rates are to be expected from the Fed and other central banks. Theoretically, interest rates should be about 2% above inflation to decrease price pressure. In light of this, a 10% Fed Fund Rate is possible. With such an interest rate in place, predictions of a fifth global recession occurring in 2023 look to be warranted.

Former Fed chairman Ben Bernanke said the decision to delay responding to the highest inflation rates in four decades was “a mistake”. The Thai Monetary Policy Committee’s (MPC) failure to respond to Thailand’s 13-year-high inflation rate was an even a bigger mistake. The problem is that when committee wants to reverse course, things could already be out of control.