The View

US-China trade war and mounting debt risk disaster 10 years after the global financial crisis

Alan Bollard says that as the Apec finance ministers gather, they should discuss the factors – such as tariffs, increasing debt and weakening currencies – that risk a repeat of the Great Recession

PUBLISHED : Tuesday, 16 October, 2018, 3:30pm
UPDATED : Tuesday, 16 October, 2018, 10:55pm

Over the past decade, we have learned that a serious banking failure with risky balance sheets can feed into a major international financial crisis. That, in turn, is big enough to cause an economic crisis, as we saw with the Great Recession. The downturn in growth, trade and productivity that followed also opened up the possibility of a new contagion today.

The global financial crisis, which I confronted as governor of the Reserve Bank of New Zealand at that time, masked some very important developments that in the ensuing years have fostered both recovery and new risks. One of the biggest has been continued strong growth in China, which helped keep world production growth buoyant thanks to huge Chinese fiscal stimulus.

During this period, China has increased its domestic value added and pushed up the value chain, in line with its “Made in China 2025” policy. Notably, it has boosted its share of trade in fast-growing markets, harnessing easing measures driven by practical engagement with other Asia-Pacific Economic Cooperation member economies, and invested heavily under the Belt and Road Initiative.

All the while, we have seen a socio-economic metamorphosis globally like no other in history – from the ongoing energy revolution, and big surges in middle-income growth and consumption in emerging Apec economies such as China and those in Southeast Asia and Latin America, to demographic shocks due to ageing and lower birth rates, and accelerating technological change.

The implications of these phenomena for traditional industries, jobs and communities have stoked fears about globalisation’s costs that lie behind current trade frictions. It is a situation that raised a red flag during the IMF-World Bank Annual Meetings in Bali and provides impetus for Apec finance ministers who are meeting this week in Port Moresby, Papua New Guinea to act.

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Ironically, much of the imbalances at the time of the global financial crisis have since narrowed, though not those in the United States, where Donald Trump’s administration has followed a policy to reduce imports from trade deficit economies. It is an approach that has disrupted US trade negotiations with the European Union, North American neighbours, South Korea, Japan and, especially, China.

The resulting breakdown in bilateral trade talks and escalation of tariffs and other protectionist barriers by the US and China is beginning to hurt both economies. More broadly, these trade tensions could reduce international growth by around 0.5 per cent by 2020, the IMF reports. It is pressures on third countries that are hardest to forecast but which should worry us most.

The fallout comes from increased production costs, which will impact shareholders, workers and consumers, sometimes in roundabout ways. Producers are looking to reconfigure increasingly complex supply chains to avoid tariff penalties. Purchasing managers are ramping up inventories just in case. Factory owners are considering relocation for cheaper options. Financial investors are reassessing country risks.

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A considerable amount of affected Chinese exports to the US have a lot of third-country content or are produced by foreign investors. In the Apec region, industrial production has relocated very fast when costs change. Now, investors in Northeast Asia and supply chain operators in Southeast Asia are considering relocation again.

So far, most economies in the region look to be in good shape, but their prosperous future is not guaranteed, as traditional trade growth drivers are threatened. It may be that some future economic risks are not yet fully priced into markets. Already, there have been significant swings in exchange rates as the US reserve currency strengthens and some third countries are considering erecting new tariff structures themselves.

Trade war shows China needs a new monetary policy model

Apec finance ministers are convening in Papua New Guinea to address these issues, including growth prospects and how to make tax policies, financing and economies more effective and inclusive. But now, as they prepare their advice for the region’s leaders, like Chinese President Xi Jinping and Hong Kong Chief Executive Carrie Lam Cheng Yuet-ngor, there is another issue on the agenda – new economic and financial risks.

Since the global financial crisis, financial sector debt has decreased appropriately, but cheap credit has brought mounting debt in the private sector and state-owned enterprises in emerging markets. Deteriorating local currencies and tightening international monetary policy could make it difficult to service some of this debt. Tariff increases causing domestic inflation would worsen policy options.

Ten years ago, we saw how badly managed financial risk could hurt the world’s economies. A decade later, we do not want to see how badly managed economic risk could trigger another financial crisis.

Dr Alan Bollard is executive director of the Asia-Pacific Economic Cooperation (Apec) Secretariat in Singapore and former governor of the Reserve Bank of New Zealand from 2002-2012