Cover Story: How recent recessions differ

This article first appeared in The Edge Malaysia Weekly, on June 27, 2022 - July 03, 2022.
Cover Story: How recent recessions differ
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TALK of a possible global recession is intensifying, partly because of sky-high inflation that has led to aggressive interest rate hikes in the US and Europe. If a recession materialises, it will not be the first time that aggressive monetary policy helped bring on one. The 1981/82 US recession was triggered by tight monetary policy as the US Federal Reserve tried to fight mounting inflation.

In 1980, inflation hit a peak of 14.5% in the US. During the period, Paul Volker took office as Fed chairman. In a bid to tame inflation, he raised the Fed funds rate — which had averaged 11.2% in 1979 — to 20% in June 1981.

As a result of the high interest rates, the US economy entered a short recession in 1981 before recovering in the middle of the year, and then falling into another recession that ran until 1982.

While US inflation is currently lower at 8.5%, it is still elevated, although slightly below the UK’s 9.1%.

The West appears to be harder hit than the East, as inflation in Southeast Asian countries are still under control. Even so, it may not be a fair comparison as countries such as Malaysia subsidise or impose price controls on a great number of items including fuel and cooking oil, although the latter will now be mostly scrapped.

What is worth noting is the trigger for the potential recession that many believe is around the corner is vastly different from that which led to the two most recent global economic crises: the 2008 global financial crisis and the Covid-19-induced recession of 2020.

What was the trigger and subsequent impact on global economies? How long did it last?

Global financial crisis

The 2008 global financial crisis was a long and deep recession, sparked by the US subprime crisis. As such, the US economy was hardest hit, with the contraction in the economy lasting for 18 long months and unemployment soaring to a high of 10%.

In the early 2000s prior to the crisis, the housing market was thriving as low interest rates on mortgages, relaxed lending rules and low down payment requirements fuelled demand for housing. Banks were doling out housing loans to borrowers — dubbed subprime borrowers — who would normally not qualify for the loans.

As was to be expected, the move helped to further fuel demand for housing and pushed house prices higher.

The US housing market was in a rapidly growing bubble, made worse by banks bundling their subprime loans within their mortgage-backed securities and selling them as low risk assets.

By 2005, mortgage rates started to climb as interest rates ticked upwards. Homebuyers who were under the adjustable-rate mortgages, estimated to be more than 75% of the subprime loans, started to see higher rates. Speculators stopped buying houses and demand for housing fell.

Inevitably, home prices also slumped. Subprime borrowers who were finding it increasingly difficult to repay their now more costly mortgages were in a pickle — they could not refinance their homes for better rates nor sell their homes for a profit. Foreclosures began to rise.

As the subprime market collapsed, it caused a domino effect across the economy. House prices declined drastically, prompting a massive sell-off in mortgage-backed securities, resulting in the collapse of several major banks.

The banking sector was on the edge and lending was affected, which in turn impacted business expenses and investments. Unemployment and underemployment rose, impacting consumer confidence and spending, culminating in a recession in the US that quickly spread to other parts of the world, as the linkages of American banks in the global financial system caused a domino effect on other banks around the world. Europe was hit particularly hard because major European banks had invested in American mortgage-backed securities.

Eventually, countries such as Spain, Greece, Ireland, Italy and Portugal were pulled into the contagion and plunged into a sovereign debt crisis, which required the European Union to step in. The affected countries took on painful austerity measures to get back on their feet.

It was reported that the US economy contracted a total of 4.5% between December 2007 and June 2009. However, world gross domestic product (GDP) grew 2% in 2008 and only saw a contraction of 1.3% in 2009, as Asian economies were less impacted from the financial crisis that stemmed from the US.

Bustling China proved a bulwark as its economy was growing at a robust 9% while India did not experience a contraction, expanding at 3.1% in 2008 and more than doubling growth the year after at 7.9%.

Covid-19 recession

Fresh in everyone’s memory is the steep but extremely brief Covid-19 recession. The virus, said to have originated from Wuhan, China in late 2019, was first compared with the SARS outbreak in Hong Kong.

In the early days, many had anticipated that the outbreak of Covid-19 would last only six months. But those hopes were quickly dashed as the highly transmissible virus spread quickly throughout the world and took a huge number of lives.

From being compared with the SARS outbreak, which was devastating enough, it was then compared with the Spanish flu pandemic of 1918.

The world was in disarray. Faced with the unprecedented health crisis, governments scrambled to contain the spread of the virus, which was also mutating at a fast rate, taking on different variants, so that each was seen as even more contagious than its predecessor.

Eventually, desperate governments around the world resorted to closing their borders as well as implementing other lockdown measures. Strict lockdowns in many parts of the world put a halt to many economic activities, causing massive disruption in supply chains globally.

Businesses struggled and unemployment became a pressing problem, impacting consumer confidence and spending power. Nonetheless, governments around the world were quick to respond, giving aid to businesses and consumers. Month after month, governments unleashed their arsenal of stimulus and enlisted the help of central banks to keep the economy from failing.

The fiscal measures have been credited for the short recession despite the pandemic driving the world into a standstill in 2020. The International Monetary Fund (IMF) estimated that the fiscal measures by governments contributed about 6% to global growth in 2020 and helped ease the global shock.

In 2020, world GDP contracted 3.3%, but it would have been much worse if governments had not undertaken the fiscal measures during the height of the pandemic.

Today, the world is still not entirely rid of Covid-19 and its effects. The virus is still present, though death rates have declined dramatically as immunisation against the virus continues across the world.

While the global economy can be said to have rebounded following the resumption of economic activity after lockdown measures were scrapped and borders reopened, economic recovery is uneven throughout the world even though the World Bank estimates that global GDP grew 5.7% in 2021.

Many countries are dealing with the after effects of the disruption from the pandemic, ranging from broken supply chains to robust demand from consumers bent on revenge spending, which in turn has resulted in an escalation in the prices of goods and skyrocketing commodity prices. This has culminated in soaring inflation in many countries.

Potential recession ahead?

Just when everyone thought the world was on a clear road to recovery after the Covid-19-induced recession in 2020, it was dealt another unexpected blow in the form of the Ukraine-Russia war, which inflicted further shocks on the only-just-recovering global supply chain.

A big supplier of global sunflower oil, Ukraine accounts for almost half of the world’s exports. As it is also a big producer of wheat, the war has pushed wheat prices through the roof while the disruption of sunflower oil supply has propelled edible oils, especially palm oil, to record-high levels, beyond RM6,000 per tonne.

The Western world has imposed a slew of sanctions on Russia for its invasion of Ukraine, including on its financial institutions and energy resources.

Given that Russia is the second-largest exporter of natural gas — Europe is highly reliant on its resources — and also a significant player in global crude oil, the sanctions have pushed crude prices significantly higher.

In the background, inflation has continued to climb, prompting central banks to raise rates dramatically in a bid to tame it. The implication of such action, many fear, is a recession that may reverberate throughout the globe.

Many are concerned over policy missteps that central banks, especially the Fed, may make in their bid to tighten monetary policy.

And this time round, China’s economic power is glaringly absent as the country is still dealing with its own issues surrounding its “zero-Covid” policy. The economic recovery in China has been uneven as lockdowns in certain districts in recent months have proven disruptive.


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