Economic woes are affecting consumers in both East and West, sometimes for similar reasons. Image: Pixabay

Although it has not yet been declared officially, in my opinion much of the world, East and West, China and America are already in a recession. Because of the unusual nature of today’s case, let us call it a recflation (pronounced wreck-flation, as in car wreck).

In the US, traditional recessions are defined as two successive quarters, that is, a six-month-long stretch of time during which the entire economy shrinks: GDP (gross domestic product or production) is negative. 

In the US, GDP did shrink for the first three months of the year 2022, and this Thursday, July 8, the US government’s statisticians will tell the world whether or nor the following three months, ending on June 30, was also a period of negative growth. 

In China, the enormous positive inertia created by the past 30 years or so when overall economic growth varied between 9% and 6% a year, drives the economy forward as if it was a great aircraft carrier plowing through a more or less calm sea: Even if the engines are put in reverse, the massive thrust of past motion keeps it going forward. 

Moreover, the political cost to China’s government of even a short period of negative growth is so great that such a state of affairs is most unlikely to be allowed to appear, and if it did, the news would not get out for some time.

China’s second-quarter GDP growth rate was only 0.04%, the worst showing in the past two Covid-plagued years. Despite this bad news, the Chinese government’s hoped-for growth rate for this year is 5.5%.

The World Bank estimates China’s growth rate by the end of 2022 will be about 4.3%. To achieve that goal, US Bloomberg predicts business taxes will be cut (in contrast to American plans to raise corporate taxes).

That contrast in strategies makes it easier for China to fight off any further slowdowns.

Critical price ratios

There is a high level of dissatisfaction among ordinary Chinese citizens, based on current economic and social factors, some of which is due to Covid lockdowns.

But economic and social distress independent from the virus has shown itself. A US Bloomberg headline in July stated: “Plunging markets flash fresh warning signs on economy; stocks erase June gains; yuan weakest in a month versus dollar; Covid Zero, property defaults continue to trouble investors.”

One causal sequence that is shared by East and West and connects inflation with the later and consequential appearance of recession goes like this: High-powered inflation changes critical price ratios. One such ratio is the disconnect between wages and prices for consumer goods.

Currently money wages in the US are rising about 5% a year, but the prices of consumer goods and services are rising at more than 9% a year. The result in that middle-class American families are losing about $5,000 a year in purchasing power. To adjust to this “new order,” these families buckle down and buy less, and when they do buy things, the things bought are further down the “food chain.” 

It follows that goods that are no longer in demand (because their prices have risen so much) linger on store shelves: Inventories for certain dis-favored goods pile up. 

Sellers of such goods drop prices charged to customers in order to maintain their cash flow, since that inward cash flow is essential if they are to pay wages to their workers, and replenish goods that are selling well, even though such goods are less profitable as they are the “down market” goods that consumers seek now that their purchasing power is lessened. 

Sellers will price such goods at bargain rates to keep up cash flow while taking account of the bargain-seeking that is going on among consumers.  

Prices are beginning to come down from previous inflationary highs, but in an unhealthy way. Middle-man sellers drop prices sometimes so low that when they go to ultimate makers of the goods they have managed to clear through inventories, they insist that ultimate manufacturers of this cheapened line of products be sold to the seller middlemen at prices so low that manufacturers cannot cover costs, especially since the previous inflation has driven up the cost of inputs to the productive process. 

Chinese producers under pressure

For example, Chinese producers’ prices have been rising at a 9-10% annual rate, while domestic prices for goods that are manufactured by such inputs are rising at a 2-3% rate, and at the same time the export markets in which a great many Chinese-produced goods are being squeezed down by political actions on the part of Western governments combined with the general demand drop mentioned above.

In other words, Western consumers “move down the food chain” and buy cheaper imported goods than they did previously. China has responded by allowing its exchange rate to move against itself (from 6.3 yuan to the dollar in March to 6.7 today). 

But such a move puts double pressure on Chinese producers, who now face higher production costs and reduced sales earnings. The most obvious way for these Chinese manufacturers to keep up profits is to reduce real wages paid to the Chinese workers who are employed in the manufacturing process, or perhaps to fire some workers to keep up necessary surplus in the cash flow needed to keep up production.  

Tightening credit

At this point producers who need working capital look to the banking system or to the general financing possibilities open to them. However, the banks are forced to charge higher interest rates due to central-bank increases in the bank rate. 

Also, credit markets in general, stock markets, bond markets and other sources of day-to-day working capital are moving to tighten credit, because from their point of view, the pressure on borrowers’ cash flow makes them bad risks, however much they may need credit to pay for high price inputs and to cover their wage bill.

It all adds up to a world where workers are losing jobs, are being paid less in real terms; where businesses are no longer creditworthy, and where bankers are forced to lend money to increasingly unprofitable firms and where foolish governments are tempted to throw even more paper money (by way of bailouts to all players) into a system that has been put into this downward spiral exactly because too much paper money was injected at the beginning of the process.

In other words, we have recflation.

The inflation/recession link described so far is especially relevant to places like China and Canada, where export sales and the inward flow of international money and earnings is highly important to maintain GDP numbers. For a country like the US, less dependent on exports but quite dependent on imports (think American imports of oil for example), a few adjustments are made to the story. 

In the US, certain imports are critical, and they must be maintained and paid for, one way or another. Examples include oil and other forms of energy (the Americans buy lots of electricity from Canada); exotic chemicals and raw materials from China are needed in batteries for politically subsidized electric vehicles. China also supplies essential electronic devices, medical and drug products, along with myriad consumer goods. 

Downward spiral

The problem is, America does not export enough product to earn the money needed to pay for these imports. Therefore, the Americans borrow these needed funds, and they also borrow the immense sums needed to maintain their bailout programs, their ever-enlarging welfare system, and most recently the massive so-called Covid offset spending that has driven their government indebtedness to well over 100% of annual GDP. 

As interest rates rise to choke off inflation, the huge domestic spending agenda proposed to offset the recession has to compete with bond-interest payment obligations, driving up interest rates for a “second kick at the can” (beyond what the central bank has done already) in order to account for the perceived added risk that something will cause even greater rates of inflation, so as to force the US government to pay its interest obligations with another dose of cheapened paper dollars. The downward spiral spins ever deeper.

Is there a policy strategy capable of mitigating this grim story? Only maybe. Adherence to ideology and intellectual fashion gets in the way.

John Maynard Keynes said it well: “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” 

In the US, green extremism induced President Joe Biden to wage war on domestic producers of fossil fuels, creating an artificial scarcity of energy. A variant of greenism makes the Americans illogically afraid of atomic power for energy production. Since energy is at the heart of nearly all economic activity, its scarcity has raised many prices and diminished output levels: more inflation and more recession. 

In China, Deng Xiaoping’s ideas about a mixed economy are being altered by President Xi Jinping, who prefers a closer adherence to orthodoxy.

In both countries, as in much of the rest of the world, a “shutdown” mentality has set the stage for man-made scarcities, shortages, supply-chain breaks and economic shortfalls that, once begun, will spiral downward, driven by domino effects of all kinds.

There is no technical reason these ideological factors could not be “turned off” almost overnight. But it won’t happen. And we will pay a practical price for our ephemeral ideas.

Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.