Be wary of the American black hole destroying global prosperity

Featured Image: [Photo: China Plus/Chen Xiwen]

 

On May 8, the White House announced that the United States was withdrawing from the Joint Comprehensive Plan of Action, better known as the Iran nuclear deal. And so, at one minute past midnight U.S. Eastern Time on Tuesday, the United States reimposed economic sanctions against Iran’s automotive and aviation industries, and the country’s metals market.

The Americans have also threatened to cut business ties with any country trading with Iran. It is reported that the two major French car groups, PSA Peugeot Citroen and Renault, have already been affected. Peugeot Citroen sold 445,000 cars in Iran last year, and now has to suspend its operations in the country. And Renault took steps ahead of the American move to reintroduce sanctions, by reducing the amount of business it was doing in Iran. This led to a fall in sales of more than 10 percent in the first half of this year.

When it comes to the global economy, White House policy is like a black hole that pulls in and destroys economic growth. This will become even more apparent on November 5, when the United States introduces the second phase of its sanctions regime targeting Iran’s energy, oil, and finance sectors.

The United States is aiming to end Iran’s oil exports. As a pillar industry in Iran, oil brings in 70 to 80 percent of the country’s export revenue. Destroying this revenue stream will be devastating for Iran’s economy. But the effect of the American sanctions won’t be limited to Iran’s domestic economy. Iran produces around 2.5 million barrels of oil a day, meeting about 3 percent of global demand. It is the third largest oil producer in the Organization of Petroleum Exporting Countries, and the fourth largest oil producer in the world. The American move to end Iran’s oil exports will inevitably lead to an increase in global oil prices.

As British financial services company AJ Bell warned investors, “History suggests that it is only when oil prices have doubled year-on-year that global growth really starts to feel the pinch. The price spikes of 1974, 1979, 1990 and 1999 all served to usher in recessions, and a near-doubling in crude in 2008 may not have helped matters then either, while even the rapid rise in summer 1987 will conjure up memories of stock market chaos.”

In July this year, Bank of America Merrill Lynch Group predicted that if the United States adopts a zero-tolerance policy on Iranian oil exports, global oil prices will soar to 120 U.S. dollars a barrel. Since the current American administration won the election in November 2016, global oil prices have already risen by 50 percent in less than two years. The chain reaction caused by rising oil prices has led to growing inflation, rising costs in the transportation and manufacturing industries, a decline in economic activity and household disposable income, and a reduction in corporate profits and consumer spending.

The International Monetary Fund has warned that the good times the global economy has been experiencing will not last. Its view is that the growing trade conflicts might cut global growth by as much as 0.5 percent by 2020, which represents a loss of about 430 billion U.S. dollars in lost GDP. And the World Bank concluded in a report in early June that a worldwide escalation of the trade tensions between the United States and its major trading partners would have consequences for global trade equivalent to that of the 2008 financial crisis. It warned that developing nations would be the hardest hit, because they were relatively more dependent on the development of the major economies. Franziska Ohnsorge, the lead author of the bank’s report, said: “The threat of trade protectionism is a real risk. Anything that puts sand in the wheels of global trade is a risk to global growth.”

Similarly, in a public speech in early July, Bank of England Governor Mark Carney pointed out that trade protectionism directly affects the real economy in three ways: It reduces trade volumes, it disrupts supply chains, and it increases import costs. According to the Bank of England’s July forecast, if the tariff increase between the United States and all its trading partners reaches 10 percentage points, it could reduce American economic output by 2.5 percent and global output by 1 percent. JPMorgan Chase predicts that the growing trade war will cause the global economy to fall by up to 1.4 percent in the next two years.

President Trump has claimed that the United States is winning its trade war with China. But the reality is that global economic growth is closely linked to trade, and raising tariffs will inevitably reduce the volume of trade and drive down business confidence. This will likely lead to stagflation, where economic stagnation is coupled with rising inflation, which in turn will drag the global economy towards a recession. As the Japan Times, in a commentary criticizing the United States for triggering a global downturn, said: “Welcome to an economist’s greatest nightmare: Stagflation.” Normally, when an economy is strong, the inflation rate will rise. However, although the trade war has brought about an economic downturn, it will also raise the rate of inflation. Richard Bernstein, former chief investment strategist at Merrill Lynch, said that there hasn’t been “any time in history where restricting the flow of goods and services has not been inflationary.”

Luca Paolini, the chief strategist at investment company Pictet Asset Management, explained that according to modeling done by his company, if the United States imposes a 10 percent tariff on foreign trade, it will lead to an increase in global inflation of 0.7 percent. Company earnings will decline, alongside a 15 percent decline in the global stock price-earnings ratio. The model also shows that in addition to the United States and China, countries such as Luxembourg, Slovakia, Hungary, the Czech Republic, and South Korea will be the ones to be most affected by export risks.

The United States is home to the world’s largest economy, and it considers itself the world’s only superpower. But the White House has injected a tremendous amount of instability into the global economy. Great power comes with great responsibility, and the world expects America to be a positive force in the world, and not a black hole that destroys prosperity.

 

Note: This article is an edited translation of a commentary from the Chinese-language “Commentaries on International Affairs,” which originally appeared on China Plus