The current economic crisis isn’t just bad; it’s severe enough to draw comparisons to the Great Depression. But while economists argue about whether our current straits rank second (or third or fourth) behind the bleak 1930s, it’s clear that the U.S. economy functions much differently now than it did then. That’s because it’s part of an inter-connected, inter-dependent network of economies spread throughout the globe.
Technology makes the world seem much smaller now; companies at opposite corners of the earth can do business together and react instantly to one another’s decisions. Climbing out from under a crisis like this one is a global effort, which can be complicated. It requires a fairly coordinated effort to work best, and even countries that trade with one another don’t necessarily agree.
Take China, for example. “China is the largest exporter in the world [by value],” says James Pressler, associate economist at Northern Trust. “The United States is the largest importer. Our economies are very connected as a result.”
The interconnectedness of the Chinese and U.S. economies means that each country depends on the other to recover from the crisis. This makes the nations partners in a sense, but also causes some friction.
The Chinese economy was growing quickly prior to the recession, and its growth was based largely on manufacturing exports. China used a large stimulus package to spur recovery, similar to the U.S. approach, and is already showing signs of growth. Its $586 billion government stimulus package represented 12.5% of its gross domestic product (GDP) — by comparison, the $787 billion U.S. stimulus package was 5.6% of America’s GDP.
Although China’s economy is developing, and gradually its citizens will be able to consume a larger share of the goods produced there, the country still depends a great deal on a healthy U.S. economy to sell the items it manufactures. “One third of China’s economy is export-driven — primarily toward the U.S. market,” Pressler says. “Therefore, China suffers immensely without a healthy U.S. economy and consumers willing to purchase those goods.”
U.S. debt causes concern. China also is becoming concerned about U.S. Treasury bonds and other instruments that the United States uses to finance its national debt. China has been a major buyer of those instruments, and its wariness to invest in U.S. debt or to use the dollar as the currency for its cash reserves is a troubling development for the United States. As President Obama has acknowledged, the U.S. deficits aren’t likely to shrink anytime soon.
“The fiscal management in Asia was more prudent coming into the crisis. In the United States, the [Bush] administration followed a pro-cyclical policy — they spent a lot when times were good — but you’re supposed to be counter-cyclical,” says Kevin Gallagher, who directs the Global Economic Governance Initiative at Boston University. He says China also limited the use of the innovative, risky financial instruments that spurred the U.S. crisis, so despite investing more on economic stimulus than the United States, relative to GDP, China is better positioned to recover quickly.
But China can’t completely abandon U.S. debt or dollars without hurting the U.S. economy, and China needs a strong United States in order to continue its own growth.
Interconnected does not mean equal. While some might be wary of America’s dependence on other economies, the United States is generally much less dependent on its trading partners than vice versa.
“Lots of other countries have experienced deep recessions or depressions in the last 20 years, and all of them went through those downturns independently — the U.S. and Europe sailed along during those periods. But when the U.S. economy goes down, that affects everybody in the world,” says Steven Suranovic, director of the International Trade and Investment Policy Program at George Washington University in Washington, D.C.
So while China might not approve of U.S. fiscal policy, its ability to enact change is limited. “China has a stake. I don’t know if they have a say,” Suranovic says. “They can make their opinions known, and how they think is worthy of consideration, but in the end, the United States will do independently what it thinks is best.”
Companies without borders make for, well, fewer borders. “One thing a recession does do is raise protectionism in local economies,” Suranovic says. Countries often are inclined to restrict trade in order to keep money from flowing across the border to other economies. During the Great Depression, for example, the United States adopted the Smoot-Hawley Tariff Act and imposed record tariffs on imports. That action was quickly matched by retaliatory measures on U.S. exports by other countries.
We’re not seeing as much protectionism with this recession. Instead, countries are generally maintaining open trade. One reason is that more companies have global operations, and even if higher tariffs might help a business in one market, they are likely to be costly in another.
“If a company is based in the United States and all its operations are here, you could put up a barrier [such as an import tariff] and that might be attractive,” Suranovic says. “But if the company has operations in Japan or Europe, you may be affected adversely, so there’s much less desire there.”
And the economic crisis isn’t causing companies to consolidate their operations. “Economies everywhere have been stunned by the reversals of the last year, but the world economy is not less global than it was a year ago,” says Peter Baugher, president of the Chicago International Dispute Resolution Association, an organization that mediates transnational business disputes. “We’re still seeing innumerable cross-border transactions.”
A benefit for individual investors? For investors who were stung by the downturn in the U.S. economy and eager to recoup their losses, it’s tempting to identify the international economies that seem to be emerging most quickly from the crisis and invest there. It’s not a bad idea, but be careful.
Again using China as an example: The Chinese economy is rebounding, but the growth may be attributable to the government stimulus. In a worst case scenario, that activity is similar to the surge U.S. auto sales saw as a result of the “cash for clunkers” program — a bump due to government intervention that may not forecast longer-term growth.
“The Chinese stock market has boomed back, and it’s easy to say that’s going to lead the path to growth, but I would be very wary of looking at those signals as signals of long-term success,” Suranovic says. “We’re going to see lots of ups and downs, booms and busts, so investors need to be very careful.”
Proceed with eyes open. Pressler sees another reason investors should keep their eyes open. “There is a risk that the surge in government spending is creating an asset bubble in the Chinese real estate and stock markets,” he cautions. “Without delicate maneuvering, these bubbles could burst and create a dramatic fall in the domestic economy at a time when trade is not yet stable and U.S. demand is not ready to buy up all China's exports.”
Baugher agrees and suggests that investors build a risk premium into foreign investments. “You’re dealing with uncertainty and hazard when you make investments where the cultural and political landscapes are less well-known. When the environment is less predictable, that increases risk — and with greater risk, an investor probably needs a higher rate of return,” Baugher says. Along with that, in order to minimize the uncertainty, it’s important for investors to do their homework and to confer with people who understand the economic environment in a country where they’re considering making an investment.
This is not the 1930s economically. Regardless of whether the present financial crisis ultimately is ranked with the Great Depression, the current global economic environment is far different from that of the 1930s. The world’s leading economies are more numerous and they are more interconnected. For investors, that makes them both promising and complex.
