Beware, America: A Strong Dollar Could Cause Another Great Recession

Why a strong currency is a double-edged sword.

What will cause the next Great Recession? There are always threats to U.S. economic growth. Much of the time, the derailment comes from unanticipated events. But here are a few prospects to keep an eye on.

The China Slowdown and Debt Bust

China, currently growing at more than 7 percent annually, has a debt problem, and—increasingly—a growth problem. According to the Boston Consulting Group, the United States is becoming increasingly competitive with China. A strengthening U.S. dollar alleviates some of this pressure, but not all of it. China’s renminbi has not fallen against the dollar, so little benefit has accrued to the Chinese economy.

China is attempting to pivot its economy from manufacturing and infrastructure to a higher proportion of internal consumption growth. The question is whether China can complete this transition without a significant blow to the global economy. The answer, unfortunately, is that this seems unlikely. China’s growth matters, because at its current growth rate, China’s economy will contribute more than $1 trillion to global GDP and about 30 percent of all global growth. Even if the Chinese economy is slowing, it is still a juggernaut.

If the Chinese economy were to take a hard landing, global economic growth would come to a standstill. U.S. trade partners Canada and Australia would struggle, and the feedback to the United States would be felt in everything from corporate earnings to employment to financial-system pressures. As the driver of much of the marginal global economic growth, China is particularly important for the incremental worker being hired and the incremental widget being sold. An economic slowdown in China would likely pull the United States into a recession.

If a Chinese debt crisis were to erupt, the direct financial linkages between China and the U.S. financial system would be minimal. But there are probably significant indirect linkages through Europe, and through the business credit extended by U.S. corporations to facilitate business growth. The U.S. housing crisis caused a contagion that spread to Europe from the United States. With China, a problem would flow through the European linkages to the United States. Financial markets would react negatively and safe-haven assets that are already trading at historic levels in much of the world would see even greater demand, potentially causing other asset prices to fall.

For the United States, the problem is that a debt crisis in China would cause a dramatic drop in economic activity. It would, therefore, have both a financial-market impact and a real-economy impact, much like the financial crisis of 2008. It is difficult to find another candidate to contribute $1T in economic growth to the global economy. China’s economy shrinking would be a shock to the system.

The European Experiment Explodes

The European Central Bank (ECB) recently announced it would no longer accept the Hellenic Republic’s debt as collateral. Strictly speaking, it should not have been accepting the paper in the first place. But since Greece was in a program to fix its economy and debt addiction, the ECB requirement for investment-grade collateral was waived. The ECB has now revoked the waiver—some would say—to show Greece it should stay in rehabilitation.

Europe has an integration problem to say the least, and the disparate nature of the individual countries’ economies makes the ECB’s job an impossible task. Choosing between the wants of Germans and the wants of Greeks creates a political situation out of one that should be based on the economic outcomes the ECB desires.

The politicization of monetary policy is an issue. Instead of providing stability in times of economic strife, the Central Bank becomes a source of volatility and instability. Of course, the threat of being cut off from the ECB may deter Greek officials from pushing the limits of their current package, but it may also cause Greeks to stop seeing the ECB as a backstop and to start seeing it as a German weapon with which to impose and perpetuate austerity.

If Greece leaves the EU, there are reasons to suspect that there would be repercussions for the rest of the world. There are the obvious financial issues—for instance, would Greece, Spain and Italy be able to borrow without the implicit backing of the ECB? But there are also the less obvious global economic consequences. Despite struggling for the better part of the last decade, Europe’s economy is larger than the United States’, and it dominates trade with China and the United States. Both would suffer significantly with faltering demand as the EU broke up (there is an argument to be made that some of the slowdown in China is due to the slowdown in Europe).

While there would certainly be a flight to safety and likely a run on banks, a breakup of the EU would destroy demand for products from the United States, China and other members of the former EU. In other words, the breakup would not just be loud, it would be long. The perceived lack of a backstop and lender of last resort could cause the Greek contagion to spread where it would not otherwise, potentially negating some of the benefits of being a member of a monetary union. A weaponized ECB could be what dooms the EU and pushes the global economy back into Recession.

The Dollar and Oil Hurt the U.S. Too Much