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G-7 Is Well Timed to Fight a Recession, But Its Leaders Are Unlikely to Act

Shawn Donnan, Raymond Colitt and Toru Fujioka
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G-7 Is Well Timed to Fight a Recession, But Its Leaders Are Unlikely to Act

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It ought to be good news that leaders from the Group of Seven are gathering for a retreat on the Bay of Biscay as the global economy slows, trade wars escalate and major economies like Germany slide toward recession.

But the allies are so divided that they may squander the chance to find a solution. Any hope for progress was complicated Friday with China’s new tariffs on U.S. goods, a central banker pushing for a rate cut and France threatening a regional trade deal over climate.

At any other time in history, the expectation from such a summit would be for a coordinated response to loosen fiscal purse strings and walk away from protectionism -- an approach that came out of similar meetings called to respond to the far more dire global financial crisis a decade ago.

This weekend, as France’s Emmanuel Macron hosts leaders including the U.K.’s new prime minister, Boris Johnson, along with U.S. President Donald Trump, disagreements over everything from Brexit to the future of the global trading system likely will stand in the way of unified solutions. China on Friday roiled the summit by imposing additional tariffs on $75 billion of U.S. goods in retaliation for Trump’s planned levies on Chinese imports.

The best economic hope for the meetings in the Atlantic port city of Biarritz may be that divisions don’t get any worse, and that central bankers conducting their own retreat some 5,000 miles away in Jackson Hole, Wyoming, save the day.

Driving that reality is Trump’s world view, which isn’t showing any signs of changing.

Read More: G-7 Wonders Which Boris Johnson Will Show Up: Balance of Power

The broad consensus from economists and other G-7 leaders is that the global economy would benefit most from an end to Trump’s trade wars. But the U.S. president has dismissed accusations that his tariff assault on China and threats to impose duties on Europe’s auto industry are contributing to any slowdown.

Currency Wars

Moreover, rather than seeking harmony, Trump is threatening to turn his trade wars into currency wars.

“Fight or go home!” Trump told the Federal Reserve in a tweet Thursday bemoaning negative yields on German bonds and a strong dollar that he views increasingly as a threat to U.S. growth.

Ahead of this weekend’s meeting, Trump administration officials insisted the U.S. economy and the president’s agenda of tax cuts, deregulation and cracking down on unfair trade ought to be envied rather than scorned, particularly in Europe where growth has slowed.

And they are traveling to Biarritz with an ask for Germany’s Angela Merkel: to boost spending to head off a recession. Germany has taken tentative steps toward fiscal stimulus but so far the government is sticking to its zero-deficit principle.

Read More: Johnson’s G-7 Goal: Be Serious and Get Something From Everyone

Some Trump aides argue concerns over the global economy are overblown thanks to the policy responses from the European Central Bank and others that are already underway, especially if those are paired with German fiscal action.

“A stronger Europe will mean stronger demand for U.S. exports and more rapid U.S. growth,” said Peter Navarro, one of Trump’s closest advisers on trade and economic policy.

“Such bullish help appears to be on the way with near certain ECB rate cuts, an increasing likelihood of a German fiscal stimulus, and a possible resolution of Brexit, which will both remove Brexit uncertainty now suppressing some investment and clear the way for a possible U.K.-U.S. trade agreement,” he said.

Rate Cut

Bold action by the Federal Reserve, such as a 100-basis-point cut in the target rate sought by Trump, would bolster the U.S. economy and the world’s too, Navarro said. Such a move is intended to shift the U.S. from “good growth in the 2% range to great growth in the 3% range,” he said, rather than reflect any fears of recession.

Navarro, who is a longstanding critic of Germany’s economic policies, is far from alone in viewing German fiscal stimulus as one of the keys to a global turnaround. Yet the push also highlights that the biggest division inside the G-7 over how to respond to a slowing world economy lies between Trump and Merkel.

Read More: Terms of Trade: Europe’s Shaky Union Faces Trump G-7 Stress Test

While the Trump administration would like to see a bold German move to abandon its obsession with balanced budgets, in Berlin there isn’t much appetite to cough up cash to help prevent a global slowdown they attribute in part to Trump’s trade wars.

The German government isn’t ready to commit to meaningful stimulus at home or at the G-7. Nor is it in much of a hurry. Spending money now when factory utilization is still rather high, would simply stimulate imports or savings rather than domestic output, the argument goes.

Contingency plans are being drawn up and Merkel has talked about “clouds” darkening the economic outlook, however. Finance Minister Olaf Scholz said in principle Germany could muster some 50 billion euros ($55 billion) in times of a crisis and the German government is aware that the ECB has limited room to respond and that a hard Brexit could tip the balance toward more rather than less action.

Recession Risk

The U.K., like Germany, is at risk of slipping into a recession after recent data showed a second-quarter 0.2% decline in gross domestic product. But Johnson’s month-old government echoes the U.S. view that delivering Brexit come Oct. 31 will end the uncertainty that has shadowed the U.K.’s economy and boost growth.

In Japan, preparations are underway for an increase in government spending to counteract an October sales tax increase. Finance Minister Taro Aso also signaled Tokyo’s readiness to deploy further fiscal stimulus if it’s warranted after a G-7 ministers meeting in July.

“Along with Germany, Japan is likely to add momentum toward fiscal policy in the global economy,” said Kyohei Morita, chief Japan economist at Credit Agricole Securities Asia.

But there are still questions over whether Japanese households can withstand the tax hike. A similar increase in 2014 triggered a sharp contraction and this time foreign demand is unlikely to provide a buffer. Japan’s exports have fallen for eight straight months thanks to the Trump trade wars and reduced demand from China.

Read More: Donald Trump Is Coming for Europe’s Most Important Alliance

That’s one reason the U.S. position and the damage being done by its trade battles is what worries some economists most. With the International Monetary Fund predicting global growth of 3.2% this year, a downgrade that nonetheless remains broadly in line with trend, and unemployment at record lows in many G-7 economies, there are reasons to be hopeful. That doesn’t reduce the risks, however.

‘What’s the Panic?’

“You do ask the question, ‘What’s the panic?’ Why are central banks looking to lower interest rates?” said Torsten Slok, chief economist at Deutsche Bank. “The answer to that question is that the trade war continues to linger and continues to be a huge cloud hanging over the global economy.”

Years ago, leaders were able to find consensus to boost the economy. As the global financial crisis grew in 2008, then President George W. Bush called an emergency G-20 meeting at which leaders agreed to a roadmap to combat the slowdown.

That November 2008 summit was followed by others at which the world’s leading economies agreed to avoid protectionism and to other coordinated actions widely seen as having helped avoid a deeper downturn.

Some attending this weekend’s G-7 summit appear determined to press their case for Trump to at least modify his tactics in his bid to rebalance global trade.

European Union officials say Donald Tusk, who will be the bloc’s chief representative at the meeting, will argue trade tensions are the single most important factor impeding global growth.

So too will Canada’s Justin Trudeau, who is intent on selling himself as a vocal advocate of pluralism and multilateralism, with an election just weeks away.

“Our government has responded to this new world by rejecting populism,” Trudeau said in a speech this week. “My message will be clear” at the G-7, he added. “We need to build a future where everyone can benefit from economic growth and where we invest to help the middle class.”

(Updates with China tariffs, Fed comments, France threat in second paragraph.)

--With assistance from Theophilos Argitis, Alex Morales and Rich Miller.

To contact the reporters on this story: Shawn Donnan in Washington at sdonnan@bloomberg.net;Raymond Colitt in Berlin at rcolitt@bloomberg.net;Toru Fujioka in Tokyo at tfujioka1@bloomberg.net

To contact the editors responsible for this story: Simon Kennedy at skennedy4@bloomberg.net, Justin Blum, Sarah McGregor

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