The next great depression?

Image: Todd Trapani


It is unclear whether the BRICS+ alliance will collapse along with the West if it falls into depression

The western world today faces a serious risk of falling into another great depression. This risk surfaced not because of a bad budget by a clumsy government, or even because of some nefarious speculation that swept the financial markets. Instead, it came to the fore because of the deterioration of global economic relations to the point of all-out war. To understand why this causes the risk of a depression, we must go back to the annals of history and remember what disgraced the world in the 1930s.

There was a time when the most important question in economics was, “What caused the Great Depression?” This question began to be asked during the depression itself and continued to be asked for years – until the 1980s or so. After the 2008 financial crisis and the so-called Great Recession, the question bubbled up again, but, probably because the great recession was not a great depression, that question was only asked for a few years.

Economists, like the economists they are, have always sought a simple answer, with different schools vying for influence to get the best one. Keynesians attributed the depression to a lack of government support for a declining economy. Monetarists claimed that it was due to mismanagement of the money supply by central banks. Austrians claimed that the depression was a natural economic response to a lot of reckless spending in the 1920s and that they should have been allowed to purge the entire system.

The reality is that these simple answers were never convincing. The Great Depression was a historic event, and it always required a historical explanation. Before the economic schools coalesced around their various tenets, this was well known. Keynes himself, for example, would have laughed at later “Keynesian” explanations of the depression. He had written in 1919 a book entitled The Economic Consequences of Peace, on the Paris Peace Conference – in which he acted as a delegate –, where he warned that the Treaty of Versailles would lead to a depression.

The depression, as Keynes predicted, grew out of the imbalanced economic structure that emerged from the First World War. War on such a terrible scale had completely devastated economic relations, both within countries, due to the redesign of the economy for war production, and internationally, as the allied blocs flayed and scared the rest of the world. The sensible thing to do after the war would have been to try to restore economic relations to a certain equilibrium as quickly as possible.

Delegates to the Paris Peace Conference did just the opposite. They saw the Treaty of Versailles, to paraphrase Clausewitz, as the continuation of war by other means. The Allied Powers wanted to punish Germany, whom they blamed for the war. They then saddled the country with an impossible debt load and soon occupied the Ruhr, Germany's most productive region. Americans also wanted to be paid. The Allies had accumulated huge debts with them, buying armaments during the war. Instead of assuming a superior position and canceling the debt – as the allies used to do until then – the Americans demanded to be paid, and with relatively high interest rates.

The 1920s was a decade of debt and decay because the international system was built on an unstable debt pyramid. In 1929, everything fell apart. But that was just the trigger. The debts that had been accumulating were the mirror of the unequal and unsustainable economic relations between the countries. Europe was a lost economy, which lived by rolling over more and more American loans. When the pyramid collapsed, Europe went with it.

The depression actually set in when the collapse of Europe gave rise to the collapse of global trade. Between 1929 and 1933, this trade dropped by about 30%. Strictly speaking, Europe had become an economic black hole. All the transactions it carried out with other countries were undermined, and as a result its economic problems spread like a cancer throughout the global economy. This cancer proved especially virulent in the United States, which at the time was Europe's biggest trading partner. Several countries, desperate to protect their domestic economies, engaged in trade wars, imposing tariffs on foreign goods. And global trade has collapsed further.

Today we see very similar dynamics moving in the world around us. Debt has been piling up in Western economies for decades, but it has become particularly acute over the past three years. This is due, in the first place, to the enormous expense of keeping people fed during the lockdowns in the pandemic and, secondly, to the rising costs – especially of energy – produced by the war in Ukraine.

And now it looks like we are ready to enter the second phase of historical repetition: the collapse of Europe. Europe's collapse will occur because it no longer has access to enough energy for its economic needs. At the start of the crisis, when Russia reacted by depriving Europe of much-needed gas, many people – myself included – might even dismiss the situation as a temporary development. Once the war was resolved, we believed the gas would be turned back on. But now Russian gas pipelines have been blown up in what appears to be an act of American sabotage. There's no going back to old Europe now.

With insufficient access to energy, its price on the continent will remain extremely high for years to come. European industry, for which energy is a key input, will no longer be competitive. If European manufacturers want to continue doing business, they will have to raise the prices of their products. This will make such products uncompetitive with those from the United States and China. These are not experiencing energy shortages. And that will put European manufacturers out of business. Europe will bleed into key jobs. Gangrene will spread, as future industry employees will have no wages to spend on the economy, and we will have a depression on the continent.

Some might assume that this would offer an opportunity for other western countries. Many think that, for example, European industry would resettle in the United States. This is unlikely to be the case. If European industry collapses, Europe will again be an economic black hole – as it was in the 1930s. Trade will be undermined and its main trading partners will feel the reflux. In short, if the United States tries to capture European manufactures for its plagues, it will soon find that there will be no one to buy what they produce.

Let's consider the statistics. The Office of the United States Trade Representative estimates that in 2019 the United States transacted more than $5,6 trillion in trade – about 26% of GDP. In the same year, trade with the European Union was estimated at 1,1 trillion – about 20% of its total trade. If Europe sinks into the abyss, that figure will dehydrate.

What are the consequences for the United States? On the one hand, exports to Europe will fall and American workers will lose jobs. It will not be a simple cyclical loss of jobs, as in a recession, where jobs come back as business returns to normal. Those jobs will be lost as long as Europe works (or, more accurately, doesn't work) with prohibitively high energy costs. Eventually, some imports that the United States depends on from Europe also cannot be replaced by trade with other nations or by domestic production. The United States will be forced to buy these goods at the highest European prices, thereby reducing the real income of American citizens.

When Europe wakes up to the mess it is in, it will probably try to react by seeking to save its industries through tariffs. In such a situation, the least bad option for Europe – not for the global economy, but for Europe specifically – will be to increase tariffs on imports, to make international products as expensive as domestic products that suffer from cost inflation. energy. Once again, we are back in the 1930s, where, while it is in the individual interest of each country to get involved in a trade war, it is not in the collective interest. A nightmare scenario.

However, there is a fundamental difference between the world of the 1920s and 1930s and that of today. In the interwar period, there was no real rival economic bloc to the West. Russia was a small player, China was an agricultural economy, and what we now call “developing economies” (Brazil, India, South Africa, etc.) were anything but “developing”. This is no longer the case. In the wake of the war in Ukraine, the developing world began to come together as the BRICS+ alliance. This alliance appears to be aimed at decoupling the Western economy as much as possible.

BRICS+ is a force to be reckoned with. It has ample access to energy – with Russia and Saudi Arabia being two of the biggest oil producers in the world. It has access to essential resources – Brazil is the main producer of iron ore in the world. And it has a manufacturing powerhouse strong enough to turn things from the ground into things on the shelf: China.

It is unclear whether the BRICS+ alliance will collapse along with the West if the West falls into depression. It does not suffer the same problems with debts, for example. Nor does much of the BRICS+ alliance face an imminent industrial collapse due to unbelievably high energy prices, as Europe is today. Aside from some potential for serious geopolitical conflicts – in Ukraine and Taiwan – BRICS+ appears to have a relatively clean bill of economic health and plenty of room to grow in the future.

The decisions that led to the great European energy war of 2022 are likely to go down in history as some of the biggest economic and geopolitical miscalculations in human history. They will join the Treaty of Versailles and the tariff wars of the 1930s in the basket of political outcasts that future generations will be taught to avoid at all costs. How did Europeans get here? How were these bad decisions made on our behalf? That I leave for future historians to resolve, probably when the archives are opened.

* Philip Pilkington is an economist. Author, among other books by The Reformation in Economics (Palgrave MacMilan).

Translation: Ricardo Cavalcanti-Schiel.

Originally published in The Critic.


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