Recessions are failed policy, not therapy

Demand creation – not tariffs on Mexico – are what the global economy needs today.

I was on CNBC’s Squawk Box this morning discussing President Donald Trump’s threatened tariffs on goods from Mexico.

At the end of the conversation, CNBC’s Rick Santelli said something that still has me fuming.

He asserted that recessions are therapeutic. I think nothing could be further from the truth. Far from being therapeutic, I believe recessions are the result of failed policy.

This is true most of time, but it feels especially true at this juncture for the global economy. Given the overall fragility of the global economy, I believe that avoiding a recession has to be a supreme policy goal at the moment.

A failed policy that leads to a recession, especially in a large economy like the US, and when the world is already dealing with deflationary pressures, risks a massive drawdown in global growth.

Why Mexican tariffs could be bad economic policy

But before we get to that, it’s worth talking about the potential for Mexican tariffs.

Trump announced on May 30 that he intends to impose tariffs on Mexican goods at 5%, which eventually could rise to 25%.

Putting aside the politics for a second, this proposed move, in conjunction with Chinese tariffs, is bad economic policy, in my view. It could trigger a significant fiscal consolidation that could shave off a meaningful amount of growth from an already low growth outlook.

In addition to impacting near-term growth, these tariffs would be detrimental to the long-term capital spending outlook for an economy that is short on productivity growth.

Unlike Chinese tariffs, the Mexican tariffs are truly playing with fire as they would impact autos, the core of US industrial production.

If implemented fully, tariffs on goods from Mexico raise the prospect of a recession in the not-too-distant future.

That being said, I, and the markets for that matter, don’t believe Trump will go through with them. And that is a key reason why we have not seen significant declines in US stock prices since the announcement of Mexican tariffs.

As we saw with the Chinese tariffs, only time will tell whether these predictions will come to pass. However, unlike the Chinese negotiations, we have an agreement hanging in the balance – the United States Mexico Canada Agreement (USMCA). These tariffs would jeopardize the ratification of this flagship trade accomplishment of the Trump administration. Trump’s desire to see the USMCA move forward gives me hope that the US will not impose tariffs on Mexico.

For now, I believe we have no choice but to wait and see what happens. By cutting risk exposure now, we would run the risk of missing out on a turnaround at some point down the road. As any seasoned investor knows, rerisking quickly after derisking is a lot easier said than done. So I am sticking with my modestly positive outlook. As an investor, until proven otherwise, I have to count on policymakers making sound and rational policies, which Mexican tariffs certainly are not.

Demand creation is critical today

Coming back to Santelli’s comment about recessions being therapeutic, I emphatically believe that this is just not the case.

While there is a case to be made for decisively dealing with excesses that are created in an economy in boom times, pining for a recession to accomplish that goal is entirely misplaced, in my opinion. In fact, I believe this is always the case, but it is especially true in today’s world.

We haven’t been able to get out of the demand destruction that took place in the Great Recession; given the global debt load, demographics and savings glut, another recession would likely bring on a winter of global deflation. That eventuality must be avoided at all costs.

Nobody knows this better than the world’s central banks, especially the US Federal Reserve (Fed). This is something they have been working on for 10 years, and it was precisely the reason for the Fed pivots during this cycle.

In my view, that misplaced liquidationist yearning for recessions is based on a false assumption that what ails the world today are supply side issues of excess and inefficient capacity. While supply side issues are important and need to be dealt with, at the moment I believe the global economy has to focus on creating more demand for goods and services.

Without that demand creation, we may liquidate the less efficient and excess sources of supply, but at a significant economic and human cost, especially in a country where half the population does not have $500 in available emergency funds.[1] I believe there will be a time to deal with supply side issues, but it is not today.

I tried to explain that to Santelli to no avail. I hope someone else is more successful with President Trump and his advisors.


Important information

Blog header image: Gorodenkoff/

The opinions referenced above are those of Krishna Memant as of May 31, 2019. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

[1] Source: The Federal Reserve, “Report on the Economic Well-Being of U.S. Households in 2018,” May 2019.  page 2.

Krishna Memani serves as the Vice Chairman of Investments for Invesco. In 2009, Mr. Memani joined OppenheimerFunds, which became part of Invesco in 2019. Before he joined OppenheimerFunds, he was a managing director at Deutsche Bank, heading US and European credit analysis. Earlier, he headed global credit research at Credit Suisse; was in charge of high grade and high yield portfolios at Putnam Investments; and was a credit analyst at Morgan Stanley.

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