Paraphrasing Paul Samuelson, one of the greatest economistsever to have lived: economists have predicted nine out of the past five recessions
Why we shouldn’t rule out an economic doomsday
Policymakers should be war gaming the worst scenario because
never before has a single signature by a single individual raised the
probability of recession so sharply.
Steven
HamiltonColumnist
Apr 9, 2025
In these unprecedented times, one thing’s for certain: if
anyone expresses certainty about what’s about to happen, then they have no idea
what’s about to happen.
Paraphrasing Paul Samuelson, one of the greatest economists ever to have lived: economists have predicted nine out of the past five recessions. To be honest, none of us knows whether a recession is or is not about to happen.
Were US President Donald Trump to kill the tariffs, why
should businesses and consumers believe they’ll stay dead? Bloomberg
Indeed, that’s not even the question we should be asking.
Instead, we should be thinking in terms of potential scenarios, assigning
probabilities to them, and considering how events and emerging data affect
those probabilities.
Critically, this is also how the government (and opposition
during the caretaker period) and policymakers
should be thinking. If they are not already behind the scenes planning for
these scenarios, then they should get cracking.
These circumstances are unprecedented because never before
has a single signature by a single individual raised the probability of recession
so sharply. Nor has another signature by that same individual been able to
make it stop.
The first thing to understand is that a recession would have
nothing to do with the direct effects on Australia of the tariffs. Our direct
exposure is trivial and the tariff rates manageable, so we will be able to find
buyers for any small excess supply.
But there are three much bigger channels via which the
tariffs could affect Australia. The first and most benign is that a glut of
production from the hardest-hit countries, such as Vietnam, China, Japan, and
South Korea, could be diverted to Australia, expanding supply, and lowering
inflation and interest rates.
“You might think the president would never let it get that
far. But animal spirits have a tendency to form their own momentum.”
The second is more malign. Our five largest non-US export
markets – China, Japan, South Korea, India, and Taiwan (all key US trading
partners) – have been hit with tariff rates of 104 per cent, 24 per cent, 25
per cent, 27 per cent, and 32 per cent. These tariffs alone will sharply reduce
production in these countries, in turn sharply reducing demand for our exports.
In anticipation, this has prompted a sharp sell-off in the
Australian dollar, now at levels not seen (outside a brief window during the
pandemic) for more than 20 years. This depreciation will offset some of the
negative export demand shock, but this offers only some consolation. The shock
it portends will be worse.
These are conventional macroeconomic forces able to be
modelled with our standard tools. I would not be surprised if, on net, they do
not indicate a recession is likely. Though I would caution that no standard
modelling exercise can accurately predict the effect of a 104 per cent tariff
rate, lying beyond any reasonable extrapolation.
The third and by far most worrying effect is in my view the
only one that will be responsible for a recession if that does indeed eventuate
– and, importantly, it’s the one that is simply not in any model. That’s the
“animal spirits” of which famed economist John Maynard Keynes conceived.
Danger of a chain reaction
The most important economic effect of the massive and
widespread tariffs Donald Trump unleashed today is on uncertainty. The range of
possible financial consequences for businesses and consumers has been blown
wide apart by the highest tariff rates in more than a century. Will that TV
cost $1000 or $2000?
And their likelihood depends entirely on the whims of one
man who has a history of erratic behaviour. A man whose only constraint, other
than what’s running through his mind at any particular moment, is the strength
of the trance he holds over the Republican members of the House and Senate.
In such an environment, it would be prudent for a household
or business to sit on its hands and wait for the uncertainty to resolve. But if
all of America’s hundreds of millions of decision makers do so all at once, the
US economy collapses. We suddenly find ourselves in a world of the Keynesian
chain reaction.
You might be inclined to think the president and his
congressional backers would never let it get that far. But animal spirits have
a tendency to form their own momentum. Were Trump to kill the tariffs, why
should businesses and consumers believe they’ll stay dead? Even now, the
omelette cannot be unscrambled.
By the time a recession is unavoidable, how confident should
we be that the administration responds effectively? How confident should we be
that this House and Senate will do what needs to be done? Does the US still
have the fiscal capacity to do so? Will bond purchasers continue to be willing
to finance it?
And what about the US Federal Reserve? Something peculiar
has been happening that nobody I’ve spoken to – inside and outside government –
knows quite what to make of. As the sharemarket has experienced the fifth-worst
Tuesday-to-Tuesday sell-off since 1940, bond yields have risen sharply –
the opposite of what one would expect.
China, which holds around $US1 trillion in US debt and is
now engaged in an all-out economic war with the US, may at some point be
inclined to “break glass” and sell some of those bonds, forcing up yields even
further. This would impair the ability of the Fed to ease monetary conditions.
The rest of the world could be dragged into recession along
with the US, just as in the global financial crisis. Who knows what other
financial vulnerabilities lurking beneath the surface might be triggered.
Australia, of course, would be sharply impacted given the major economic
impairment of our major trading partners.
Will this happen? I don’t know. But it is not inconceivable.
If policymakers aren’t already considering what they would do if it did, then
they should get going.
