Will the US Sneeze?

Apr 16 , 2022
By Christian Tesfaye

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It seems it was only a few weeks ago that the biggest worry in the world was the COVID-19 pandemic. A once-in-a-century event (hopefully) led governments around the world scrambling to stem the public health crisis from transforming into an economic one. On the fiscal and monetary policy front, leaders around the world went into an expansionary binge. Even the International Monetary Fund (IMF), hawks under most circumstances, advised governments to stimulate demand, using deficits if necessary.

Nowhere was this more dramatic than in the United States. The Trump and then Biden administrations signed a collective five trillion dollars in stimulus packages into law. Some 1.8 trillion and 1.7 trillion dollars went to households and businesses, respectively. The Federal Reserve cut interest rates to nearly zero, expanding the money supply in the economy.

When the dust finally settled, it was the likes of Larry Summers, former US Treasury Secretary, who has been cautioning against overheating the economy, that was proven right. Thanks to the stimulus package and the near-zero interest rates, the US economy did not crater, and depression was avoided. But like any high, a hangover was just around the corner, and its name is inflation.

Combined with bad luck – gummed up supply chains and soaring energy prices because of Russia’s invasion of Ukraine, which created a supply shock – the cost of living is rising almost everywhere on the planet. The US is no different, with inflation at highs reminiscent of the early 1980s. Belatedly, the Federal Reserve has started to hike interest rates. The more inflation persists, the higher interest rates would go. The more expensive borrowing becomes, the more that spending would be wound down.

Ironically, the Federal Reserve started cutting interests in 2020 because it was concerned that COVID-19 induced lockdowns would hamper spending and send the country into a recession. Only two years later, it is the Federal Reserve that may have to hit the breaks on spending and send the economy into a recession.

If this were happening in any other country, except China, it would not have mattered much. But when the US economy sneezes, the world catches a cold. A recession in the United States will reverberate across the planet because almost everyone does business with the country. Ethiopia is no different.

We need to pay close attention to three possible developments as we navigate the short- to medium-term outlook. One is the cost of borrowing. Interest rate hikes do not only impact the ability of businesses and individuals to borrow in the US. There is a global credit market. It will make borrowing expensive everywhere since every bond by corporations and governments needs to compete with US treasury securities.

When borrowing costs go up, the harder it will be for governments to take out loans and make debt repayments as well. Companies will also find interest rates too high to consider expanding investments or making new ones, a development that will directly impact foreign direct investment (FDI).

The headache does not end there. As the Fed increases interest rates, savings in the US will increase and spending will decline. This is good for curbing inflation, but it is terrible for everything else. Less demand translates into fewer investments and higher unemployment (in most cases). Americans will not only be buying fewer “Made in America” goods but consuming less exports of Chinese electronics, Saudi oil and Ethiopian coffee.

No less consequential in the event of a recession, or at least a slowdown in the US economy, is that depressed business activity there will harm remittance and tourism revenues in many other countries. The impact on tourism may not be that perceptible because the recovery from COVID-19 is still ongoing. But countries such as Ethiopia will feel the brunt as US residents of Ethiopian origin remit less money back home.

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PUBLISHED ON Apr 16,2022 [ VOL 23 , NO 1146]

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