Photo credit should read PHILIPPE LOPEZ/AFP via Getty Images

The next Great Depression?

Economic warfare has severe implications

Artillery Row

The Western world today faces a serious risk of slipping into another Great Depression. This risk has arisen not because of a poor budget drawn up by a blundering government — or even due to some nefarious speculation taking place in financial markets. Rather, it has arisen due to global economic relations deteriorating to the point of all out warfare. To understand why this is provoking a risk of depression, we must reach back into the annals of history to recall what cursed the world in the 1930s.

Once upon a time, the most important question in economics was, “What caused the Great Depression?” This question started to be asked during the depression itself and continued being asked for years afterwards — roughly up until the 1980s. After the 2008 financial crisis and the so-called Great Recession, the question bubbled up again but, likely because the Great Recession was no Great Depression, it was only asked for a few years. 

Economists, being economists, always sought a simple answer, with different schools vying for influence over the best. Keynesians attributed the depression to a lack of government support of a flagging economy. Monetarists claimed that it was due to mismanagement of the money supply by the central banks. Austrians claimed that the depression was a natural economic response to too much reckless spending in the 1920s and should have been allowed to purge the system completely.

The reality is that these simple answers were never convincing. The Great Depression was an historical event, and it always demanded an historical explanation. Before the economic schools congealed around their various dogmas, this was well-known. Keynes himself would have chuckled at the later simplistic “Keynesian” explanations of the depression, for example. He had written a book in 1919, entitled The Economic Consequences of the Peace, about the Paris Peace Conference — to which he was a delegate — where he warned that the Treaty of Versailles would lead to a depression.

The depression, as Keynes predicted, arose out of the lopsided economic structure that emerged from the First World War. War on such an awful scale had completely upended economic relations — both domestically, due to regearing the economy for war production; and internationally, as various allied blocs hunkered down and shut out the rest of the world. The wise thing to do after the war would have been to try to restore economic relations to normality as soon as possible.

When the debt pyramid collapsed, Europe went with it

The delegates at the Paris Peace Conference did precisely the opposite. They viewed the Treaty of Versailles as being, to paraphrase Clausewitz, a continuation of war by other means. The Allied powers wanted to punish Germany, who they blamed for the war. They saddled the country with an impossible debt load and later occupied the Ruhr, Germany’s most productive region. The Americans wanted to be paid, too. The Allies had racked up massive debt with the Americans as they bought armaments from them during the war. Instead of taking the high ground and cancelling the debt — as allies had typically done up until then — the Americans demanded to be paid back at relatively high interest rates. 

The 1920s were a decade of debt and decadence because the international system was built on an unstable pyramid of debt. In 1929, that all came crashing down. But it was just a trigger. The debts that had been building up were the mirror image of inequitable and unsustainable economic relations between countries. Europe was a basket case economy being allowed to muddle through by the provision of ever more American loans. When the pyramid collapsed, Europe went with it.

The depression really set in when Europe’s collapse gave rise to a collapse of global trade. Between 1929 and 1933, global trade fell by around 30 per cent. In effect, Europe became an economic black hole. All the transactions she had with other countries dried up, and so her economic problems spread like cancer through the global economy. This cancer proved especially virulent in America, who was at the time Europe’s largest trade partner. Various countries, desperate to protect their domestic economies, then engaged in trade wars by imposing tariffs on foreign goods. Global trade fell even more sharply. 

Today we see very similar dynamics at play in the world today. Debt has been building up in the Western economies for decades but has become particularly acute in the past three years. This is due, firstly, to the enormous spending required to keep people fed during the lockdowns and, secondly, due to the mounting costs — especially energy costs — that are being borne due to the war in Ukraine. 

Now we look set to move into the second phase of historical repetition: the collapse of Europe. The collapse of Europe will take place because Europe no longer has access to sufficient energy for its economic needs. At first, when Russia moved to starve Europe of much-needed gas, many people — myself included — could dismiss it as a temporary development. Once the war was resolved, we assumed that the gas would be turned back on. But recently the pipelines carrying gas from Russia to Europe have been blown up in what looks like an act of sabotage. There is no going back for Europe now.

With insufficient access to energy, the price of energy in Europe will remain extremely high for years to come. European industry, for which energy is a key input, will become uncompetitive. If European manufacturers want to continue to do business, they will have to raise the prices of their goods. That will render these goods uncompetitive with foreign goods — from America, say, or China. Both are not suffering nearly as much from energy shortages. This will put European manufacturers out of business, Europe will haemorrhage key jobs, the rot will spread as would-be manufacturing employees have no wages to spend in the economy, and we get a depression in Europe.

Some might assume that this might provide an opportunity for other Western countries. Many think that, for example, America might be able to “reshore” European manufacturing. This is unlikely to be the case. If European industry crumbles, Europe once again becomes an economic black hole — as it did in the 1930s. Trade will dry up and its key trade partners will feel the burn. In short, if America tries to ship European manufacturing to its shores, it will soon find that there is no one to buy the products.

Consider the statistics. The Office of the United States Trade Representative estimates that in 2019, the United States engaged in over $5.6tn of trade — roughly 26 per cent of GDP. In the same year, trade with the European Union was estimated at $1.1tn — around 20 per cent of total trade. If Europe sinks into the abyss, much of this trade will dry up.

BRICS+ is a force to be reckoned with

What will this look like for the United States? For one, exports to Europe will fall and American workers will lose jobs. This will not be a simple cyclical loss of jobs, as happens in a recession, where the jobs come back as business returns to normal. No, these jobs will be lost so long as Europe is labouring (or, more accurately, not labouring) under impossibly high energy costs. There will also be some imports that the United States will rely on Europe for, which cannot be substituted for by trading with another nation or producing them domestically. The United States will be forced to buy these goods at a higher price, thereby lowering real income for American citizens.

When Europe wakes up to the mess they are in, they will likely have to respond by trying to save their 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 raise tariffs on trade to render international products as expensive as the domestic products suffering from energy cost inflation. Once again, we are back to the 1930s where it is in each country’s individual interest to engage in trade war, yet it is in no one’s collective interest. A nightmare scenario.

Yet there is one key difference between the world of the 1920s and 1930s and today. Back 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 the “developing economies” (Brazil, India, South Africa etc.) were anything but developing. That is no longer the case. In the wake of the war in Ukraine, the developing world has started to band together as the BRICS+ alliance. This alliance seems to be aiming at decoupling from 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 largest oil producers in the world. It has access to core resources — Brazil is the world’s premier iron ore producer. And it has an impressive manufacturing economy to turn the stuff in the ground into stuff on the shelf: China.

It is not clear that the BRICS+ alliance will be pulled down with the West if the latter falls into a depression. It does not suffer the same problems with debt, for example. Nor are any large parts of the BRICS+ alliance faced with an impending industrial collapse due to impossibly high energy prices, as Europe is today. Apart from some potential for serious geopolitical conflict — in Ukraine and Taiwan — BRICS+ looks like it has a relatively clean bill of economic health and much room to grow in the future.

The decisions made that led to the great European energy war of 2022 will likely go down in history as some of the greatest economic and geopolitical miscalculations in the history of mankind. They will join the Treaty of Versailles and the tariff wars of the 1930s in the basket of policy pariahs that future generations will be taught to avoid at all costs. How did we get here? How have such poor decisions been made on our behalf? I will leave it to future historians to work that out — probably when the archives are opened.

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