In the United States, it is uncertain whether the labor market’s slow growth will turn into contraction. The U.S. non-farm payrolls report in July surprised the market, with new jobs hitting a record low in three and a half years and unemployment rising to its highest level in nearly three years. It was also noteworthy that the number of “discouraged workers” (people not looking for a job because they are pessimistic about their chances of finding one) and those who, for economic reasons, can find only part-time work — another measure of unemployment — rose by 0.4 percentage points to reach 7.8 percent, the highest level since October 2021.
More important, during an economic recession, the U.S. usually revises data, with final values mostly lower than the original reports. This could also happen this time, accelerating the spread of panic as the labor market cools. If the driving forces behind all this are still in operation, the slow growth of jobs may well turn into a general contraction of the labor market.
At the same time, it is uncertain whether the stock market shock will lead to a longer period of turmoil in U.S. financial markets. The stock market plunged over worries about the new economy and losing bets on Wall Street’s favorite trade. In the past year, the market was too excited about the potential of artificial intelligence technologies, pushing up the prices of Magnificent Seven stocks. However, few tech giants’ businesses have really been affected by AI. Their price premiums are not fully supported by their performance. If their profits and sales decline in the future, worries will again arise and the market will see more turmoils. At the same time, falling stock prices will directly impact family wealth, thus weakening spending. Companies that have already stopped hiring may be forced to start layoffs, which in turn will affect their stock prices and financial wellness in a self-reinforcing cycle.
Finally, it is uncertain whether the Federal Reserve’s string of rate increases will have an amplified lag effect. As Milton Friedman said, there are “long and variable lags” between a monetary policy adjustment and its effect on the macroeconomy. As a matter of fact, the Fed's high interest rate policy has led to a loss of more than $1 trillion in the market value of bonds and loan portfolios of the entire banking system.
At the same time, it has increased risks in the commercial real estate sector, with the vacancy rate hitting a record high. A recent National Bureau of Economic Research study showed that close to 400 small and medium-sized banks may fail due to high interest rates and an expected wave of property loan defaults. The Fed has been restricting money growth since 2022 and the current money supply is lower than that in July that year. Since its establishment in 1913, such a contraction has only occurred four times, from 1920 to 1922, from 1929 to 1933, from 1937 to 1938 and from 1948 to 1949. The second event led to the Great Depression, while the other three were followed by recessions.
In addition, if the market expectation of rate cuts deviates from actual Fed policy, the results will be even worse. At present, the market expects the Fed to cut interest rates quickly and sharply to forestall a potential recession. However, the Fed has hinted that it will do so only if inflation remains moderate in the coming months. If inflation is persistently high, the Fed may postpone rate cuts and accept the consequences of a recession.
Undoubtedly the American economy has a material impact on the world, since the U.S. dollar remains the dominant reserve currency and U.S. treasury bonds remain a risk-free anchor for the pricing of many other assets. But now the so-called safe haven has itself become the source of global market turmoil.
More important, a failure to make a soft landing will catalyze long-term shifts in American political and economic policies. In that case, the country may vigorously turn to protectionism. At present, both political parties in the U.S. stress the need to protect American employment from foreign competition. But an economic recession will push them further toward protectionism. Donald Trump made it clear that, if elected, he will impose a 60 percent tariff on Chinese imports and a 10 percent universal tariff. The beggar-thy-neighbor policy that destroyed the economy in the 1930s may well return.
Vice President Kamala Harris has now become the Democratic de facto presidential nominee, indicating a deviation from the middle ground by the Democrats. Harris opposed two major trade agreements that were supported by Joe Biden — the US-Mexico-Canada Agreement (USMCA) and the Trans-Pacific Partnership (TPP). She was among the 10 senators voting against the USMCA on grounds that it lacked sufficient environmental protections. She also opposed the TPP, arguing likewise that it did not do enough to protect the environment and workers.
If the U.S. economy cannot make a soft landing, the country may also vigorously turn to industrial policies. The Biden administration has expressly embraced intervention. The CHIPS Act and the Inflation Reduction Act subsidize domestic semiconductor production and apply domestic content requirements to protect the manufacture of electric vehicles in the United States. An economic recession would further stimulate the enthusiasm of the government to play a role in the market to solve social problems. Trump’s choice of Ohio Senator JD Vance as his running mate demonstrates a firmer pursuit of populism and anti-establishment policies. Vance has vowed to bring jobs and manufacturing back to the U.S., restrain global trade and protect American supply chains, with more products stamped with that beautiful logo: Made in the USA.
This “American interests first” philosophy is built on the belief that technological progress and globalization have created a subversive and chaotic economy and that the U.S. needs to increase economic intervention and create domestic jobs.
