How the economy evades every crisis

Mint

3 days ago

After Adolf Hitler's troops rolled into France in 1940, many feared the imminent destruction of Europe and its economy. British investors did not. In the year following the invasion, London's stockmarket rose; indeed, by the end of hostilities, British companies had delivered real returns to shareholders of 100%. The plucky investors must have seemed mad at the time, but they were proved right and made handsome profits.
Although today's dangers are not in the same league as a world war, they are significant. Pundits talk of a 'polycrisis" running from the covid-19 pandemic, land war in Europe and the worst energy shock since the 1970s to stubborn inflation, banking scares, a Chinese property bust and trade war. One measure of global risk is 30% higher than its long-term average (see chart 1). consumer-confidence surveys suggest that households are unusually pessimistic about the state of the economy, both in America and elsewhere (see chart 2). Geopolitical consultants are raking it in, as Wall Street banks fork out on analysts to pontificate about developments in the Donbas or a potential Chinese invasion of Taiwan.
It is, in some ways, a repeat of 1940. In the face of chaos, the global economy powers on. Since 2011 growth has continued at around 3% a year. During the worst of the euro crisis in 2012? Around 3%. What about 2016, the year Britain voted for Brexit and America for Donald Trump, or 2022, when Russia invaded Ukraine? Also 3%. The exception was in 2020-21, during the pandemic. When governments introduced lockdowns, many feared a slump to rival the Depression. In fact, over the following two years the world economy ground out annual GDP growth of 2%; one year of contraction, followed by a storming recovery.
The world economy appears impressively and increasingly shock-absorbent. Supply chains in goods—widely believed to be a source of fragility—have shown themselves to be resilient. A more diverse supply of energy, and a less fossil-fuel-intensive economy, have reduced the impact of changes in the oil price. And across the world, economic policymaking has improved. According to the conventional narrative, the great moderation, a period of steady growth and predictable policymaking, ran from the late 1980s to the global financial crisis of 2007-09. But perhaps it did not die alongside Lehman Brothers.
According to IMF data, this year just 5% of countries are on track for a recession, the least since 2007. Unemployment in the OECD club of rich countries is below 5% and close to a record low. In the first quarter of 2025 global corporate earnings rose by 7% year on year. Emerging markets, long prone to capital flight in times of trouble, now tend to avoid currency or debt crises (see chart 3). Consumers across the world, despite claiming to be down in the dumps, spend freely. On almost any measure, the economy is basically fine.
Little wonder that investors are optimistic. Over the past 15 years, as the polycrisis has built, American stocks have marched upwards. More than half the rich world's stockmarkets are within 5% of their all-time high. Wall Street's fear gauge, the VIX, an index of stockmarket volatility, is running below its long-term average. Markets fell in April, when Mr Trump announced his 'Liberation Day" tariffs, but quickly recouped their losses. Many investors now follow a simple rule when markets decline: 'Buy the dip."
They do not even seem to worry much about companies at the sharp end of geopolitical risk. American businesses especially exposed to tariffs, such as sporting-goods firms, are only mildly underperforming the broader market. When Vladimir Putin launched his war in 2022, Ukraine's stockmarket collapsed. It has since made up ground, rising by a quarter this year. Nowhere is there a starker contrast between pundits and markets than Taiwan. Goldman Sachs, a bank, produces two indices of 'cross-strait" risks. According to the index built using newspaper articles, the strait has rarely been so dangerous. By contrast, the market-based index, derived from share prices, hardly seems bothered (see chart 4). Either investors are naive—or, as in 1940, they have a more sophisticated intuition of how a conflict would play out.
So there is a puzzle: chaotic geopolitics and a decidedly placid economy. This may mirror events in 1940, but it is unusual historically. Typically economists find a link between geopolitical ructions and a worsening economy. A paper by Dario Caldara and Matteo Iacoviello, both of the Federal Reserve, suggest that higher geopolitical risk 'foreshadows" lower investment and employment. Hites Ahir and Davide Furceri of the IMF and Nicholas Bloom of Stanford University find that increases in uncertainty tend to be followed by 'significant declines in output".
Perhaps something has changed. Mr Ahir and his colleagues present evidence suggesting so. Since 1990 uncertainty has hurt growth less than before. Recent developments hint at further progress.
Out of the fire
The emergence of a new form of capitalism—call it the teflon economy—may be behind these shifts. On one side of the equation, firms are better than ever at dealing with shocks, meaning that markets continue to function even at a time when politics breaks down. On the other side, governments offer their economies unprecedented levels of protection.
Start with supply chains, which have received a number of shocks in recent years. The conventional narrative that they are prone to 'failure" is largely wrong. During the pandemic some commodities became a lot more expensive—but this was a consequence of an enormous surge in demand, rather than falling supply. Semiconductors are a classic example. In 2021 chipmakers shipped 1.2trn units, some 15% more than the year before. The industry did not really suffer a 'supply crunch". Rather, it responded efficiently to an extreme surge in demand.
According to the New York Fed's supply-chain pressure index, bottlenecks have remained in line with the long-run average, even in the face of Mr Trump's trade war. We find similar results in our analysis of 33,000 commodities that America imported from 1989 to 2024. For each year, we counted the number where imports declined from the previous year by more than 20%, even as the price of those imports rose by more than 20% This hints at situations where a supply chain genuinely 'fails". We calculate that the failure rate has been trending down over time.
Modern supply chains are resilient because they are professionally run. Specialised logistics firms have global reach, with cutting-edge warehousing and transport capabilities. Better communications enable rerouting when required. Lots of people have jobs that in effect amount to finding the most marginal of marginal gains. In America there are 95% more supply-chain managers than two decades ago.
Some investors believe structural changes to the economy are also playing a part. 'A services economy is incredibly consistent," says Rick Rieder, chief investment officer for fixed-income markets at BlackRock, the world's largest asset manager. 'They really do not go into recession except when there is a real major shock: a pandemic or a financial crisis." Since 1990, goods consumption in America has fallen on a quarter-on-quarter basis in 27 quarters. Spending on services, by contrast, has contracted in only 5 quarters.
Fast growth in American shale oil and gas production has made the world less dependent on both Russia and the Middle East, as became apparent after Mr Putin's invasion of Ukraine, which failed to produce the deep recession in Europe that had been expected by many analysts. OPEC produced fewer than 33m barrels of oil a day last year, just 12% more than in 1973, when the cartel curtailed production and sent prices rocketing. At the same time, the rest of the world produced 64m barrels of oil a day, a figure that has more than doubled since the oil shock of the 1970s. Moreover, the global economy is becoming less dependent on the fuel: oil intensity, defined as the amount consumed per unit of GDP, has dropped by around 60% since 1973 (see chart 5). Hence why events such as the recent Israeli and American bombing of Iran barely dent the price of crude.
Excellent as supply-chain agility may be, it would matter less if consumer demand crashed every time sentiment soured. That does not happen, in large part because of government action. Politicians in the rich world have become extreme fiscal activists. During the pandemic, they spent over 10% of GDP on rescue packages. In 2022, during the energy crisis, the average European government spent another 3% of GDP. In 2023, in the middle of a banking scare, America hugely expanded its deposit insurance. When there is bad news, politicians are quick to spend big.
And even when there is no bad news, politicians spend big just to be sure. The average rich-country government now runs a fiscal deficit of over 4% of GDP, far above the norm in the 1990s and 2000s. Their support goes beyond budget deficits, which are simple to measure. Many countries now have vast 'contingent liabilities"—off-balance-sheet commitments that nonetheless represent an enormous potential outlay. America's federal government is on the hook for contingent liabilities worth more than five times the country's GDP. When the feds are backstopping the entire economy, it is hardly surprising that recessions are few and far between.
This approach has clear benefits. Is it not better to live in a world where joblessness rarely spikes? Even during the pandemic the OECD's unemployment rate never exceeded 7%. Losing a job can scar someone for life; avoiding that fate boosts incomes and health. Persistently high asset prices, meanwhile, are good for anyone with a retirement account or stock portfolio. However, the system also has costs. If central banks and governments succeed in postponing financial crashes, they will simply encourage more reckless behaviour, sowing the seeds of a deep downturn.
Emerging markets have made progress, too. Flexible exchange rates are more common; policymakers are better at avoiding shocks. From 2000 to 2022, the number of emerging-market central banks targeting inflation rose from five to 34, as Gita Gopinath of the IMF has noted. Local bond markets are more established, meaning poor countries can borrow in their own currency at respectable rates, leaving them less exposed to global fluctuations. Even the combination of a pandemic, surging commodity prices and rising American interest rates did not derail developing economies. As a share of emerging-market GDP, excluding China, sovereign debt in default rose to 1.2% in 2023, up from 0.6% in 2019. That pales in comparison to past crises. In 1987 the volume of emerging-market debt in default hit 11.7% of GDP.
Truly troubled countries, such as Egypt and Pakistan, today avoid default. Yet, as in the rich world, this comes with costs. As China has grown as a lender and entered negotiations, restructurings have almost ground to a halt. The IMF and official creditors are reluctant to force borrowers into default, instead preferring to drip feed loans. Although few countries default, 59 were under strain in 2024 by the IMF's and World Bank's count, a record high.
Many aspects of teflon capitalism are here to stay, for better or worse. Policymaking in emerging markets is unlikely to regress. China is not about to make default talks any easier. Rich countries, which are rapidly ageing, want economic security; populist politics demands it. Investors now expect rescue packages at the first sign of trouble, and will keep buying the dip.
In the meantime, two risks loom. First, higher interest rates make profligacy expensive. This year America will spend over 3% of GDP on debt service, more than on defence. At some point, governments will have to cut back. Second, geopolitical shocks may yet escalate to a point where even today's robust supply chains cannot cope. A Chinese invasion of Taiwan could destroy, pretty much overnight, the West's supply of high-end semiconductors.
In 1940 investors in the City wagered that Hitler's conquest of Europe would come to nothing. Investors in 2025 are making a subtler bet: that politicians, regulators and central bankers will continue to stand behind them when things go wrong. The danger is that, in the next crisis, the bill for perpetual protection could come due—and it could be steep.