IMF official: World economy is on the brink of “cold war 2”

A senior International Monetary Fund representative has warned that the world economy is at the brink a second Cold War, which could “annihilate”, the progress made since collapse of the Soviet Union.

Gita Gopinath is the first deputy managing director of the IMF. She said that the fragmentation of world economies into regional power blocks – centered around the US, China, and other countries – could wipe out trillions in global output.

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If we enter a second cold war, knowing its costs, it is possible that we will not experience mutually assured destruction. She said that we might see the benefits of open trade wiped out.

Gopinath warned that the world had reached a “turning-point” in tensions between the most powerful nations on the planet. He urged the governments to work together and pull back when possible.

Her intervention coincides with a slowdown of international trade after Russia’s invasion in Ukraine, in February 2022, exacerbated tensions that already existed between the US and European countries in the west as well as China and Russia in east.

Geoeconomic fragmentation has become a growing reality. “If fragmentation increases, we may find ourselves in a cold war,” said she.

Gopinath outlined the possible damage that could be caused by a complete collapse of trade between the two blocks – divided according to the UN vote for the 2022 Ukraine Resolution – and said the global economy would suffer losses of about 2.5% (GDP) or $2.5tn, or around £2tn ($2.5tn), if the trade were completely eliminated.

Losses could be as high as 7% of the world’s GDP, depending on how well economies adjust to these new divisions. Foreign direct investment could be divided into two groups centered around the US, China and some non-aligned countries. This could result in global losses over time of 2%.

In recent years, international trade and investment have been hampered by a breakdown of relations between the most powerful economies in the world. This has coincided with an increase in protectionist policies since the financial crisis in 2008.

Companies have responded by pushing to “derisk” their supply chains, after years of unchecked internationalisation since the fall Berlin Wall. The Covid pandemic disrupted long supply chains, and this has led to a surge of “reshoring” and “friendshoring”. This is where firms source key materials from domestic or politically aligned suppliers.

The government is also putting billions of dollars into the creation of jobs and to boost domestic economic growth, as well as fostering green industries in order to combat climate change.

Gopinath acknowledged that this playbook could be beneficial to countries, but warned that failure in managing the process “could easily overwhelm these benefits and reverse nearly three decades worth of peace, growth, and integration that lifted billions of people out of poverty”.

She said that in a speech she gave on Monday in Colombia, there might be benefits to countries who are not politically aligned if they act as “connectors” between rival economic powers.

Gopinath emphasized how certain large electronics manufacturers are moving production from China into Vietnam due to the US imposing tariffs on Chinese products. Vietnam, however, sources the majority of its inputs in China.

Latin American countries, such as South American commodity exporters or Mexico could also benefit. This year, Mexico was the largest exporter to the US. She said that many of the Chinese companies opening factories in Mexico are targeting the US market. The Mexican association for private industrial parks expects one out of five new businesses to be Chinese in the next two year.

She said: “They can directly benefit from trade and investments diversion in an economy that is fragmented and reduce the costs of trade by cushioning its negative effects.”

Gopinath said that these countries may also suffer from an increasing breakdown of international trade. In an extreme scenario, those who have benefited from mild fragmentation could end up with a bigger slice of a smaller pie if fragmentation becomes worse. Everyone could lose.