Coronavirus Covid 19 is creating havoc around the world both in terms of human suffering and economic damage. The financial markets have responded in kind with large declines in the stock market.
As countries scramble to provide a solution to combating the virus, governments are stepping in to support their economies via fiscal policies, tax breaks, and financial support for employers, employees, and self-employed. Central banks are also helping out with looser monetary policies such as $1.5 trillion in the financial system (such as short-term money markets), interest rate cuts, asset purchases, and lending programs (see details here). But what’s next?
Although the Covid19 is a heart breaking humanitarian disaster, our analysis will primarily focus on the economic and financial impact. Many variables remain unknown so take this guide as a snapshot of the current environment.
Please feel free to add your own comments and analysis in the comment’s section, because we are just a small team and certainly not able to capture all of the ongoing trends.
Covid19 is likely to throw the world economy into a recession. Some analysts and policy makers are even mentioning the start of a depression. The main questions are: how deep and how long?
The potential economic damage could be mind blowing. Imagine all of the small and large businesses being impacted by the current turmoil and restrictions. Restaurantes, shops, stores are being shut down for weeks. Airlines, airports, hotels, the travel industry, oil companies, and others are also facing extremely hard times. The demand for products is bound to dip, because citizens need cash for basic items. In turn, unemployment should rise whereas small and medium companies face bankruptcy pressures.
Kevin Hassett, an economist and former CNN contributor who is returning to the Trump administration to help the coronavirus response, said this week that the pandemic could spark a repeat of the Great Depression that began in 1929 and lasted for years.
“We’re going to have to either have a Great Depression, or figure out a way to send people back to work even though that’s risky,” he said. “Because at some point, we can’t not have an economy, right?”
In any case, this lockdown and social distancing is likely to remain in place in some form for a while. Or there could be waves of stronger and lighter lockdowns. The moment the lockdown is lifted, this virus goes back to spreading across a non-immunised herd of people. It’s a cycle that is broken only when a remedy is found, aka a vaccine, which will take 1+ year in the most optimistic of the estimates. People’s habits will have to change. Mandatory masks and gloves, no grouping, no big events, only few people at a time in a given shop/supermarket, distanced tables in bars, restaurants, cinemas, pre-booked training at the gym so that you don’t create big groups, lots of online work and shopping, etc. Quite an adjustment, weakening old habits and creating opportunities in other areas (online shopping).
Not all countries will endure the same pain. A lot will depend on the initial government reaction in curtailing the spread of Covid19 and the willingness to accept economic pain in return for limiting the spread now and pushing the number of cases into the future. But generally speaking, the global economy is going to take a hard hit.
Governments and central banks will try to make up for the demand shock. Their attempt will certainly help soften the blow. Without their help, the pain and disaster would be much worse.
Letting the economic damage run its course would certainly be the worst scenario. Governments and central banks must soften the blow, like they did with the Great Recession during 2008-09. In fact, the U.S. was the country that intervened the most (via Government spending and support from central bank) and they showed a much stronger economic rebound than the E.U., which was not as consistent and persistent (Germany remained a budget hawk and the ECB even raised rates by 0.5% before going down to 0%).
But even with government and central bank support, there will be short and long-term damage. There will probably be multiple effects:
The previous crisis in 2008-09 started as a housing bubble but the derivatives and financial products based on housing debt almost caused the entire financial system to melt down. The domino effect was a real and present danger.
The negative impact of the 2008-09 Great Recession was curbed by interventions from central banks and governments. The central banks from the US (FED), the Euro zone (ECB), and Japan (BOJ) lowered the interest rates either down to 0% (US) or below 0% into negative territory. They also initiated multiple rounds of quantitative easing. Governments stepped in too, especially the US. But in fact government debt levels across the world grew sharply. The fiscal and monetary stimulus softened the initial blow and also kicked started an unprecedented long, yet slow economic recovery from 2009 to 2020.
This time around, it could be the Coronavirus pandemic that creates a similar domino effect. Banks again made bets on loans that they have given to other companies. If companies will not be able to pay back, banks will again be hurt by bankruptcies and derivatives.
But it’s not only about the financial system. The last time around after the Great Recession in 2008-09, the quantitative easing programs from the US central bank and the tax cuts from the US government helped fuel assets, gave the stock market an enormous boast, and increased the wealth gap between the top 1% and top 0.1% and the rest. One of the factors was the stock buybacks but companies did not invest that much in automation, yet.
This current crisis could be a game changer because of the nature of the Coronavirus. Social distancing is needed and it might remain on our radar for longer than we think – with Covid 19 or any new outbreak. The risk for employment is that companies might actually use their capital to invest in AI, automation, and robotics – rather than stock buybacks. Good for the shareholder but not for the employee and employment. The risk is that it will create a tsunami of unemployment and the change that it might never recover is real, especially as companies see the benefit of relying less on humans (due to the Covid 19 experience). Read more in the NY times piece “Robots Welcome to Take Over, as Pandemic Accelerates Automation”.
The USD short term should move up (due to risk off environment) but in the longer term horizon, the US Dollar could face resistance if its global reserve function were to weaken in any way. The FED remains creative, which means a huge balance sheet. At one point, buyers might walk away from USD Treasuries and the FED will have to buy even more. Then they will do like BoJ and buy Equities. Currencies will only keep their perceived value, if governments can manage the debt and keep their economies floating.
Australia and Canada will be pushing for more immigrants as it stimulates more economic growth – construction sector.China exceeds the USA for patent applications by a factor of 4, and their GDP based on current projections will exceed USA in 8 years .It seems this will be an opportunity for the West to curb their influence and growth. West will bring critical industries back in-country after this, or setup companies in other nations.
Some countries are better equipped to handle the extra debt burden than others. The Czech Republic for instance has a very low debt to GDP ratio of 32.6% in 2018. It could easily double the debt levels and still be perfectly healthy. They have plenty of fiscal space to manage the economic impact of the Coronavirus. Other countries do not have the same luxury. Italy’s debt to GDP ratio of 134.8% will force it to make very difficult choices during the Coronavirus and its economic aftermath.
The U.S. also has a high debt to GDP ratio of above 100% in 2015 and 2017 for instance. But it has the advantage of being the global reserve currency. It will not be punished that quickly and as hard by financial investors and institutions. That said, there is a debt problem in the U.S.: student loan debt, credit card debt, state debt, corporate debt, etc. The low interest rates of the 2010s made credit extremely cheap. And states, households, and corporations used that opportunity to its max.
The main problem is that the decade of growth did not create much of a buffer. Central banks hardly moved away from their quantitative easing programs and governments and debt levels remained stubbornly high. In the U.S., most of the government tax breaks and quantitative easing ended up in the pockets of corporations and high net worth individuals. Companies in turn were buying back their own stock and thus fueling an epic stock market rise.
As a result, the inequality rose from 34.6 in 1978 to 41.50 in 2016 in the U.S and productivity gains did not benefit employees. In fact, the gap between productivity and a typical worker’s compensation has increased dramatically since 1979. Between 1948 and 1979, the productivity grew by +108.1% and the compensation was +93.2%. Between 1979 and 2018, the productivity grew by +69.6% and the compensation was +11.6%.
All in all, wages have been under pressure the last decades. Now the number of jobs might be too. The question is how long the current social economic system can handle adverse pressure like this.
The inequality in the West is also having political consequences. The political divide in the E.U. is widening, the UK brexit out of the E.U., and the presidential win of Donald Trump are potentially some of the consequences.
High debt, over leveraging, derivatives, weak wage growth, and rising inequality remain weak pillars. Yet, the economy and financial systems are likely to survive in the West in some form or fashion. But the balance between government and markets could swing in favor of more government involvement.
We expect that China’s currency will appreciate heavily after Covid-19. It needs to rebalance against the West. As usual, there will be some story that will trigger this kind of movement.
We can see that most new innovation comes from China despite (or perhaps because of?) its centralised government structures. It reopens the debate about how the balance of government and market. And the most likely answer is that a mixture remains the best answer (not fully depending on market only or government only). The main question is in what dosis.
The right balance of market versus government could also be different in the information Age. In the past, creativity and innovation came from industry in a capitalist society but it doesn’t necessarily happen like that in the information age.
Governments might have a serious advantage over network systems. Industry might struggle to compete with this. Keep in mind that it was the US government that launched the internet.
According to the book “Why Nations Fail: the origins of power, prosperity and poverty” by D. Acemoglu and J. Robinson, economic prosperity depends above all on the inclusiveness of economic and political institutions (more inclusive creates more economic growth). They also explain that catastrophes can have a huge effect on the institutions of society. For instance, the Bubonic plague in 1346 was a critical juncture that shaped the economic and political institutions of Western and Eastern Europe. The current Coronavirus could have a similar role.
The 3 largest long-term trends that are likely to impact governments and countries and their economic and political institutions in the 21st century are:
These 3 trends will severely impact all countries. That said, every country has an unique position. The current economic and political frameworks will also determine their capabilities to respond to these 3 trends.
In the short run, most countries will analyze their food supply chain and manufacturing, medical supply chain and manufacturing, and provide tax concessions to employers.
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