Our Global Economy is a Corona Victim. But for How Long?
This unprecedented health scare has had similarly unprecedented economic repercussions, impacting individuals, communities, businesses, organisations, governments and nations. No-one is untouched, economically or financially at this point. Corona is already becoming a grand leveller.And whether we like to acknowledge it or not, most of the experts are just as disordered and perplexed. At this stage, while there is plenty of speculation, there’s no meaningful clarity on what the true impact might be on our economies and our wallets in the coming months and years.
What is clear is the volatility of the global financial markets, reflecting the deeply unstable nature of the situation. Not just stock markets but bond and commodity markets experiencing extraordinary unpredictability. Crashes and rallies collectively unseen since these markets even began.
It's easy to see why. When, for example, we consider the lockdown in Italy, which has already been going on for weeks, we can understand the dramatic reduction in economic activity. Pretty much overnight the regular movement of daily life and daily economic life – eating, working, playing – halted in an instant. Less activity equals fewer financial transactions and less economic growth.
You tell me…most of us around the world are now in isolation. Has your personal economic activity and what you see around you pretty much dropped off a cliff? I thought so.
Hence economists, investors and traders are clearly spooked by Corona and rightly so. They fear its spread will destroy economic growth and that government action may not be enough to stop the decline.
By way of offsetting those risks, central banks around the world were quick to use their favourite preferred tool in times of crisis: interest rates. No sooner had the crisis begun to make its way outside of China, rates started to crumble, making borrowing cheaper for corporates and individuals alike. Indirectly putting money into our pockets.
Keynes’ Liquidity Trap
However interest rates have been at historically low levels for so long that the real teeth of reducing interest rates has been all but lost.
In times of great uncertainty, even when interest rates are low, people are more inclined to save cash and financial capital rather than spending or even investing it. Hence, the results may well be the opposite of what we might ordinarily expect from a reduction in rates: zero economic growth or – even worse - recession.
You tell me… the minute the pandemic is over, will you be out and about spending buying shoes in Shinjuku or Oxford Street? Or going more cautiously and saving up for a rainy day? Exactly.
We are facing a traditional Keynesian Liquidity Trap and this is exactly what commentators are nervous of.
Government Pump Priming
So what to do in a Liquidity Trap? Well, the other policy tool available to governments is to put money more directly into our pockets to stimulate growth. What is commonly known as ‘pump priming’ our economies.
And in general I’ve been impressed by the speed and responses of many governments so far in both recognising the conundrum and acting upon it, trying to protect people and markets. As examples, in addition to the monies promised around Europe and the UK, the US Senate has agreed an exceptional $2 trillion package to help workers and businesses during the coronavirus emergency.
However, government pump priming has risks associated with it too:
1. First, as with any other government policy, but especially ‘emergency’ policies, the details of how they will be translated into financial and economic reality will be blurred for some time. What will be the exact mechanism by which the UK will support 80% of employee wages? So for a while at least the uncertainty will continue.
2. Second, even with perfect clarity on an execution strategy, there will be a lag between political announcement and financial delivery, creating further uncertainty for people and organisations.
3. Third, the sheer variety and complexity of policy measures being utilised. Even within the same nation there will be policies for pensioners, policies for employees, for restaurant owners, banks and so on. So assessing the real economic consequences is again rather hard. And of course the same must be said from country to country. Consider what this means for a giant multinational. Its global markets are all differently affected and the policy responses in each nation or market place is different. So in my opinion it will be extremely difficult to make decisions for many months after the virus itself has gone away. In reality most companies worth their salt will be hoarding their cash for a while, just like you and I.
4. Four, one big question no one is yet touching on: given the pre-existing global imbalances of trade and debt, to what degree can individual governments realistically afford these gigantic spending packages? And if the markets allow them to happen, what may be the implications for currencies, growth and populations in those countries. Are we simply delaying recession for later…. which leads to my final point.
5. What is the impact we should therefore be expecting of all of this for future generations to be funding these additional new deficits. No clear idea where to start on that quite yet…and it's perhaps more moral than it is economic per se.
As you can see, it's complicated! And if markets were volatile before a Corona Crisis, now there’s just a lot more uncertainty, volatility and caution around making any kind of economic decisions. And a lack of economic decision making equals reduced growth.
Recession is defined as negative growth over two consecutive quarters. Even if Corona was solved tomorrow at the physical health level, personally I don’t see people and businesses making ‘normal’ pre Crisis decisions for at least another 9-12 months. It's just the natural psychological lag. But again, you tell me… how inclined will you be to hop on a plane to the Amalfi coast for a vacation in August? How much has your pension fund suffered and what do you plan to do about it? MMMMmmmm.
How the recession progresses will depend on the shock’s ability to damage an individual economy’s supply side and its capability of generating capital. If credit intermediation is interrupted and capital isn’t easy to come by, recovery will be slow, unemployment will be high rates and productivity will continue to crash.
When a financial crisis happens, such as in 1929 or 2008, the economy supply side is damaged. And governments learned how to deal with them. However, Coronavirus extends liquidity and capital problems to the real economy — and does so at unprecedented scale. This is what we need to be concerned about economically and financially.
On the other hand, perhaps this Crisis squarely highlights our obsession with economic growth and it's perversity in light of both the reality of limited resources and its true impact on our well-being. Yes, that is a whole other story but also a gigantic opportunity. In my opinion, the idea of reconstructing our obsession with economic growth is a serious one that we should all now be paying a lot more attention to, and one that I feel extremely passionate about.
Nevertheless, for now the impact on overall global economics and imbalances remains unclear, but it’s certain that if governments, corporates, investors and individuals don’t act together and unite – regardless of our nationality and demographic - the consequences will be far more dangerous for all of us.