Repress Covid, Repress Finance?

by | May 5, 2020

The economic crisis unfolding in western economies is the fastest and deepest on record.

It is unequivocally grim. In the United States, a closely watched series, a weekly count of initial claims for unemployment benefit, showed that 30 million people had filed in the 6 weeks to 25 April, more than wiping out the 23 million jobs created in the 11 years between February 2009 and the same month in 2020. By June, the US unemployment rate could be 20 per cent, compared to 3.5 per cent in February, and double the post second world war peak recorded in 1983. In the UK, the unemployment rate is predicted to rise above 10 per cent this summer, levels not seen since the early Thatcher years in the early 1980s.

Consumer and business sentiment measures are in freefall in the northern hemisphere, and the contagion into emerging and developing countries is growing. In western countries, GDP fell sharply in the first quarter of 2020, but the current quarter’s contraction will be much bigger, ranging between 15 and 35 per cent. Service industries, normally a stabilising influence in downturns, will be especially badly affected.

As people are physically unable to consume as before, savings are exploding. In the US, the household savings rate in March shot up from 8 to 13.1 per cent, the highest for 39 years.  British households and businesses increased their bank deposits by over £57 billion in March, the largest monthly rise ever recorded and 8 times as large as the average over the last 6 months. The corollary of higher private savings is an explosion in government deficits and debt to the highest levels we have seen in peacetime. Public debt to GDP ratios in excess of 100 per cent, until recently the preserve only of the likes of Japan, Italy, Greece and Ireland, are likely to become commonplace.

Can these trends get still worse?

The short answer is yes.

We might end up, as some economists warn, in a protracted depression If so, our system of democracy, and even peace between nations might be at risk. Autocrats in several countries—not just in China and Russia—have already used the pandemic to consolidate power, and others might succumb to autocracy if the veneer of tolerance in our societies were to crack. Further, just consider how Covid-19 has opened up a new front in Sino-Western tensions, as ‘blame’ and mutual recriminations have undermined what little is left of trust relations. We are not short of triggers in Sino-Western relations.

Yet, reading some of these Cassandras, I think they are flirting with economic horror clickbait. Telling the public things are dire isn’t news, discussing with them what we might do about it is. The most important issue, of course, is to get the balance right between bad economic and bad epidemiological outcomes.  And bear in mind, that unlike the 1930s, can anyone seriously imagine central banks and governments today reversing expansionary policies?

Fundamentally, we must hope that governments continue to exercise caution as they ease lockdown restrictions so that they can manage both the economy and keep the infection contained. To do this they will have to adopt or approve widespread use of masks, testing and contact tracing while anti-viral treatments are being developed, and hopefully an effective vaccine.

As several European countries, including the UK, and some US states join the throng to to ease restrictions, the path ahead is undoubtedly a tricky one. Re-open the economy too fast, and there’s the risk of a new wave of infections and fatalities leading to overwhelmed health services, more lockdowns, greater economic harm and popular unrest. Re-open it too slowly, and you run the risk of permanent economic damage and popular non-compliance.

Light at the end of the tunnel?

All of this makes a V-shaped economic recovery a risk, rather than a base case, though the IMF has precisely such a central scenario. It predicts that in the UK, for example, a 6.5 per cent fall in GDP this year will be followed by a 4 per cent rise in 2021.

Let’s hope they are right, but I wouldn’t hold my breath. If we look to China, as it is about 6-8 weeks ahead of us, the streets, subways and planes are fuller again, children are at play, parents seem relaxed, production is up, but shops, restaurants and buses are largely empty. Barely anyone goes to cinemas, which remain mostly shut.

We might get a better 2021 but it might take a while to get back to the level of output and demand we enjoyed at the start of 2020. The ECB’s Chief Economist, Philip Lane, recently said it might take 3 years to get back to where things were. Hopefully, it will come sooner.

How so?

As I stated earlier, we are creating a debt pile up, which is bad news but not without caveats.

It’s bad because recourse to debt is precisely how we have gotten out of every economic crisis since the 1980s. As things stand, UK public debt could rise by 15 percentage point to about 100 percent of GDP in 2021. There are only 3 ways to deal this, and two of them are off the table. These are default, in the sense of refusing to pay creditors, eg holders of gilts, and austerity, which no political party wanting to be elected can now propagate.

This leaves a third option, which is the pursuit of financial repression and inflation. This is good news not because they are to be recommended, as such, but they do give us a way out, and suggest an end to debt dependency.

Financial repression is basically about keeping interest rates below the rise in the monetary value of GDP for an extended period. It’s in effect a tax on savers, and on wealth, at a time we want people not to save, and a subsidy to borrowers, debtors and those on lower incomes who tend to consume more out of income. It would almost certainly be accompanied by policies to redistribute income to lower income groups, change the tax treatment of debt so as to discourage it, and wider controls in the economy, possibly also over the movement of capital. It’s a policy environment not seen since before the Thatcher era.

Once the grip of vicious deflationary demand conditions eases, we are likely to see higher inflation too, which is also good to reduce debt burdens. Direct monetary financing of public deficit has begun in a small way already, and more will doubtless occur.  We should also expect higher prices to reflect supply constraints in the economy of tomorrow. Think border controls, lower immigration, travel restrictions, shorter and dearer supply chains, ‘just in case’ production rather than ‘just in time’, weak investment and the ageing society effects on labor and skill supplies.

It may not be pretty, but the alternative is much worse.

Filed Under: Featured . Economics

About the Author

George Magnus is an independent economist and commentator, and Research  Associate at the China Centre, Oxford University, and at the School of Oriental and African Studies, London. George was the Chief Economist, and then Senior Economic Adviser at UBS Investment Bank from 1995-2012. He had a front row seat and key managerial position for multiple episodes of boom and bust in both advanced economies and emerging markets, including notably the Great Financial Crisis of 2008. George famously anticipated it in 2006-2007 with a series of research papers in which he warned of an impending Minsky Moment. Whilst at UBS, he served for four years as the Chair of the Investment Committee of the pension and life assurance fund. For four years until 2016, he served finally as an external senior adviser with clients of the investment bank. He had previously worked as the Chief Economist at SG Warburg (1987-1995), and before that in a senior capacity before ‘Big Bang’ at Laurie Milbank/Chase Securities, and before that, Bank of America in London and San Francisco. George is closely followed nowadays for his insights and observations about the global economy in general, and China and demographics, in particular. His China focus derives from a long period of observation and study that goes back to his first visit in 1994. He also opines regularly on demographic trends around the world, as well as on key issues nowadays such as Brexit, and the US and world economy. He is a regular contributor to the Financial Times, Prospect Magazine, BBC TV and radio, Bloomberg TV and other outlets. His written work and a blog can be found on his website at George’s current book, Red Flags: why Xi’s China is in Jeopardy was published in September 2018 by Yale University Press. It examines China’s contemporary economic and commercial challenges and aspirations to modernity in the light of a governance system that is a throwback to much earlier times in the People’s Republic.  His earlier books are The Age of Aging (2008), which investigated the effects of the unique experience of demographic change on the global economy; and Uprising: will emerging markets shape or shake the world economy? (2011)which examined the rise of China and other major emerging markets, and questioned controversially the widely accepted narrative that China was destined to rule the world.

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