It has been said that generals are always fighting the last war. Are governments and central banks, in their rush to deploy big bazooka stimulus packages, falling into the same trap?
In contrast to the Global Financial Crisis, where institutions such as the UK’s Northern Rock and Lehman Brothers in the US had to fail before policymakers were able to do “whatever it takes” to avoid global meltdown, the policy response to global coronavirus crisis has been swift and seemingly at scale – approximately $4.5 trillion and growing.
But, much of this stimulus is made up of loans and loan guarantees which may never be taken up. With the world economy already staggering under an unsustainable mountain of $250 trillion of debt, or 318% of global GDP, is the cure for our embattled economy yet more unaffordable debt?
This is a public health crisis which is forcing governments to close major swathes of economic activity in order to combat the spread of the virus. Trying to stimulate economies when we are simultaneously shutting them down appears at odds.
Governments should stop fretting about Wall Street and supporting financial asset prices and focus on three key issues:
- First, how can they meet the needs of the majority of the population who depend on a fully functioning economy to survive day by day?
- Second, how can they ensure that those parts of the economy which are going into deep freeze can be readily revived once the crisis is over, especially if consumer confidence is shot?
- Third, if we are going to use government balance sheets to fund extraordinary measures to deal with the crisis, how will this massive build-up of debt be serviced once the crisis is over?
One of the biggest reasons why the economic impact of the coronavirus is so problematic is that the global economy was already in fragile state going into this crisis. Unorthodox monetary policy post-2008 may have saved us from another 1930 style depression, but the underlying structural weaknesses and imbalances which precipitated the GFC were never addressed. Instead, we chose to “kick the can down the road” by reflating the debt bubble and deferring the inevitable reckoning. Not surprisingly, growth, even before the crisis hit, was anemic, with many major economies already virtually in recession.
Now, the COVID19 crisis has exposed a myriad of weaknesses in the global economic model, not least the lack of resilience and redundancy in the system.
The hidden risk of the “just in time” economy is not only about global supply chains that can choke up the moment a component from the other side of the world arrives a minute late. It is about an economy where half of all Americans have no real savings and live paycheck to paycheck. An economy where most businesses are run with minimal capital buffers and highly leveraged balance sheets. An economy where public companies have largely prioritized share buybacks over investing in increased production capacity. An economy made of businesses run so lean, they have limited ability to cope with unforeseen economic shocks. An economy which is so highly tuned, that the slightest disruption in the flow of money round the system risks a chain reaction of personal and corporate failures with devasting consequences for society.
In the short term, governments will have to set aside questions about moral hazard and find effective ways of paying people not to work, and quickly, if we are to avoid a cascade of growing defaults, unemployment, homelessness and social unrest. But very soon governments will have to address the more difficult questions about whether it is right to bail out questionable business models and whether shareholders who benefited in the past from generous dividends and share repurchase programs ought not to sustain some of the pain. And the bigger question still, of whether this is not the time for an activist state to finally reset the rules of the game.
Many believe that governments missed a key trick in 2008 in not using the bank bail-out to reform the capitalism system once and for all. They now have a second chance and will pay a heavy price, economically as well as politically, if they don’t take it.
In return for government assistance, tough conditionality should apply. Cash should only be granted in return for equity and with it greater stakeholder accountability in governance, improved employee rights, commitments to repatriate activities from low tax or weak employee rights jurisdictions, not to mention from countries with weak environmental standards. Companies also need to commit to sustainable policies including more resilient capital structures, offering a better balance between equity and debt, and more flexible supply chains with greater redundancy.
Next, once we emerge from lockdown, we will need to get the economy back on its feet. With interest rates at zero or negative and central banks the default buyer of bonds, that may mean further fiscal stimulus, and even more radical measures such as forgiveness of a substantial chunk of personal and public debt, not least the $1.5 trillion student debt that is weighing in the US consumer. Otherwise, we risk a massive debt overhang choking off any hope of a sustainable recovery. De-leveraging, after all, is the story of future growth lost.
Most advanced countries have universal health systems which guarantee COVID19 victims will receive the best possible care irrespective of income, but what of the US where a father and young daughter quarantined after coronavirus exposure allegedly face “a pile of medical bills” adding up to $3,918, and some 44 million people have no health insurance at all? This and the lack of comprehensive sick pay is no longer just a social and political issue in the world’s largest economy – it is a fundamental human rights issue at the core of the social contract between the individual and the state.
There are also intergenerational problems which will need to be faced. Should the young, who are allegedly low risk, have to pay so heavily in lost educational, career and social opportunities to avoid deaths among the senior cohort, many of which might have been avoidable if our governments had been better prepared?
First we need to win the war with this virus. Then, and equally important, we need to win the peace. To do that, we will need to make the hard policy choices to build a more sustainable, equitable and robust ‘system’ for our children.