In a sea of red ink

There is an expanding sea of red ink as far as one can see in the context of a generalised deep recession in which most countries’ gross domestic product (GDP) is expected to decline between (-) 3 and (-) 10 per cent. This is one key feature of the global economic picture that is emerging — making the Covid-19 outbreak not only an unprecedented pandemic in modern times, but also an economic, political and leadership challenge of planetary dimension.

The response to the crisis has been an extraordinary effort by governments to mobilise monetary and fiscal policy tools to help their respective economies absorb the shock created by the freezing of almost all business activity as one country after another went into lockdown. Additional debt worth $5 trillion was already created to contain the economic and social damage worldwide by the end of March/early April. But this will not fit the bill as the severity of the crisis is becoming more obvious by the day, and pressure is growing for more support to avoid a full economic collapse.

So, one can expect that before the end of May, the overall total of stimulus packages around the world — grants, government-guaranteed loans, treasury bond issuances, expanded quantitative easing programmes — will amount to at least $9 trillion. Most of this will add to the already existing $13 trillion of negative yielding bonds. Even before the development of the pandemic, the Institute of International Finance had estimated the total global debt at more than $257 trillion and the global debt-to-GDP ratio at around 325 per cent by the first quarter of 2020. All these projections have been blown up now as corporations are piling up more debt and countries’ debt-to-GDP ratios are skyrocketing.

In Europe, Italy’s sovereign debt-to-GDP ratio is expected to grow from 130 to 150 or even 160 per cent by the end of the pandemic; France’s from just below 100 to 115-118 per cent, Germany’s from 60 to more than 75 per cent. America’s debt-to-GDP ratio will jump from 107 per cent to around 120 per cent. China, still struggling to reduce its overall domestic debt-to-GDP ratio of 300 per cent, is carefully calibrating its stimulus measures and the further loosening of its monetary policy to get its economy into at least neutral territory after the 6.8 per cent GDP decline in the first quarter of 2020. But Beijing will have to cope with an even higher level of debt. Japan’s sovereign debt — the highest in the world at 237 per cent of GDP — is expected to reach 250 per cent.

Will all this money sloshing around in the economy mean a return of inflation or higher interest rates? Definitely not in a scenario where the global economy is expected to contract by anywhere between (-) 3 to (-) 5 per cent and where the prospects for a V-shaped recovery are quickly evaporating and a more realistic forecast might be a U-shaped one, consolidating by 2022.

However, the key point here is how this global sea of red ink will impact growth prospects in the medium and longer term post Covid-19. It would be extremely unlikely to see interest rates rise over the foreseeable future considering the pattern seen post the 2008-2009 financial crisis, and the need to be able to service the huge amounts of debt incurred by governments and the private sector. Central banks will be ready to keep quantitative easing programmes alive as long as needed to sustain a recovery, limiting the constraints that high debt levels create for economic growth. This will even be the case as the urgency to repair or contain the damages created by the pandemic will put pressure on governments to not engage in any kind of belt-tightening. The preoccupation for balancing budgets will come much later into this decade.

However, as countries — and the global economy — will have to accommodate to life with high debt, one key risk is that a number of emerging and developing market economies could increase debt beyond their servicing capabilities to avoid a social and economic collapse. This is where conditional extension of maturities and calibrated write-offs will have to come into play. Not out of the lenders’ “good heart” but as the expression of smart self-interest.

A lot of uncertainties remain on how, when, and at what total economic and social cost, this pandemic will be tamed. Nevertheless, some key consequences of this crisis are already emerging:

First, the post-Covid European Union (EU) will be more divided than before as the grudges of southern countries, which are most hit by the pandemic, against the northern ones, and the refusal of EU nations to genuine financial solidarity will add up to the still alive frustrations created by the way the financial crisis of 2008-2009 was handled — in particular, the absurd diktats of austerity enforced at the time by Germany and its Dutch and Finnish allies.

Second, the pandemic will widen the gap between France and Germany’s economic might as Berlin will come out of the crisis in a much stronger position than France. This will hamper even more President Emmanuel Macron’s efforts to give shape to his vision of a more integrated Europe, and keep the Eurozone in its half-baked mode.

Third, Germany and China will be among the top countries emerging from the crisis as they will be one step ahead of the curve compared to others. The inner strengths of these two economies, their ability to mobilise resources and their strong economic and business interaction will create synergies between them. 

Fourth, there will be no Covid-19 winner in the soft power competition between Washington and Beijing, as China’s image will suffer from the consequences of its lack of transparency at the beginning of the pandemic and the Trump administration — with Donald Trump in lead role — has made its management of the pandemic a case study of ineptitude and incompetence, which would be laughable if the consequences were not so dramatic. However, when it comes to hard power, expect China — maybe not in the short term, but indeed in the medium term — to emerge from this crisis in a stronger position than the US.

But hold your breath: We are just beginning to fathom the shape of the post-Covid economic and geopolitical landscape.

The writer is president of Smadja & Smadja, a strategic advisory firm;  @ClaudeSmadja