During these days of confinement I have been reading the book Crisis Economics written by Nouriel Roubini y Stephen Mihm in 2010. Roubini analyses in detail the most relevant economic crises experienced in our recent history since the 19th century and the economic policies applied to contain them. Although each crisis is different, there are certain triggers that have been repeated throughout history such as asset bubbles and debt overhang which have led governments and central banks to intervene by applying expansionary monetary policies combined with large fiscal stimulus measures to re-incentivise consumption and public spending. All this in order to relaunch economic growth.
In this article I would like to present the reflections of Nouriel RoubiniThe European Commission has published a report on the possible scenarios and future trends that we may encounter in this decade. Today, more than a decade after the great financial crisis of 2007-2009, we are facing a very fragile global economic situation that continues to have the structural risks and imbalances inherited from the economic policies applied in the last decade. The COVID-19 crisis has only intensified and accentuated these imbalances which, if not corrected at some point in this decade, could lead to a major economic depression. In 2020, the fiscal stimulus packages of governments and central banks globally are likely to be of such a magnitude that even if we end up in a severe economic recession, they will prevent a major depression.
Possible future economic scenarios may be affected by the following trends:
1.- Public deficit: debt and spill-over effects
The response of governments and central banks to the COVID-19 pandemic involves a massive and unprecedented increase in fiscal deficits to over 10% of gross domestic product (GDP), at a time when public debt in many countries is at almost unsustainable levels. The economic indicator -ratio- Total debt/GDP globally in 2019 was 322%. In 2020 this ratio will be close to 350%. Spain closed 2019 with a ratio of 95.5%. In Spain, forecasts for 2020 envisage a potential scenario of an annual GDP fall of 10%, the public deficit would reach 12% (2.7% in 2019) and the total debt/GDP ratio would be around 120%. The COVID-19 pandemic has directly impacted the labour market with a significant increase in unemployment and loss of private sector income with debt within the private sector that in many cases will be unsustainable, increasing credit and loan defaults and business bankruptcies. Rising global unemployment combined with significant increases in debt in many countries and falling GDP reflect a scenario of deep economic recession.
2.- Demographics and health coverage
The COVID-19 crisis has shown us the imminent need to increase public investment in health infrastructures and medical coverage of the population. Even more so when we consider that in developed countries we have an ageing population. States and governments have an implicit present and future debt in the financing of the so-called "welfare state", which includes the financing of social support structures (social security, health care coverage and infrastructure, and pensions). This growing implicit debt means a further increase in the public deficit.
3.- Increased risk of deflation and subsequent stagflation
In addition to a very high level of global debt, we face a demand shock for goods and services (productive overcapacity and idle machinery), a labour market with high levels of unemployment and a collapse in the price of raw materials such as oil and other industrial metals.
It is the perfect storm for a "debt deflation" scenario, based on the theory of economist Irving Fisher, according to which the real value of debt rises due to deflation, increasing the risk of default on individual and corporate debt and the consequent insolvency of businesses and companies.
Central banks will focus their efforts on combating deflation and controlling inflationary risks stemming from massive debt accumulation, using less conventional and more impactful monetary and fiscal policies. In the short term, central banks will continue with an aggressive process of monetising fiscal deficits, Quantitative Easingto avoid economic depression and deflation. This policy has been applied since the great financial crisis of 2007-2009 (interest rates at historic lows and an increase in the monetary base but with anaemic global GDP growth). The growth of fiscal deficits globally and expectations that they will continue to be financed with more debt in the future may create inflationary scenarios that combined with economic stagnation would cause stagflation.
4.- Digital disruption of the economy
With millions of people losing their jobs, or working for reduced wages, the economies of the 21st century will see a widening gap between rich and poor social classes. To protect against future breaks in production chains, advanced economies will internalise production from low labour cost countries to higher labour cost domestic production chains. But this protectionist movement, rather than helping local workers, will accelerate automation processes in companies, putting even more downward pressure on wages, generating social discontent and encouraging populist and nationalist movements.
5.- Deglobalisation and fragmentation of economies
The COVID-19 pandemic is accelerating the trend towards balkanisation and fragmentation of economies, a trend that was already underway in the last decade. The United States and China will decouple more rapidly, and most developed countries will adopt protectionist policies to protect local industries and workers from global disruption. The post-pandemic world will be marked by severe restrictions on trade in capital goods, services, capital, labour, technology, information and data. This is already happening in the pharmaceutical sector, medical equipment goods and food sector where governments are imposing export restrictions and other protectionist measures in response to the pandemic.
6.- Environmental crises and climate change
Another risk that cannot be ignored is the risk of environmental crises which, as the Covid-19 pandemic is showing us, can have a more devastating economic effect than the great financial crisis of 2007-2009. Recurrent epidemics (HIV since the 1980s, SARS in 2003, H1N1 in 2009, MERS in 2011 and Ebola in 2014-2016) are, as in the case of climate change, catastrophic events generated by humans under conditions of low health and sanitary standards, and which are spread by the great interconnectivity of a globalised world. In the future, new pandemics and the destructive effects of climate change can be expected to become more frequent, more virulent and more costly.
Conclusions
The trends listed above may represent the perfect storm for economies to be plunged into phases of deep economic recession during this decade. To minimise, mitigate or try to solve the problems raised, we need globally very competent political leadership to stimulate a more inclusive, cooperative and stable international order, as well as highly coordinated economic, monetary and fiscal policies among central banks. In this decade we are going to find exorbitant fiscal deficits in some countries whose governments will finance them mainly with more public debt as direct and indirect tax collection decreases. With reference to Europe, the European Central Bank is the largest investor in public debt that will end up financing these deficits. In this decade it is not unreasonable to think that some countries in Europe will have to restructure their public debt and ask for a bailout from the relevant authorities. History repeats itself with new crises, but it is in the nature of human beings to overcome them. Every crisis is different, but there is a solution.
Partner-Senior Advisor of Beka Finance