By Claude Smadja
An expanding sea of red ink, as far as one can see in a context of generalized deep recession in which most countries’ GDP are expected to decline between minus three and minus ten percent . This is one key feature of the emerging global economic picture – making of Covid 19 not only an unprecedented modern times pandemic, but also an economic, political and leadership challenge of planetary dimension.
The response to the crisis has been an extraordinary effort by governments to mobilize 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 the other was going into lockdown. Five trillion dollars of additional debt were already created to contain the economic and social damage worldwide by the end of March-early April. But this could not fit the bill as the severity of the crisis was becoming more obvious by the day, and pressure was 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, helicopter money, government guaranteed loans, treasury bonds issuances, expanded Quantitative Easing programmes – will amount to at least nine trillion dollars. Most of this will add to the already existing thirteen trillion dollars of negative yielding bonds. Even before the development of the pandemic, the International Institute of Finance was putting total global debt at more than 257 trillion dollars and the global debt-to-GDP ratio at around 325 percent by the first quarter of 2020. All these projections have now been blown up as corporations are piling up more debt and new stimulus measures are making countries’ debt-to-GDP ratios go through the roof.
In Europe, Italy’s sovereign debt-to-GDP ratio is expected to grow from 130 to 150 or even 160 percent by the end of the pandemic; France’s from just below 100 to 115-118 percent, Germany’s from 60 to more than 75 percent. America’s debt-to-GDP ratio now at 106 percent will go up to around 120 percent. China, still struggling to mitigate financial risk and reduce its overall domestic debt-to-GDP ratio of 300 percent, is trying to calibrate its support measures and the further loosening of its monetary policy to get its economy into at least neutral territory by the end of the year, after the 6.8% GDP decline in the first quarter. Nevertheless, Beijing will have to cope with an even higher level of debt. Japan’s sovereign debt – the highest in the world at 237% of GDP – is expected to reach 250 percent. Will all this money sloshing around mean a return of inflation or/and higher interest rates? Definitely not in a context where the global economy is expected to contract this year by anywhere between minus three to minus five percent and where prospects for a V shaped recovery are quickly evaporating as a more realistic forecast might be at best 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 in the foreseeable future considering the pattern that we have seen post the 2008-2009 financial crisis and the deflationary impact that the pandemic will have on supply as well as on demand at the global level. The positive factor is that it will help 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. This will be even so as the urgency to repair or contain the damages created by the pandemic will put pressure on governments not to engage into any kind of belt-tightening. Austerity is going to be a dirty word in the coming period and the preoccupation for balancing budgets will come much later into this decade.
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 or emerging market countries could go into default as they were forced to 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.
We are not yet there as 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 will be more divided than before as the grudges of Southern countries most hit by the pandemic against the Northern ones and their refusal of genuine financial solidarity will add up to the still alive frustrations created by the way the financial crisis of 2008-2009 was handled ,and the absurd diktats of austerity enforced at the time by Germany and its Dutch and Finnish allies. President Macron is definitely right in asserting that any solution claiming to help countries such as Italy and Spain to overcome the crisis by just kicking the can of an aggravated debt burden down the road and not demonstrating genuine financial solidarity will create an existential threat to the whole European project.
Second, the pandemic will widen the existing differential between France and Germany’s economic might as Berlin entered the crisis, and will come out of it, in a much stronger position financially and economically than Paris. And Germany has suffered so far more than three times less death casualties from the pandemic than France. This will hamper even more President Macron’s efforts to impose his vision of Europe as political project on his reluctant partners to the East and to the North and this will keep the EU and the eurozone in their present half-baked mode.
Third, Germany and China will be among the top countries emerging first from the crisis as they will be one step ahead of the curve compared to other European countries – with respect to Germany – and compared to the US with respect to China. And this, despite all the structural issues that the Chinese economy is facing, and the vulnerabilities which had become more apparent in the German economic and growth model. Both Beijing and Berlin have the ability to mobilize strong resources and their solid relationship and very strong economic and business interaction – China is Germany’s Number One trading partner – will create synergies between them as they strive to revive their economies.
Fourth, there will be no Covid 19 winner in the soft power competition between Washington and Beijing. 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 the star role – has made of its management of the pandemic a case study of incompetence and incoherence – which would be laughable if the consequences were not so tragic. 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 economic position than the US, and presumably with some geopolitical gains as the pandemic has demonstrated to almost every country that it was not possible to count on the US in situations of emergencies. Whoever is the successor of Donald Trump at the White House will have a daunting task to restore American credibility.
But hold your breath: We are just beginning to fathom the shape of the post Covid economic and geopolitical global landscape.
The writer is President of Smadja & Smadja, a Strategic Advisory Firm