The COVID 19 outbreak has exposed fundamental weaknesses in the structure of the global economy that serve to amplify the damage caused by the pandemic. To peer into the abyss, just take a look at the fiscal and monetary situations in the United States. Prior to the onset of the coronavirus crisis, the United States federal government was already expected to run a trillion-dollar deficit in the current fiscal year. Right now, that same government is planning to layer on top of that pre-existing deficit fiscal stimulus of around $2 trillion, with even more debt to be added behind that. This means the United States budget deficit is likely to hit $3 trillion this year. And this is going to get greatly worsened by the Coronavirus crisis
But that number doesn’t even take into account the loss of tax revenues that are due to the decline in business activity and employment. In the 2008 recession, federal tax revenues declined by over $400 billion. That number is likely to be greater this time around. Nor does it take into account higher levels of spending on social welfare programs that are part of existing programs and do not require special “stimulus” funding to be appropriated. They go up automatically.
Holger Schmieding, Chief economist at Berenberg Bank in London argued that it is safe to assume that the federal budget deficit in the current fiscal year will zoom past the $4 trillion mark and approach $5 trillion before it’s all over. This makes the $1 trillion deficit of 2009 look quaint by comparison. The United States GDP in fiscal 2019 had been expected to come in at $21.4 trillion. Assuming there is a 15% decline in fiscal 2020 due to the pandemic, GDP looks like it will come in at around $18 trillion. That would put the projected United States budget deficit at around 28% of GDP.
According to Holger Schmieding, many economists would consider that number unsustainable on its face. But the situation is even worse than what economic theory might suggest. The fact is that there are precious few options for funding the government deficit. With interest rates about to go negative, for example, how is the federal government going to induce United States investors to pour money into financing a $5 trillion deficit?
To make matters worse, the biggest foreign investors in United States treasuries are hitting economic walls of their very own. Specifically, the Chinese economy is suffering because of a lack of foreign demand and the Gulf States are hurting because of the collapse in oil prices. China and Saudi Arabia are indispensable links in the recycling of global capital and a breakdown in that flow of funds augurs a fundamental repositioning of the United States dollar on the world market.
Richard Phillips, a New York-based international analyst with extensive financial sector experience stated that the only remaining alternative to dealing with United States budget deficits will be to continue Fed policy prescriptions enacted following the financial crisis of 2008 and intensified during the current crisis. That would translate into a potentially massive expansion of the Fed balance sheet as it stands up as “purchaser of last resort” for Treasuries, a process which has already begun.
Richard Phillips noted that funding United States fiscal deficits is a problem of one sort. Some of the more secular problems embedded in the global economy are of a different sort. For example, there have been indications of a looming corporate debt crisis in the United States for some time. Corporate debt today stands at over $10 trillion – an historically high number that is equal to more than 50% of the United States economy. To make matters even worse, much of this debt has been issued by non-investment grade rated companies and are considered junk.
Crises of such a scale can make or break leaders. Here are some tentative conclusions about potential global consequences and the political outlook in key countries of the advanced world. The pandemic is taking a particularly heavy toll on countries whose overconfident leaders trusted their own personal and political instincts more than sound scientific advice, at least initially.
According to Holger Schmieding, their countries often suffered starker consequences in terms of loss of life than other countries that are not governed by populists. This may make it more difficult for populists to peddle their fact-defying slogans in the future. However, the costs of the recession fall heavily on less skilled service workers and new entrants to the labor market, whether they live in countries governed by populists or not. This may cause new problems.
Uwe Bott, Chief Economist of The Global Economic Research Center adamantly argued that all of the major global players, the United States, China and the European Union, got their initial response to the crisis partly wrong. So did many second-league players, such as the UK and, much more badly, Russia and Brazil. An even more fragmented world could be a more dangerous place, especially if the current United States government continues on its path to weaken global institutions, as well as its own soft power.
According to Uwe Bott, in the United States, President Donald Trump is no longer the favorite to win the presidential election on November 3. If Joe Biden makes it into the White House instead, he may pursue a more centrist policy agenda. He may actually have some political leeway, as the Democrats have a good chance to win a majority in both houses of Congress. The resulting mix of more domestic regulation with a calmer foreign and trade policy may sour the economic mood among some corporate titans in the United States. But it could perhaps help pacify a very unruly sociaal situation inside the United States and would certainly come as a relief to other parts of the world.
Richard Phillips stated that with a belated decision to promote a generous €750 billion recovery fund, Germany may be helping to rein in the surge in anti-EU sentiment in parts of southern Europe. However, the future cohesion of the EU looks a little less secure now as the initial impression of insufficient solidarity in the critical months of March and April may linger.
As Uwe Bott explained it, thanks to luck and a deft policy response by Germany’s centrist coalition, the risk that a Green-left-left coalition could take over in Berlin in late 2021 has receded a little. But it has not vanished. The weakness of the small liberal FDP, which may struggle to stay in parliament, could be a bigger factor in the national power equation than the rise of the right-wing AfD, which has stalled.
It remains true that President Macron’s earlier economic reforms have strengthened the French economy significantly. But his reform momentum has stalled. There is an appreciable risk now that the reforms may not suffice to deliver a golden decade for France in the 2020s. Meanwhile, political risks remain elevated in Italy and Spain.