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.
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.
Richard Phillips, a New York-based international analyst stated that it is therefore 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!
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.
According to Richard Phillips, 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.
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.
Holger Schmieding, Chief economist at Berenberg Bank in London stressed that as these issuers come under cash flow pressure due to the pandemic, defaults are likely. And the blowback from this will hit the United States banking industry squarely in the face. It bears the additional burden of holding syndicated loans to these self-same borrowers. And to make matters worse, a large percentage of these corporate bonds are directly or indirectly related to the energy sector, which has problems of its own. Industry observers estimate excess capacity is around 20% of global production.
And then, there is China. It has been overleveraged for some time. The Chinese government has been sweeping its structural economic problems under the rug of obfuscation. But hiding the problems doesn’t make them go away. And what about the EU? The EU has embraced leverage through the European Central Bank (ECB), even though its member states, especially Germany, remain wary of leveraging their currency and economies in the first place. ECB President Christine Lagarde recently announced an 850-billion-euro facility to purchase EU government and corporate bonds. This underscores the scope of structural problems within the EU.
According to Holger Schmieding, against this backdrop, lawmakers in Washington seem determined to stave off recession. This in itself may be a mistake, because it doesn’t seem possible to hold back the economic tide, no matter what level of stimulus is applied. The first rule here should be to stabilize the patient before working on recovery. With so much of the United States (and Europe) in lockdown already and more to come in the weeks ahead, there is little scope to reverse a massive decline in GDP. Instead of trying to stop the decline, the important consideration should be to make the decline in GDP temporary. Shoveling money at the problem now may seem like a good idea. But when the pandemic is deemed under control, there will be precious little in the way of resources available to jump start a robust recovery.
Valbona Zeneli, Chair of the Strategic Initiatives Department at the George Marshall European Center for Security Studies argued that if the crisis ends with the United States of America fiscally and monetarily bankrupt, the idea of a full-blown depression becomes all too real. Given the way policymakers are behaving, the United States seems set on a course to be fiscally and monetarily bankrupt when the crisis ends. According to. Valbona Zeneli, the wiser solution now might be to judiciously provide limited financial support to the needy and encourage forbearance in both the public and private sectors for the next 60 days. In other words, put the economy on hold for 60 days and provide for the needy, while the medical issues are addressed and resolved.
There was a broad-based lack of confidence in the former Trump Administration’s ability to handle these unprecedented challenges. This lack of confidence was not only applies to the experts, i.e., economic policymakers and professional investors inside and outside the United States. Confidence is truly nonexistent among the more than 50% of Americans think President Trump was not fit for office. It was true that President Trump’s handling of the crisis has failed to build confidence in anyone other than his most ardent Fox News watching fans. President Trump was busy on a daily basis to gild the lily, misstate the facts and ad lib serious policy all along the way.
Now, it is President Joe Biden not Donald Trump who is in the White House. According to recent opinion polls, President Biden’s 100 days performance is commended by Americans. The crucial issue now is not only President Biden, but also policymakers need to take a sobering look at the state of the United States economy and then proceed cautiously in a sober-minded fashion. They need to keep in mind that this is not reality television!