The Corona Catastrophe
August 28, 2020
By: Shayan Siddiqui
Governments throughout the world have been trying to solve the plethora of problems that have arisen, especially those concerning unemployment and healthcare. In response, interest rates throughout the world at a near 0% and in much of Europe they are negative and it is projected to stay that way. In the USA, the federal budget is expected to run a 3.7 trillion dollar deficit, increasing the national debt to GDP ratio to a projected 101%. Likely, this is going to increase as both the Republicans and Democrats are looking to pass more relief measures valued in the ballpark of 1-3 trillion dollars. To the north, the government of Canada is expected to run a 250 billion dollar deficit. This calculation caused the rating agency, Fitch, to downgrade the rating of Canadian bonds from AAA to AA+, which is a first-time occurrence in the past 30 years. Additionally, the German finance minister asked to borrow a further 70.5 billion dollars, expanding their deficit to 250 billion dollars for the year. It is important to remember that the mounting debt that governments have taken upon themselves in order to better their citizens will eventually need to be paid off one way or another.
On a brighter note, the stock market is doing relatively well, with a strong rally since late March and the S&P 500 breaking its current all-time record. Almost all other indexes throughout the world are on track to rise past their pre-COVID levels. The only major exceptions are the Hang Seng Index which has been plagued by volatility due to political instability, and the FTSE which has been affected by Brexit uncertainty. Blue-chip companies continue to return profits, even the unlikely ones like Tesla, who is now eligible to join the S&P 500 because it has had a full year of fiscal profits. However, one must be reminded that the stock market is not the whole economy and these large publicly-traded companies are destined to pass this pandemic. Even the S&P 500, the hallmark of publicly traded corporate America, is only at its all-time high due to the surge in prices of tech stocks. With Apple hitting a 2 trillion dollar valuation and all other major tech companies (Amazon, Microsoft, Google, Facebook) seeing growing stock prices, they contribute 20% of the weighing of the index.
What we need to worry about are the local businesses, like your mom and pop shops; who make up to 40-50% of GDP in most economies. These businesses did not have the necessary systems in place to survive a four-month shutdown. There is no question that these businesses will not be able to survive the second wave of shutdowns as we are seeing currently throughout the world. Bankruptcy is a challenge most of these businesses are facing, which will only exasperate the current collapse of the commercial real estate market. However, the major banks are ready to face this conundrum. For example, JP Morgan set aside $8.9 billion to cover loan losses, mirroring other major banks' decisions to stay liquid. No one knows what will happen next year, it is all uncertain for now.
If there is a collapse of small businesses, millions would be out of work, thereby creating a large population of people unable to pay mortgages or rent. This could be remedied by government intervention via expanding existing unemployment benefits and mortgage help for landlords. However, this would make central banks dig an even larger hole, further putting into jeopardy the bond ratings of countries. If the government does not take this route, the results will put a strain on the banking sector. The residential housing market will slump, which could cause another repeat of 2008 where we will have to bail the banks out again. The global financial system is at risk of being shaken to its very core unless we can inject some pessimism into the banking world, where they should switch to more liquid asset options in preparation for the worst.
After COVID-19’s strain on the healthcare system has passed (with no recurring waves), governments should focus on restarting their economies, and they must reduce their debt to GDP ratio; around 77% for developed economies and 64% for emerging markets. This could be achieved in two ways; either by reducing debt or increasing GDP.
Reducing debt would be unfavourable in our current situation as the most common ways typically involve either lowering interest rates, increasing taxes, or spending cuts. Our interest rates are already near zero and not many countries want to introduce negative rates. The reason why lowering the interest rates works is that the low rates encourage individuals and businesses to borrow money to spend on goods and services, which in return creates jobs and increases tax revenue. Cuts to government services, in our current climate, will be hugely unpopular. Raising taxes might look lucrative, however, the extra taxes raised will be offset by a loss in GDP due to capital moving out of a country to tax havens.
Due to the aforementioned reasons, I would suggest trying to increase GDP. This could be done in several ways. We could go the way of FDR and attempt a massive infrastructure project. This would be good in the short term as people will become employed and government expenditure will go up, which are components of GDP. However, I personally would suggest increases in spending to the healthcare and educational sectors. Improving healthcare would overall increase economic output as workers will be sick for fewer days and may be able to work more years. Improving the education system to better equip students for the future, especially in the oncoming fourth industrial revolution, will create workers who can perform to the needs of a technology-driven economy. These options are more long term and the benefits won’t show immediately, which is a hard sell to most governments. But the effects a more educated and healthy populous in an economy can have is to the tune of not billions, but trillions of dollars.
All in all, the full economic impacts of the COVID-19 pandemic are unknown as we are not fully out of lockdown, and with what looks to be a second wave coming, are still bracing for impact. Governments must balance both economic recovery and human lives in order to create the best possible future for all.