Covid-19 is set to delay the recovery of an already sick economy
The pandemic cannot be viewed in isolation, but as an unexpected contagion of a world economy already in the ICU
The economic and humanitarian devastation being wrought by the Covid-19 crisis across the world is being treated by the media and policymakers as an exceptional event.
Nearly all of the public domain estimates of its potential economic impact are based on lockdown calculations of the various sectors and, in some cases, the medical costs. However, the impact of the coronavirus pandemic cannot be divorced from the existing national and international macro-economic environment. It also cannot be separated from macro-economic policy options and their potential unintended consequences.
The reporting on the crisis masks a concerning fact: when the pandemic erupted many economies were already on a downward trend. This may deepen the impact of the crisis and prolong the time it takes for most countries, SA included, to recover.
It helps set the scene to draw on the lessons and magnitude of major recessions and depressions over the past century, starting with the Great Depression, which began in 1929. This caused untold human tragedy by reducing incomes in the US by between 6% and 12% annually as that shock played itself out.
The notable causes of that shock were price meltdowns in the stock and housing markets, massive bank failures, a devastating drought and poor policy. The latter included higher interest rates, contractionary fiscal policy and a trade war.
The Japanese “lost decade”, which started in the early 1990s and is yet to play itself out, was similarly caused by price meltdowns in the stock and housing markets, bank failures and poor policy. The latter in this case was dominated by policy that was “too little, too late”.
It is this rich cocktail of economic contraction and contradiction that was the macro-economic environment in which the coronavirus pandemic found itself
The third important economic crisis was the dot-com bubble of 2001/2002. It was caused by a stock and housing market bubble. The end of the bubble was characterised by a price meltdown in the stock market and policy that was “too much, too soon”. It was these policy responses that were the fuel for the financial crisis that started in 2008, when there were also massive stock and housing market bubbles.
Again, the end of the bubble resulted in price meltdowns in the stock and housing markets and massive bank failures. It also resulted in many countries breaking the rules of fiscal prudency, and quantitative easing (QE) funding this fiscal imprudence. In the US this increase in QE amounted to $3.5-trillion; in the eurozone it was €3.5-trillion.
So what do these historical examples have in common with what we are experiencing now? It was clear by the end of last year that most countries were on the verge of recession. The evidence can be seen in falling or negative GDP growth supported by various indicators, including business confidence, consumer confidence, the purchasing managers index and the Baltic dry index (which is indicative of world trade).
GDP growth in January 2020 was about 0.4% in Germany, 0.5% in France, 0.4% in Japan and 1% in the UK. Though China appeared fairly strong at 6%, the numbers were dropping month to month, which was the case in the US as well, where 2.3% was noted at the beginning of the year. In SA there was only 0.2% growth in 2019 and we began the year technically in recession.
Stock markets can be expected to reflect underlying economic conditions. The economic outlook determines potential sales and profits. These influence corporate values and dividends and are reflected in stock prices. Strikingly, this was not always the case. Stock markets boomed throughout 2019 — the US, Germany, France, China, Russia, even the UK (in the face of Brexit) and Japan had markets that were irrationally buoyant.
The funding for this exuberance? The ongoing policy-driven economic stimulus in the rich world.
It is this rich cocktail of economic contraction and contradiction that was the macro-economic environment in which the coronavirus pandemic found itself. The immediate consequence was a stock market meltdown of similar proportions to previous economic shocks. The Dow Jones drop was similar to the financial crisis and the Nasdaq to the dot-com bubble.
What many countries around the world — and SA for sure — are likely looking at is another financial crisis ... coming as it does on the heels of a declining global economy, may prove to be more devastating than the other big financial crises of our times
The UK, Dutch and SA market drops were very similar to those in the financial crisis. This heralded the onset of macro-economic shocks that would reinforce the coronavirus impact, with devastating economic consequences. The world was poised on the verge of an economic meltdown not just because of Covid-19 but also because countries had already entered recession then suffered a devastating stock market meltdown. All of this left people feeling very poor.
Enter governments with necessary policy responses and stimulus packages. In the US these are currently estimated at $2.4-trillion and it appears that this will be funded through QE. This should be seen in contrast to the $3.5-trillion QE between 2009 and 2014 after the financial crisis. Current eurozone plans include €750bn with an opaque funding mechanism. This must be compared to the €3.5-trillion QE between 2009 and 2019.
The immediate response to this policy stimulus? A massive stock market rebound. It was the policy responses to the dot-com bubble that fueled the financial crisis. It was the policy responses to the financial crisis that fueled the stock market bubble of 2019. You can draw you own conclusion about what the policy response to the coronavirus is doing to stock markets.
To date, the policy responses to Covid-19 are smaller than those to the financial crisis. These have, however, only been over the past three months. The policy responses to the financial crisis continued for nearly a decade. The conclusions are surely self-evident.
As a footnote, any forecast of the direct economic impact of the pandemic is going to be wrong. There may, however, be some merit to making a minimum estimate. A simple “back of an envelope” calculation can be done on a sector-by-sector basis. Imagine a five-week lockdown in which the main sectors contract, over a quarter, by, for example, 45% in mining, 35% in manufacturing and 35% in tourism.
Imagine further that all sectors recover over the course of a year to their level at the beginning of 2020. There will be an annual drop in GDP of 10%. This minimum estimate is little different to the worst international economic crisis of all time — the Great Depression.
By looking at the pandemic in isolation from both short-term trends in local and international economies and existing structural weaknesses in international economies, we risk not being properly prepared for the magnitude of what we are facing. What many countries around the world — and SA for sure — are likely looking at is another financial crisis, this time brought on by a natural phenomenon, a virus. But this event, coming as it does on the heels of a declining global economy, may prove to be more devastating than the other big financial crises of our times.
This makes it imperative for the government to stimulate the economy to recover as soon as possible and limit the potential damage of this crisis, by introducing policies that support local businesses and promote the rebuilding of local industries.
• Standish, a former UCT Graduate School of Business economist, is founding partner at StratEcon. This article is based on a talk he gave to alumni of the UCT GSB in April.
Would you like to comment on this article or view other readers' comments?
Register (it’s quick and free) or sign in now.
Please read our Comment Policy before commenting.