The Global Economy Won’t Bounce Back Soon

Authored by Daniel Lacalle,

The Danger Of Estimating Rapid Recovery

In February, the general consensus among large investment banks and supranational entities was that there would be a one-time impact on GDP in the first quarter due to the impact of the coronavirus, followed by a stronger recovery in the form of V.

The IMF anticipated a modest correction to world GDP of 0.1%, and the biggest cut in growth estimates for 2020 was 0.4%.

Those days are over.

The latest round of world growth reviews includes a reduction in growth estimates for the first and second quarters and a very modest recovery in the third and fourth quarters. Estimates of average GDP are now down 0.7%, and JP Morgan expects the eurozone to enter a deep recession in the next two quarters (-1.8% and -3.3% in the first and second quarters), followed by a very poor recovery that would still leave the estimate for the entire year 2020 in contraction. 

The investment bank also assumes that the United States will fall by 2% and 3% respectively, but with modest growth throughout the year (considerably more than consensus)…

Capital Economics estimates a year-long blow to the US economy that would cut 0.8% from previous estimates, although it continues to predict growth, but a greater impact in the euro area, with growth throughout the year 2020 to an average of -1.2%, led by a prediction of -2% for Italy. This, unfortunately, seems only the beginning of a cycle of decline that adds to the problem of an economy that was already slowing down in 2019.

The decision to close air travel and to close all non-essential business is now a reality in the world’s major economies. The United States has banned all European flights, while Italy enters a complete blockade, Spain declares a state of emergency and Franceclose all public places and nonessential businesses. These decisions are key to containing the spread of the virus and trying to prevent the collapse of health systems, and our thoughts are with all those infected. Closing travel and business has a negative domino effect on the economy. It is an important measure to prevent a rapid spread of the disease and there will be more cancellations of events and activities.

By now, at least we have a clearer picture of the severity of the pandemic, and we can discuss the economic consequences, so I think it’s important to remind readers of some important factors:

1. We cannot assume that the above estimates are too pessimistic. If we have learned anything from the history of world growth estimates, it is that most of us tend to be more optimistic than realists even in periods of crisis. Most analysts did not see a crisis in 2008 and, most importantly, most did not see it in 2009, when it was evident. It is true that 80 percent of the estimates at the beginning of any year have to be revised, but it is not because they are too pessimistic, but rather the opposite.

2. Calls for large tax packages to offset the pandemic may be futile. Allen-Reynolds of Capital Economics warned that “even if governments agreed to a broader fiscal and spending package, the economic impact would be much less than in the past, particularly if the fiscal stimulus was concentrated in Germany,” because the production gaps are almost non-existent. This is not a demand problem, but a supply shock, and supply shocks with bricks, mortar, and deficit spending are not addressed.

3. A quick recovery in the third quarter is now virtually impossible. The collapse of the developed economies is already guaranteed and will probably take us more than a couple of weeks. The collapse of emerging economies is likely to start in May and affect estimates for 2020 and 2021. All the analyzes we’ve seen so far only take into account the factors of a recession in 2020, not a crisis, let alone a major impact on the economy in 2021, but the financial implications of an already over-leveraged world add a series of credit events to an economic collapse.

4. The latest wave of downgrades is already a large-scale stimulus, rate cuts, and quantitative easing. The diminishing returns of monetary easing were already evident in 2018 and especially in 2019, with global manufacturing purchasing managers (PMI) indices contracting and growth estimates dropping significantly throughout the year. Average downward growth reviews by country averaged 20% between January and December, amid a coordinated and massive injection operation by the central bank that injected up to $ 170 billion a month into the economy (considering the Banco Popular de China (PBOC), the Bank of Japan (BOJ), the European Central Bank (ECB) and the Federal Reserve) and saw widespread cuts in rates.

5. The economic implications of a pandemic will not be resolved with a massive increase in spending. Governments will implement large demand policies that are the wrong response to a collapse of the economy. Most companies will experience a collapse in sales and the consequent accumulation of working capital, and none of this will be resolved by deficit spending. A supply shock cannot be mitigated with demand policies, which increase debt and excess capacity in sectors already in debt and swollen and do not help sectors that are experiencing an abrupt collapse in activity.

6. A forced temporary collapse must also include the collapse of the tax collection system. Governments already finance themselves at negative rates. They must eliminate (not defer) the payment of taxes to companies in the crisis period to avoid a massive increase in unemployment and a domination of bankruptcies, and facilitate working capital lines with zero rates to allow companies and self-employed workers circumvent a closure. Governments that make the mistake of maintaining the current fiscal structure or simply extend the payment period for six months will see the huge negative consequences of a closure in the next nine months.

If, as expected, the collapse spreads to more countries every week, the negative effects on the economy will be longer and exponential, and the mirage of a recovery in the third quarter will be even less likely. 

It is very likely that the closure of the main developed economies will be followed by a closure of the emerging markets, creating a shock to supply that has not been seen in decades. The adoption of massive inflationary and demand-driven measures in a shock to supply is not only a mistake, but is the recipe for stagflation and guarantees a multi-year negative impact generated by the increase in debt, the weakening of productivity, the increase in inflation in non-reproducible goods while deflation is making headlines and economic stagnation.