Valdai Club

The coronavirus problem has revealed the imbalances in the global economy. If it hadn’t been for the coronavirus something still would have to have been done to deal with the risk of recession. But now the majority of world powers have an excuse to do it in a coordinated and synchronized manner. Alexander Losev, general director of the Sputnik Capital Management Asset Management Comp., explains how they will do it in this analytical article.

Entering Global Recession 

The global economy approached 2020 in less than ideal shape: a slowing of economic growth rates, a decline in investment activity and the growth in global debt that has already reached an astronomical $20 trillion. 

In the fall of 2018 the Group of Thirty wrote in its report “Managing the Next Financial Crisis: An Assessment of Emergency Arrangements in the Major Economies” that a new global crisis was inevitable and the next crisis “may emerge in unexpected ways from unexpected sources of systemic risk.”

The provision of monetary incentives to central banks, and low interest rates, which lasted for over a decade has weakened the immunity of the financial system and has led to stock market and derivatives bubbles.

The risk of global economic recession (decline in production and zero GDP growth) was obviously increasing already in January 2020. This was borne out by the debt problems of the Chinese economy, the reduction of industrial production in Germany, Japan and South Korea in the fourth quarter of 2019, and a drop of the Baltic Dry Index from September that reflects the cost of dry cargo shipments by sea on 20 main trade routes.

The spread of the coronavirus that has led to tough quarantine measures in the majority of countries and the shutdown of entire industries and services has accelerated and aggravated all of these negative processes. The global economy is now experiencing a dual supply and demand shock. The global financial crisis has become a reality in 2020: company assets, as well as individual savings and sovereign funds are burning on stock exchange markets. The global stock market lost $30 trillion in capitalization by middle March. 

Regrettably, the reduced revaluation of all global assets has further aggravated the imbalances and problems of a global economy that is barely coping with the test for its endurance by the global spread of the COVID-2019 coronavirus. Without resolute and coordinated actions by the governments and central banks of major countries, the restoration of markets will be short-lived and a new wave of panic and sales will not be long in coming.

Since China is already restoring its companies’ operations after the quarantine, the answer to the question of how long it will take the global economy to overcome the recession depends on the actions of the advanced countries that are linked with China through commodity, production and financial chains. The coronavirus problem has revealed the main imbalances in the global economy. If it hadn’t been for the coronavirus something still would have to have been done to deal with the risk of recession. But now the majority of world powers have an excuse to do this in a coordinated and synchronized manner.

The Group of Seven

The Group of Seven (G7) is an informal association of US-led countries, which includes Britain, Germany, Italy, Canada, France and Japan. In 2019, its share in the global GDP was 29.37 percent. However, considering that these countries are playing an important role in the global management of political processes, world finances and international trade, and that their corporations have key technologies and intellectual property and set global standards, their influence on all basic economic processes is far beyond their contribution to global GDP. The leading powers need to simultaneously save themselves and take part in the redistribution of resources and assets. They have already announced their willingness to take unprecedented measures, including monetary, credit and fiscal incentives despite the risk of future inflation and their already accumulated huge debt that has cumulatively reached $47.5 trillion or 118 percent of their aggregate GDP. 

The interdependence of the leading world powers is high. Sudden deglobalization due to the shutdown of transnationals’ enterprises, the closure of national borders and markets, and blocking the export of goods and cross-border financial transactions are creating new risks for states and require prompt and large-scale measures.

It is important to bear in mind that globalization was accompanied by  financialization, that is, the permanent process of conversing raw materials and commodity markets into financial markets. This process made the raw materials markets dependent to a certain extent on the dynamics of the exchange rate of the dollar relative to other currencies, the surplus or shortage of the dollar’s liquidity and the parameters of the monetary policy of the US Federal Reserve System (FRS) that has become the main emission center for the global currency of reserves and settlements. 

In addition, the coronavirus problem has removed the issue of carbon emissions from the environmental agenda and actually disarmed the Greta Thunberg movement. Now those who stand behind her (by some estimates these are individuals and foundations that manage funds of some $40 trillion) will now have to deal with the redistribution of the global structure of property against the backdrop of this unprecedented decline in the cost of assets on strictly financial rather than environmental principles.

Measures taken by the G7

It became obvious in March 2020 that the United States is in a financial crisis that is comparable to that of 1987 and that it is entering recession. In its report on March 2020, Bank of America wrote: “We are officially declaring that the economy has fallen into a recession ... joining the rest of the world, and it is a deep plunge.” “The salvation will come if there is a targeted and aggressive policy response to offset the loss of economic activity and ensure a sound financial system,” it went on.

The United States is taking unprecedented measures because for the US administration and President Donald Trump personally the speed of overcoming this recession is a matter of the political future. To stimulate the economy, the US Congress has endorsed a package of measures worth $2 trillion. The funds will be spent to support companies, industries and individual states that are sustaining losses due to the quarantine and shutdown of business; to finance companies that have suspended operations temporarily to prevent the dismissal of employees; on direct payments of $1,200 to citizens with an annual income of up to $75,000, payments of $500 for each child in a family, on $367 billion for unemployment payments and loans to small business, and $130 billion in support for hospitals. Airlines will receive $5 billion and national security companies will get $17 billion.

The initial payment by the FRS of $700 billion on the asset buyout and $1.5 trillion on repurchase agreements were not sufficient for the US financial market. The tailspin continued; pension funds, investment and sovereign funds, as well as corporate and bank assets burned in the Wall Street fire for almost all of March.

To prevent the collapse of the financial system, the FRS is launching a new program of measures worth $4 trillion. As a result, the sum spent on supporting the US economy in 2020 will exceed the scale of Quantitative Easing (QE) in 2008-2014.

But even this huge sum will not be enough for world financial markets. The problem is that a long-term period of low interest rates, QE and the FRS’s soft monetary policy has made the dollar the most popular funding currency in the world. Commodity trading in world markets is conducted in dollars, and in international trade, the world received dollars for its goods sold in the US. So, there was no shortage of dollars. Now the situation is different. 

Dollar obligations and debts are still there but the assets supporting them have lost their value. For now the global capital market has been shut down for the quarantine. International trade has abruptly stopped: products are not being delivered, nor being paid for in dollars. As a result, there is a shortage of goods in markets outside the US. This shortage is as much as $12-13 trillion. Funds are required to service current obligations and refinancing. Until the current crisis, FRS’s transaction lines to support the exchange of dollars for national currencies had only been established with the G7 central banks and they were obviously insufficient. To partially alleviate this problem, the FRS must open transaction lines with the central banks in all leading states. The global financial system will not be stabilized as long as there is a shortage of dollars in external markets.

Britain, Germany and France have announced a willingness to support their citizens and businesses. Monetary incentives worth 120 billion euros and a program to buyout state and corporate bonds worth 750 billion euros, announced by the European Central Bank will be supplemented with fiscal measures. Until now, the financial potential of individual EU countries has been limited by the EU’s key agreement – the 1997 Stability and Growth Pact. It defined the parameters of budget and tax policies (up to 60 percent of debt ceiling and a maximum budget deficit – 3 percent of GDP). True, to abide by the pact’s requirements the national economies of its members have to grow by at least 5 percent a year but this has not been the case for over two decades. The recession caused by the spread of the coronavirus will give the leading European countries an excuse to stop fulfilling the pact’s obligations.
The German Economic Affairs Ministry announced in the middle March that it would be able to provide companies with loans of up to 550 billion euros. 

As a result, Germany is now establishing an economic security fund worth 600 billion euros. This sum includes 400 billion euros of loans to companies, 100 billion euros on special programs from the Kreditanstalt für Wiederaufbau national development bank and another 100 billion euros for the reserve on buying out companies that are on the verge of bankruptcy. Germany will also attract 156 billion euros for targeted programs by issuing bonds and channel 50 billion euros into emergency support for self-employed, small and medium companies.
 
Britain is allocating 350 billion pounds to support business. Its program on asset buyout totals 650 billion pounds. The government will pay up to 80 percent of workers’ salaries. Small- and medium-size business that are sustaining damage from the quarantine will be reimbursed for loan payments for the first 12 months and will be granted easy loans for up to six years.

France will grant 300 billion euros to support its companies and provide emergency aid worth 45 billion euros to workers and business. It will introduce direct subsidies, selective tax breaks and advance payments,  government  guarantees on loans received by companies from banks and provide guarantees to banks that channel state aid into the real economy.

Italy looks more modest compared to measures taken by the US, Germany and France. It has announced support worth 50 million euros for the production and delivery of medical devices and individual protective gear.

Japan is one of the few G7 countries that pulled through the spread of the COVID-2019. In middle February, the first stage of emergency measures was worth 500 billion yen ($4.5 billion) in the form of emergency loans for small and medium companies and the tourist industry. The Bank of Japan has launched a program of buying out EFT worth up to 12 trillion yen ($112 billion) and said it would adjust the program of buying out corporate bonds. The total support program is expected to reach 29 trillion yen $270 billion).

Canada will spend 82 billion Canadian dollars to support its population and businesses. On Thursday, the Canadian Mortgage and Housing Corp increased its program for buying insured mortgage loans from 50 billion to 150 billion Canadian dollars. On Wednesday, the Canadian Parliament endorsed a financial package worth $52 billion. Workers hit by the spread of the coronavirus will receive a monthly allowance of 2,000 Canadian dollars for up to four months.

Consequences and conclusions

The losses of the global economy from the coronavirus will be made up for by central bank emissions and government fiscal measures.

Unlike most other countries, the G7 states have the advantage of being able to print money and spend it on assets.  This is the quote of the crisis: “For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath (Matthew 25:29). The states that control the focal points of the global economic and financial structure can achieve tangible advantages at the expense of other countries. It will take the rest of the world more time to overcome the recession. Cheap oil will also benefit the majority of G7 states with the exception of the US and Canada, and will allow the economies of both advanced and developing nations to get back to normal faster.

The financial markets will remain volatile and further developments in the global economy will depend on the ability of countries, companies and individuals to service their debts, including dollar debt since a stronger dollar will only increase the debt of countries outside the US.

Part-time employment and unemployment will remain high in many regions of the world. Social and geopolitical risks will grow if no attempt is made to change the economic system. 

In the past 50 years, the global economy has been swept by four waves of debt growth. The first three waves ended in financial crises for many countries with burgeoning market economies and developing nations. The last wave of debt growth that began in 2010 has already become the biggest and most rapidly growing wave. 

For now, the world economic crisis has been suspended, but because every possible stimulating measure will be aimed at overcoming the 2020 recession,  it is becoming inevitable.  In the foreseeable future, the world will face serious and terrible non-evolutionary changes because the G7 elite are losing control over the information and digital space. Only those countries that are able to create their own world order, their own system of settlements and control over information, financial and trade flows and take part in founding a new system of global governance will be able to survive. Russia can also increase its influence, considering its enormous resources and low debt.