COVID-19 IS AN EVENT WITHOUT MODERN PRECEDENT
They say that a week is a long time in politics, but the past month has definitely been a very long time in the world of economics. All has utterly changed over the past number of weeks. When I presented at the IOD Evening Briefing series on 20th February, I alluded to the fact that 2019 was a difficult year for the global economy, largely due to the trade dispute between the US and China, and of course Brexit. I was moderately optimistic for 2020, based on the premise that President Trump would water down his trade issues with China due to the fact that he faces an election in November that he really wants to win. As a consequence, or so my logic went, he would not want to go into that election against a background of global and US economic difficulties as a result of a trade spat between the US and China. This is how things appeared to be going in the early weeks of 2020 as Trump and the Chinese developed a relationship of reconciliation and they very definitely started to dilute the dispute.
On my list of things to watch in 2020, I included COVID-19 (thankfully), but I did not highlight it as an issue that would blow the world economy apart over a few short weeks. Unfortunately, that is exactly what it has done. Back then I assumed it would be another SARS-type event. How wrong could I have been.
An economy is made up of the millions of transactions that take place every day, and the more transactions that take place, the stronger economic growth is and vice-versa. What we have witnessed over the past few weeks is basically the voluntary or mandatory shutting down of large swathes of most economies and economic activity is collapsing before our eyes.
At this early stage of the COVID-19 crisis, it is very obvious that the economic and financial impact is dramatic. Unfortunately, we do not have a lot of visibility at the moment, but signs that the Chinese economy and society are coming back to life does give some grounds for optimism.
Equity markets have become incredibly volatile over the past month and severe losses have been endured in all markets. In the year to date (up to March 27th), the US S&P 500 has lost 17%; the Dow Jones has lost 19.5%; the FTSE 100 has lost 30.4%; the German DAX has lost 26.4%; the Japanese NIKKEI has lost 16.7%; and the ISEQ has lost 31.4%. Movements of 4 or 5% a day or indeed an hour are not unusual at the moment.
On currency markets, the dollar has strengthened somewhat, reflecting the traditional safe-haven status of the dollar. Sterling has fallen sharply against the dollar and the euro. The weakness of sterling probably reflects a combination of the way in which the UK Prime minister has handled the COVID-19 crisis and Brexit. Neither has inspired confidence. However, just like equity markets, currency markets are also very volatile at the moment.
In terms of economic data releases, we are now starting to see the first indications of the impact in March. The Purchasing Mangers’ Index (PMI) is a monthly survey of business confidence in both manufacturing and services. A reading above 50 means that more businesses expect growth than contraction, and vice-versa for a reading below 50.
• In March the composite PMI in the US fell from 49.6 to 40.5; the UK index fell from 53 to 37.1; and the Euro Zone index fell from 51.6 to 31.4. These declines are without precedent and are truly dramatic. Within the composite indices, services are taking the biggest hit as many service activities are being shut down.
• The German Ifo survey of business confidence in March fell from 96 to 86.1.
• Initial jobless claims in the US increased by 3.28 million in the week to 21st March. This is the largest weekly increase ever recorded, with the previous highest increases of 672,000 in 1982 and 659,000 in 2009.
The official policy response around the world has been quite dramatic and inevitably there will be more of the same over the coming months. The following is a sample of the official actions already taken or being considered:
• The Bank of England has cut interest rates from 0.75% to 0.1% and has committed to a further £250 billion of official bond purchases;
• The UK government has introduced a massive fiscal stimulus package;
• The US administration has got approval for the largest ever fiscal stimulus package seen anywhere, totalling $2 trillion;
• The Federal Reserve has cut interests to zero in two emergency moves. The last time there was an emergency rate cut in the US was in the immediate aftermath of the collapse of Lehman Brothers in September 2008. The US central bank is also supplying massive liquidity to the markets;
• The German government has announced a fiscal stimulus package of €156 billion (equivalent €10% of GDP);
• The EU has effectively ditched the EU fiscal rules. I argued at the IOD briefing in February that the EU would have to re-visit those rules in any event in 2020, given the extreme weakness of the Euro Zone. COVID-19 has obviously increased the requirement for such action;
• The EU is giving consideration to the issuance of an EU-backed ‘Corona Bond’. This would help control sovereign risk, which is very important in the context of countries like Italy and Greece, but the Germans are opposed; and
• The EU is giving consideration to utilising the precautionary credit line available under the European Stability Mechanism (ESM). This credit line is intended to help countries with sound economic fundamentals, which are affected by an adverse shock beyond their control. This mechanism would be equivalent to around 3% of GDP, but this could be increased.
The aforementioned is just a sample of the monetary and fiscal policy response seen to date. The key problem is that the global economy was already quite vulnerable before COVID-19 hit, so the impact is proving pretty dramatic to date. The other problem is that given the pre-existing low level of interest rates everywhere and the liquidity that has been injected into the world economy over recent years through quantitative easing (QE), the monetary policy armoury was already limited. Consequently, there is a massive onus on governments to use aggressive fiscal policy measures. Thankfully this is now happening to varying degrees around the world.
The official policy response to date is impressive and does suggest that policy makers stand ready to do whatever is necessary to support global banks, households and businesses. It is imperative that what is currently an economic shock and crisis, is not allowed morph into a banking crisis, which was the distinguishing feature of the 2007/2008 crisis. That is why it is essential that central banks pump liquidity into the banking system and that loan default rates are controlled through government support for businesses and households.
The global economy will see a massive contraction in activity in the second quarter, but the timing of recovery will depend on how quickly the virus is brought under control. This is a medical uncertainty, rather than an economic one. It will be important for policy makers to do whatever is necessary until a vaccine is developed.
There is likely to be a number of longer-term implications flowing from the current crisis. The Brexit transition period will simply have to be extended, but the Prime Minister is, in a logic-defying manner, ruling this out; there will be political fallout, affecting those who did well in handling the crisis and those who did not; there will be a massive government debt legacy; there is a risk of an even greater move towards economic nationalism, with tighter borders; food security and safety should become more important; and the model of capitalism will likely come under serious scrutiny. Proper investment in health services will have to be given priority everywhere. One hopes that out of the current crisis, some positive lessons will be learned.
For the Irish economy, thousands of jobs are currently being lost and economic activity is effectively grinding to a halt, with the exception of public services, and the very important food-supply chain. I hope at the end of all of this, whenever that comes, Irish people will once again realise the importance of domestically provided food that is produced to the highest safety standards possible. Food safety standards and security are just so important, but unfortunately it takes a crisis such as this to hammer that message home.
It is pretty obvious the economic devastation that is being rained down on Ireland at the moment. Tourism is the biggest casualty; non-retail grocery is probably next in line; but most sectors of the economy.
The imperative for policy makers in Ireland is to ensure that those businesses that were viable before COVID-19 struck, will be around to pick up the pieces once life starts to return to normal. For example, pubs, hotels and restaurants will be essential to rebuild the tourism sector, but without strong official support, many will not be in a position to re-open. The reality for many businesses is that cashflow has collapsed, but many costs are still there. This is not a sustainable situation.
The banks will need to support businesses through this; the Revenue Commissioners will have to give breaks on VAT and other tax payments; commercial rates will have to be frozen and central government will instead have to provide funding to local authorities; rents will have to be frozen; and businesses will have to be subsidised directly to keep cashflow alive.
It is vital to recognise that while households will have to be supported, without viable businesses it will not be possible to rebuild our economy. The Irish government package of €3.7 billion is a step in the right direction, but I strongly suspect much more will be needed over the coming weeks.
COVID-19 will eventually pass and what we have to ensure is that businesses and households are kept alive both literally and metaphorically.