Are we heading into another Depression? | Free to read
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The Covid-19 lockdowns have led to the largest rises in unemployment since the 1930s. The Financial Times asked leading economists and market analysts what to expect and what might be done to avert turmoil
A fumbling fragmentation looks more likely than another Depression
Robert Zoellick, former World Bank president and author of ‘America in the World’
The deep economic dive has shocked people. The pace and extent of recovery depends on the discovery and availability of treatments and vaccines. I suspect we will see slow revivals, episodic setbacks and costly adjustments — but not a decade of economic disaster. Many small businesses and some storied brands will not survive, while skilful adaptors and disrupters, especially in the digital economy, will emerge stronger. I will be watching for signals of confidence from consumers, businesses, and societies.
The Depression caused more than economic pain. It metastasised to a loss of faith in democracies, the triumph of ideologies of hate, a turn to demagogues, a breakdown of international trade and finance and, ultimately, the second world war.
Today, the US, the innovator and guarantor of the late 20th-century order, is recklessly deconstructing its own framework. China, which rose successfully within this supportive international system, threatens it from within while exploring an alternative design based on tributary states. Ageing Japan, fearful of China and uncertain of America’s reliability, treads cautiously. India drifts back to the diplomacy of “strategic autonomy”. Russia manipulates for external advantage while withering internally. The EU struggles to preserve internal coherence while waking painfully to dashed dreams of a postmodernist international legal order. Britain debates with itself. Middle-weight economies struggle to calculate where they will fit within the fractious new world. Billions of people in developing countries do the best they can.
This picture of fragmentation reveals spectres of dangers, old and new. The world needs biological security and advances in biotechnology. People demand inclusive economic growth. Environmental and energy challenges loom. We are just beginning a huge digital transformation. Would-be regional hegemons still seek weapons of mass destruction and terrorists want to wreak devastation and fear. Democracies wonder about the future of freedom. The world weighs the future of China. Gloom is not, however, destiny. Crises test the resilience of nations. Leaders in key countries — and officials and entrepreneurs working across states to achieve practical results — will set the course. These actors require public support. Speaking for the US, Abraham Lincoln said long ago that “public opinion in this country is everything”. It still is.
A V-shaped recovery is on track
Mike Wilson, Morgan Stanley’s chief investment officer
While 2020 has been an unusual year to say the least, I would argue that financial market behaviour has been quite predictable. The pandemic led to a sharp drop in the market, record unemployment and, tragically, 100,000 deaths thus far in the US. But it also prompted policymakers to respond with unprecedented support. The US Federal Reserve is now on track to expand its balance sheet by 38 per cent of gross domestic product over the next 18 months to $12tn, or twice as much as it did after the 2008 financial crisis. We project that fiscal spending plans will result in US deficits this year approaching 25 per cent of GDP, a level not witnessed since the second world war.
Though Covid-19 came out of the blue, recessions are never caused by a single event. Instead, they are the result of excesses that have built up in the real economy. With the prior expansion lasting a record 10 years, there were plenty of excesses by the time 2020 rolled around. The pandemic was just the trigger for a recession that was already approaching. In fact, markets had already been trading defensively for years, with most individual stocks in a bear market. As usual, when the downturn finally arrived, the bear market ended with a sell-off in March.
Historically, economies frequently experience a V-shaped recovery after a recession. The severity of this particular recession, combined with the unprecedented policy response, makes it unlikely we will see anything but a V-shaped recovery this time. Equity markets thus have recovered appropriately, with the S&P 500 up 35 per cent from its March lows. In fact, on many metrics we track, the market recovery looks almost identical to what happened after the collapse of Lehman Brothers. Just as in 2009, most investors naturally remain very sceptical.
It appears that the US economy is reopening without significant increases in Covid-19 cases. This is encouraging and if cases do rise again in a second wave, the healthcare system should be better prepared to respond, making another lockdown less likely. Such an outcome should mean the unprecedented fiscal and monetary stimulus boosts the economy rather than just making up for lost ground. With this framework and the past as prologue, we expect the rally to continue and broaden out to the more cyclical parts of the equity market, where valuations remain inexpensive.
Without a global recovery plan, demand will stagnate and inequality will increase
Mariana Mazzucato, professor and director of the Institute for Innovation and Public Purpose, University College London
Covid-19 has brought economies to their knees. The question is how long and how severe the resulting recession will be. The answer depends on the quality and quantity of global stimulus packages. To work, they must address both demand and supply, delivering income to the most vulnerable through well-structured universal basic income policies or national job guarantee schemes, and assistance to companies to get back on their feet as well as providing a bold, green direction for investment.
Economic growth will also depend heavily on the speed at which we can find a vaccine, manufacture it at scale and make it globally accessible. The World Health Organization initiative to ensure worldwide sharing of all Covid-19-related knowledge, data and technologies by making a pool of Covid-19 patent licences freely available to all countries is a great move in this direction. The virus can only be defeated with truly collective intelligence.
In developed economies such as Japan, the EU and the UK, government stimulus has been large but mainly reactive and the same levels have not been matched elsewhere, especially in developing countries. Given the global nature of the economy, without a truly global recovery plan, demand will stagnate. Even worse, inequality, which has made the crisis worse than it had to be, will only increase.
While assisting citizens and businesses is the right thing to do, the structure of that aid matters. Loans and mortgage holidays, which only delay interest payments, risk increasing private debt, already at record levels. True debt relief for the most vulnerable individuals and families could avoid this. We need policies that are not only reactive but also strategic, bringing us closer to an investment-led global Green New Deal. Bold plans to create carbon-neutral cities and regions could foster creativity and innovation — especially now that many have rediscovered the joys of walking and biking. Social, organisational and technological innovation could help change how we eat, how we move, and how we build, spurring a green transformation. Conditions attached to bailouts of the most polluting industries, from steel to airlines, can make this happen quicker.
Let’s remember 2020 as the year we rediscovered the need for strong global health systems and the world avoided a new Depression with a Green New Deal and an investment-led recovery.
Expect Europe’s biggest peacetime recession in nearly 100 years
Erik Nielsen, UniCredit’s chief global economist
Attempting to forecast the economic effects of the lockdown is truly a fool’s game. Never before have we seen a man-made recession of this scale, nor have we seen policy responses of this magnitude to cushion the impact on people’s livelihood. On balance, however, I expect the biggest peacetime recession in almost 100 years.
The initial collapse in economic activity appears to be coming to an end. Depending on the severity of the lockdown in individual countries, preliminary indicators suggest that we are now some 15 to 30 per cent below GDP levels at the beginning of the year. Southern Europe and France have suffered most; northern and central Europe somewhat less — and countries such as Russia and Turkey still less so far, as the virus spread there later.
The next three months will see an easing of lockdowns throughout western Europe, first leading to a stabilisation of activity — at very depressed levels — followed by some growth and areas of strong rebound. The biggest risk is a flare-up of new infections as rules are eased, and another round of lockdowns. This would then change the base case of a “Nike logo-shaped” GDP growth trajectory into a “W-shaped” one. Following the bounce off a deep trough, I expect a long, gradual recovery as we learn to live with the virus. Until an effective vaccine becomes widely available it is difficult to imagine a return to normality or to pre-crisis GDP levels.
In aggregate, I expect eurozone GDP to contract by about 13 per cent this year. Even though 2021 will probably see impressive growth rates, the GDP level at the end of next year will still be some 4 per cent below the pre-crisis level. Central Europe will probably suffer slightly less and pre-crisis GDP levels could be broadly restored by the end of 2021. While Turkish and Russian GDP will drop by about 5.5 per cent this year, assuming the external financing picture does not deteriorate further, Turkey will probably bounce back stronger in 2021, while Russia will take considerably longer. Once we are through the crisis, I suspect we will have suffered a GDP drop on the same scale as during the 1930s, but followed by a faster and more robust recovery.
For Asia, at least, this is not the Depression
Trinh Nguyen, senior economist for emerging Asia at Natixis
Economic data is frightful right now — from retail sales to exports, growth engines are sputtering sharply. After a supply shock from China’s factory closures in February, Asia is confronting both domestic and external demand shocks in the second quarter. Mobility restrictions, especially in economies dependent on domestic demand such as India, Indonesia and the Philippines, have suppressed already shy spenders. Even in countries with “normalised” mobility, self-restraint has left shopkeepers wanting. Missing tourists, falling export sales, weakening remittances and cautious foreign investors have put income pressure on current account deficit economies, and even excess-saving ones such as China, Singapore and Thailand.
It is easy to feel depressed. Asia’s GDP contracted in the first quarter, led by China’s sharp fall, and Q2 will be worse as many economies extend lockdowns. China scrapping its GDP target means we should not count on the country to stimulate regional demand. At the same time, Asia’s high dependency on small and medium-sized enterprises for employment will probably result in worse labour market conditions and therefore purchasing power.
After a slow start, some Asian economies are stepping up support. India increased fiscal support by 2.7 per cent of GDP with funds for lower-income households. The Philippines is proposing an additional $26bn stimulus. Indonesia is adding $43bn to soften the impact on SMEs. South Korea’s New Deal will create jobs and foster industries such as 5G and artificial intelligence.
Beyond rate cuts, Asian central banks have done more to ease liquidity shocks, from Bank Indonesia buying government bonds to the Bank of Thailand creating a corporate bond fund. The US Fed has flooded all markets with dollar liquidity through repo and swap lines.
While regional growth will probably contract in 2020, worse than the 1997 Asian financial crisis, this is not the beginning of another Depression. Asia’s flexible response, such as allowing foreign exchange rates to absorb shocks, will stabilise funding conditions. Economies with current account deficits are likely to require less external funding as import demand falls.
I expect the region to recover in 2021. Worsening demographics and rising debt as well as deglobalisation are key risks but also opportunities. Companies looking for diversification, growth and lower prices will be attracted to India, Indonesia, the Philippines and Vietnam. The growing need for infrastructure in countries with demographic booms will attract foreign investors.
It could be the 1930s all over again for Latin America
Andrés Velasco, dean of the school of public policy at the London School of Economics
During the Depression, Latin America was buffeted by a collapse in commodity prices, a slowdown in world trade and a massive capital outflow. The same shocks are hitting the region today, but this time one has to add a decline in remittances (crucial for Central America and the Caribbean) and a productivity freeze, due to having much of the labour force under lockdown.
Back then, the economic contraction was brutal. Between 1929 and 1933, output fell by 10 per cent in Argentina and Mexico and by an eye-popping 37 per cent in Chile. Brazil and Colombia also suffered sharp initial drops, but by 1933 had recovered pre-Depression income levels. In the era of Covid-19, Latin America is well on its way to replicating that dismal performance. Back in mid-April the IMF predicted the region’s economy would shrink by 5.2 per cent in 2020 alone, with particularly sharp drops of 6.6 per cent in Mexico and 5.7 per cent in Argentina. Those forecasts are already outdated. Actual 2020 contractions will probably be much larger.
In the alphabet soup of alternative economic paths, a V-shaped recovery for Latin America looks farfetched — unless, that is, a vaccine arrives quickly and, with it, a worldwide resumption of growth. The virus came late to the region and some countries — Brazil, Ecuador and Mexico — have been remarkably inept at containing it. In others, high public debt and spotty access to international capital limit what governments can do to counteract the effects of the pandemic. Only Chile and Peru have the fiscal space to finance aggressive containment policies. Even there, new cases of contagion and Covid-19-related deaths are up sharply in the past two weeks.
Under the Inter-American Development Bank’s mildest scenario, Latin America’s economy contracts by 6.3 per cent in 2020-22. In the most extreme case, the cumulative contraction reaches 14.4 per cent — not too different from what the region experienced in the Depression.
In the 1930s, the countries that recovered quickly were those, mostly in South America, that adopted unorthodox measures. They cut interest rates and allowed their currencies to depreciate after leaving the gold standard. Most also defaulted on their foreign debts — except in the Caribbean, where platoons of US Marines guaranteed repayment.
Today, flexible exchange rates are the new orthodoxy, so that is not a constraint. But availability of dollar finance is. Unless institutions such as the IMF and the IADB sharply step up their lending, a new wave of debt defaults could make it the 1930s all over again.