A return to "normal" interest rates would tip underperforming companies and highly indebted governments over the edge. Photo / 123rf
COMMENT:
Covid-19 is not just a medical and economic crisis. It is a historical watershed moment with massive effects for entire generations.
And still, it is difficult to visualise how profound the Covid-19 change will be.
If you were born over the past half-century, you would have experienced history as essentially linear. Life kept evolving and improving. The future was usually a better version of the present. Things can only get better was a song title in our early adult years – and we subscribed to its sentiment.
We are not used to dramatic changes anymore, and we are even less accustomed to drastic setbacks. To understand the magnitude of the change we are about to experience requires putting our own lives' experience into perspective.
For anyone born in Australasia, Western Europe or North America in 1900, and assuming an average life expectancy of somewhere between 70-80 years, it would have been a life of two unequal halves.
The first half of that person's life was characterised by disasters: first, the Great War of 1914 – the world's worst military conflict until then. It was followed by the Spanish Flu of 1918, Black Friday 1929 and the Great Depression of the 1930s, only to culminate in World War II, which exceeded the horrors of World War I.
By their early 40s, assuming they survived, that average person would have been through a grim period of history. However, they would have afterwards enjoyed a much better second half of their lives.
Not just because the 1950s-1980s were less war-torn in Western countries. But also because the post-WWII period saw dramatic improvements in living standards. Cars, refrigerators and TVs were common household items. Medicines became better and more widespread. And thanks to improvements in civil aviation, long-distance holidays were suddenly possible and affordable.
Our great-grandparents' generation would have witnessed all the horrors of life in their childhood, youth and early adult years: wars, financial and economic crises and a pandemic. But then they eventually experienced peace, stability and prosperity later in life.
When looking at the world in 2020, one may wonder if we are not bound to re-live our great-grandparents' experience, except in reverse.
For us, the past few decades were a story of progress. From a time with just a handful of TV and radio programmes, we now have endless variety on the Internet. We have witnessed consumer goods becoming cheaper and better, not least thanks to global supply chains. After 1989, we enjoyed the relative stability of a US-led, Western-dominated geopolitical order.
To be sure, we experienced pain as well. We saw stock market crashes, terror attacks and regional wars. But we always got through them. And when things got tough, we could rely on governments and central banks to bail us out and get us back to 'trend growth.'
With Covid-19, this tried-and-tested method will not return us to the world before. This crisis is too big and costly. Governments do not have enough ammunition to fight it.
Finally, Covid-19 happens against the backdrop of major geopolitical change.
Globally, governments and central banks have deployed trillions in funds to cushion the economic effects of the pandemic. Exactly how much is anyone's guess because it is hard to keep up with the various programmes. In May, the International Monetary Fund estimated the figure to be US$9 trillion. Which probably means the number is US$14 trillion, bajillion or gazillion by now.
The only thing we know is that a recession is in full swing – as is a pandemic. Judging by the global case numbers of Covid-19, which are approaching 15 million, we are still at the beginning. Unless herd immunity is nearly achieved in many countries, there is no reason to expect the global health emergency will be over soon.
Between politicians, science experts and business leaders, it is a widely shared expectation that the health crisis will take three to five years to subside. But in such a timeframe, it is unrealistic to expect governments to maintain a high level of assistance and bailouts. They just cannot afford it.
At the same time, governments and central banks cannot afford not to support their economies. Ironically, the level of previous support requires them to extend the bailouts.
Just look at the US stock market. The S&P 500 index now has a price-earnings ratio of almost 28 – almost twice as high as its long-term historical average. That means investors are willing to pay $28 for each $1 of earnings that the company generates. Or consider the yields on government bonds. US Treasury bonds, German bunds or British gilts have never had yields lower than today – often negative.
Both bond yields and price-earnings ratios reflect the effects of vast amounts of cash flooded into markets by central banks – not just since Covid-19 but for decades. If the Covid-19 crisis drags on, central banks could not easily withdraw their support without crashing bond and equity markets. There are ginormous bubbles in both.
The monetary support must be maintained because corporates and governments are now used to operating in a zero or negative interest rate environment. A return to 'normal' (i.e. positive) interest rates would tip underperforming companies and highly indebted governments over the edge.
What we are witnessing is a Catch-22 for many governments and their central banks. They cannot afford to maintain the level of support they provide, but they cannot afford to withdraw it either.
The global economy now finds itself in both a synchronised recession and heightened geopolitical tension, particularly between China and the US. This confluence is unlike previous crises which only affected individual regions, such as the Asian Financial Crisis of 1997. And even the so-called "Global" Financial Crisis was mainly a Northern Hemisphere problem.
We cannot predict with certainty when and how the Covid-19 crisis will end. But we can already see how the world will not be the same anymore. It will be a world with a diminished economy, heavily indebted governments, highly stretched central banks and vast bubbles in asset markets. And that is the optimistic scenario.
In a pessimistic scenario, we could see the collapse of governments, currencies or markets before the Covid-19 pandemic ends. It requires little imagination to envision what such developments would do to political – and geopolitical – stability.
The coming decades will be fraught with difficulty. The relative stability and continuous progress which we enjoyed for the past decades will become a fond memory for Boomers, Gen X'ers and Millennials. Those carefree times will not come back. The new normal will feel anything but.
There is little we can do other than to brace ourselves and deal with it. Just as our great-grandparents did.
Dr Oliver Hartwich is the Executive Director of The New Zealand Initiative
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