Thursday, August 13, 2020

Economic consequences of the Pandemic Depression

Compare the performance of selected global stock indexes, bond ETFs, currencies and commodities from The Wall Street Journal for 2020, updated on Aug 12, 2020 at 5:50 pm ET. A chart of the losers is at the bottom of the page.

Carmen Reinhart and Kenneth Rogoff, American economists, in their 2009 book, 'This Time Is Different: Eight Centuries of Financial Folly,' said that the good news from their historical study of eight centuries of international financial crises was that they all ended. They noted that each time, the experts have chimed, “this time is different” — claiming that the old rules of valuation no longer apply and that the new situation bears little similarity to past disasters.

This time is different while early confidence of V-shaped recoveries is waning.

The Great Recession which began in 2007/2008 was a banking crisis among 11 advanced countries — the United States and 10 European countries — there was some collateral damage elsewhere in Europe and in 2009 only Poland and Albania reported rises in economic output.

China and India were growing strongly and other emerging and developing countries were benefiting from high commodity prices that resulted in buoyant public finances.

This time advanced, emerging and developing economies are all facing economic headwinds.

“This situation is so dire that it deserves to be called a ‘depression’ — a pandemic depression,” Prof Carmen Reinhart (who in May became the chief economist of the World Bank) and Vincent Reinhart, her husband (a former Federal Reserve economist), write in the September/October 2020 issue of 'Foreign Affairs.' “The memory of the Great Depression has prevented economists and others from using that word.”

The Reinharts add "In all of the worst financial crises since the mid-nineteenth century, it took an average of eight years for per capita GDP to return to the pre-crisis level. (The median was seven years.) With historic levels of fiscal and monetary stimulus, one might expect that the United States will fare better. But most countries do not have the capacity to offset the economic damage of Covid-19. The ongoing rebound is the beginning of a long journey out of a deep hole."

Over 200 countries have been affected by the Covid-19 virus and from March in particular governments across the world have reduced economic activities through lockdowns of populations at various degrees. The World Bank expects extreme poverty to rise and last year the number of developing countries dependent on commodities hit a 20-year high.

While rising public debt is no longer an obsession of economists in advanced countries, the World Bank warned last year that in just the eight years 2010-2018 total debt (public + private) rose 54% of GDP to 170% in emerging and developing economies. The bulk of this debt rise was incurred by China (equivalent to more than $20tn), nevertheless the rest of the increase was broad-based and occurred in virtually every region of the world. The total of external debt of what the World Bank calls 'Low and Middle-Income Countries' rose from $3.5tn in 2008 to $7.8tn in 2018 (page 17).

Economists estimate that developing and emerging market countries owe $370bn to China compared to $246bn in debt owed to the group of 22 Paris Club rich countries.

Before the current crisis, 75% of the countries had budget deficits, their foreign currency-denominated corporate debt was significantly higher, and their current account deficits were four times as large as they were in 2007. "Under these circumstances, a sudden rise in risk premiums could precipitate a financial crisis, as has happened many times in the past," the World Bank warned.

Corporate debt has jumped in advanced countries in the past decade.

The Financial Times says, "The rise is most striking in the US, where the Fed estimates that corporate debt has risen from $3.3tn before the financial crisis to $6.5tn last year. Given that Google parent Alphabet, Apple, Facebook and Microsoft alone held net cash at the end of last year of $328bn, this suggests that much of the debt is concentrated in old economy sectors where many companies are less cash generative than Big Tech."

Between 2008-2018, global corporate bond issuance averaged $1.7tn per year, compared to an annual average of $864bn during the years leading up to the crisis.

The FT reports that European banks are facing as much as €800bn in loan losses and a €30bn hit to their revenue over the next three years as a result of the coronavirus crisis, according to a report from Oliver Wyman, a financial consultancy.

"In the consultancy’s base or expected scenario — a slow economic recovery with most countries avoiding a second lockdown — it estimates bad debts would surge to €400bn, about 2.5 times the level in the prior three years.

In the adverse or worst-case scenario — a severe second wave of the virus — that figure doubles and banks’ non-performing loan ratios rise to 10% of their total lending."

World merchandise trade fell by 18.5% in the second quarter; the July forecast by the European Commission raised the expected dip in gross domestic product (GDP) in 2020 among European economies, with a weaker recovery in 2021 than anticipated in April. Even though the official US unemployment rate fell to 10.2% in July, Robert Samuelson, The Washington Post's economics columnist noted that comparisons with February — the last month before the pandemic was fully reflected in job statistics — show that the number of employed fell by 15.2m; the unemployed rose by 10.6m; those not in the labour force increased by 5.5m. In the European Union in June the jobless rate slightly rose as governments had subsidised employment including working from home. Jobless numbers rose by 281,000.

Central banks to the rescue

Central banks have taken swift action to mitigate the Covid-19 crisis and inflation remains at historic lows in advanced countries.

While investors have piled into silver, gold, and Big Tech firms stocks as shown by the Nasdaq and S&P Technology indexes on The Wall Street Journal chart above, there is one key asset class that is missing from the charts.

The Bank for International Settlements (BIS) reported this year that the real (inflation-adjusted) house price rise in advanced economies was 19% since 2010 while the rise in emerging economies was 14% on average.

Research by economists at the Federal Reserve Bank of San Francisco, the German Bundesbank, and economists at the University of California, Davis, show that in respect of the period 1870-2015 the average real return on residential housing outclassed equities (shares/ stocks) while from 1950 equities had a higher return using data from 16 advanced economies.

"Our investigation has confirmed many of the broad patterns that have occupied much research in economics and finance. The returns to risky assets, and risk premiums, have been high and stable over the past 150 years, and substantial diversification opportunities exist between risky asset classes, and across countries. Arguably the most surprising result of our study is that long-run returns on housing and equity look remarkably similar. Yet while returns are comparable, residential real estate is less volatile on a national level, opening up new and interesting risk premium puzzles."

In the paper, The Rate of Return on Everything, 1870–2015, the data show that the Nordic countries had the highest housing returns.

The authors say “Residential real estate is the main asset in most household portfolios…but so far very little has been known about long-run returns on housing...Although housing wealth is on average roughly one half of national wealth in a typical economy, data on total housing returns (price appreciation plus rents) has been lacking.”

On May 29, 2020, in a New York Times article, Robert Shiller, a professor of economics at Yale University and a 2013 recipient of the Nobel Prize in Economic Sciences, wrote, "It is too early to tell which narratives will prevail and what path the economy will take after this pandemic subsides. Limited case studies will take us only so far. But we shouldn’t be surprised if we see post-pandemic economic weakness over the next decade."

Employment crisis

According to the recently published Employment Outlook 2020 produced by the Organisation for Economic Cooperation and Development (OECD) — comprising 37 mainly rich countries — by 2021 real income per capita in the majority of OECD economies will be back to 2016 levels even in the absence of a widespread second wave of infections. In the “double-hit” scenario where a second wave strikes all OECD economies in late 2020, real per capita income in the median OECD economy in 2021 would be back to 2013 levels.

Low-income workers are paying the highest price. During the lockdown top-earning workers were on average 50% more likely to work from home than those in the bottom quartile; the latter were more often employed in essential services during the lockdowns and at risk of exposing themselves to the virus while working. At the same time, low-income workers were twice as likely to have to stop working completely as their higher-income peers were.

Workers in non-standard jobs – such as self-employed workers and those on temporary or part-time contracts – have been highly exposed to the job and income losses prompted by the pandemic. In the Netherlands, for example, 48% of self-employed workers experienced a reduction in hours, compared to only 27% of employees. In the UK 75% of the self-employed report having experienced a drop in earnings in the previous week, compared to less than 25% of salaried workers. This exposure stems partially from the sectoral concentration of workers in non-standard jobs. And evidence from European OECD countries suggests that such jobs may represent up to 40% of total employment in sectors most affected by containment measures.

In France, the rise in new unemployment claims in March and April 2020 was entirely driven by temporary agency workers and workers in temporary jobs whose contracts were not renewed. While in Italy the fall in the number of jobs between the end of February and the end of April compared to the same period in 2019 was largely driven by reduced hiring on temporary contracts.

The vulnerability of workers in non-standard jobs is compounded, in most OECD countries, by their limited access to unemployment and sickness benefits.

Women have played a key role in the health care response to the pandemic. They make up two-thirds of the healthcare workforce worldwide including 85% of nurses and midwives. "However, beyond the health sector, early evidence suggests that the COVID-19 crisis, contrary to the global financial crisis, appears to have affected the employment and labour market prospects of women disproportionally compared to men."

On average across OECD countries, women makeup about 53% of employment in food and beverage services, 60% in accommodation services, and 62% in the retail sector.

Young people risk, once more, being among the big losers of the current crisis. During the global financial crisis, across the OECD, almost one in ten jobs held by under 30-year-olds were destroyed, and the recovery was very slow, particularly for the disadvantaged. It took a decade, until 2017, before youth unemployment returned to its pre-crisis rate and the impact on the incidence of non-employment, low-pay and underemployment lasted longer still. "Early evidence already suggests that young people have been heavily affected by the COVID-19 crisis. They tend to hold jobs that are more precarious and are overrepresented among workers in hard-hit industries, such as accommodation and food services. In the United Kingdom, even excluding students in part-time jobs, workers below 25 were about two and a half times as likely as other employees to work in sectors that were shutdown."


"Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker" Paul Krugman, then a Princeton University professor wrote in, 'The Age of Diminishing Expectations' (1994).

People's standard of living depend on it.

The OECD says, "There are different measures of productivity and the choice between them depends either on the purpose of the productivity measurement and/or data availability. One of the most widely used measures of productivity is Gross Domestic Product (GDP) per hour worked. This measure captures the use of labour inputs better than just output per employee."

US annual productivity averaged 2.5% in the 15 years to 2004 and 1.4% in the 15 years from that year while in the Euro Area average productivity growth came down from 1.4% in the 1990s to about 1% in recent years.

Economists do not agree on the reasons for the declines at a time when there is a lot of digital innovation.

Demographics; falling creation of new firms; significant innovation done only by a small number of big firms a decline in capital investments and the dip in real interest rates are among the factors. See here; here and here.

The OECD says "Well-known global companies such as Google, Apple and Amazon of the digital era as well as more traditional ones of the likes of BMW, L’Oreal and NestlĂ© have recorded impressive productivity gains over the 2000s as they created more and more revenue per employee. At the same time, aggregate productivity growth in the OECD that reflects the performance of all businesses not just the few most successful ones — has stagnated."


While the wide availability of a vaccine against the Covid-19 virus would help to boost confidence, the wind-down of central bank emergency actions could trigger a lot of bankruptcies.

Instability in emerging and developing countries is likely to increase.

Housing and land are asset classes and in a time of very low-interest rates, they can be attractive targets for investors.

This is the downside of central banks' actions and there are several other factors that artificially restrict supply.

The Joint Centre for Housing Studies of Harvard University in a 2018 report noted "Adjusting for inflation, the median rent payment rose 61% between 1960 and 2016 while the median renter income grew only 5%. The pattern for homeowners is similar, with the median home value increasing 112% and the median owner income rising only 50%.

According to The Economist, "In 1990 a generation of baby-boomers, with a median age of 35, owned a third of America’s real estate by value. In 2019 a similarly sized cohort of millennials, aged 31, owned just 4%...Data-crunching by The Economist suggests that the number of new houses constructed per person in the rich world has fallen by half since the 1960s. Because supply is constrained and the system is skewed towards ownership, most people feel they risk being left behind if they rent. As a result, politicians focus on subsidising marginal buyers, as Britain has done in recent years. That channels cash to the middle classes and further boosts prices. And it fuels the build-up of mortgage debt that makes crises more likely."

Economics can bring woes to countries whether rich or poor.

The FT's US finance editor Robert Armstrong on why the price of most assets is rising and what a drop may look like.

The Covid-19 pandemic has caused economic chaos and uncertainty. Zanny Minton Beddoes, The Economist's editor-in-chief, and Edward Carr, the deputy editor, answer questions about the global economy

The Wall Street Journal market losers in 2020 to Aug 12