March Inside Track

  • The abruptness and severity of the shock inflicted by Covid-19 has no equivalent in modern history. The pandemic’s power of exponentials has taken most decision-makers by surprise and brought a large portion of global economic activity to a sudden and dramatic halt. This has never happened before, not even during the Great Depression or the two World Wars. In Q2, global GDP might plunge by 20-30% (Y-o- Y) and joblessness rise in monumental proportions. A return to growth in the Autumn is now the best- case scenario, but it is contingent upon many “ifs”.
  • Among economists, an overwhelming consensus exists that the much talked-about trade-off between saving lives and pursuing economic growth is a false one. The key reason is this: the economy is not a machine activated by robots, but a highly complex network of innumerable interactions between people whose decisions (to invest, to consume etc.) are largely driven by emotions and sentiments. The inference: economic activity won’t pick up until the pandemic is firmly under control and fears abate. In addition, research shows that the tougher the lockdowns, the stronger the long-term economic recovery. For policy-makers the greatest threat lies in the risk of relapse: it would instantly extinguish resurgent consumer confidence while crushing the markets still further.
  • The pandemic has magnified the macro challenge of social inequalities by laying bare the shocking disparities in the degree of risk to which different social classes are exposed. In much of the world a pattern has emerged: the wealthiest have escaped to their holiday homes; the middle class hunkers down at home to tele-work and homeschool, while the working class (those who still have a job) are not at home but at the front line working to help save lives (albeit indirectly) and the economy – cleaning hospitals, manning the checkouts, transporting essentials and ensuring our security.
  • In such a context, it is unsurprising that the risk of acute social unrest is increasingly plausible. Rightly, many decision-makers and thinkers are pondering what might happen when millions emerge from the confinement with “no jobs, no income and no hope”. The risk is lower in countries with a strong welfare system and higher in those without one – notably in the US where many unemployed people aren’t even eligible for benefits (but this might change).
  • Because of the above, monetary authorities and governments are entering the “Whatever It Takes” They will deploy massive monetary and fiscal stimuli – policies inconceivable just a month ago are becoming the norm. In a bid to prevent the deepening economic recession turning into full blown depression, governments will increasingly act as “payers of last resort” to stem the flow of business destruction and mass layoffs provoked by the pandemic. MMT (Modern Monetary Theory) – deridedinthepre-pandemiceraas a leftist invention – is now all that remains in the economists’ quiver. “Helicopter money”, i.e. direct cash disbursements to households, is coming; and it will be fully monetized, not financed through standard government debt.
  • Thinking about a post pandemic economic landscape and the various exit strategies, consumer response represents one of the greatest uncertainties. After such global pain in terms of lost jobs and reduced income, we find it hard to imagine a scenario of rapid recovery. There’ll inevitably be a great sense of caution and “wait-and-see”, with consumer demand remaining weak for a long time. For governments, turning to the printing press will be an exceedingly complex and potentially perilous exercise to calibrate correctly: with too little money available, the economy will tank, if there is too much, inflation will spin out of control.
  • Covid-19 will accelerate sustainability concerns and ESG outperformance. First, the evidence, so far, suggests that ESG have withstood the sell-off better than most other strategies – they’ve proven more resilient, which is what sustainability is all about. Second, we think (without data to corroborate our conviction), that companies that walk the stakeholders’ walk will perform better in the post- pandemic era. They’ve proven to be more benevolent than others (avoiding lay-offs and providing help when they could), and thus offering more resilience in the current and futures crises.
  • The geopolitical implications of the pandemic will be profound and far-reaching. Among the most consequential: (1) A collapse of global governance, when it was most needed, augurs badly for the management of future crises; (2) The mistrust and rivalry between China and the US will greaten; (3) US standing in the world has taken a beating but the resultant vacuum will not necessarily be filled by China’s ascendancy (the country’s recent forays into soft power won’t last long); (4) The retreat of globalisation: it cannot be undone, but it can be slowed down and curtailed as supply chains shorten – regionalism and localism will be the big “winners”; (5) The return of the nation-state and big government: in times of acute crisis, only nation-states remain cohesive and capable of making collective decisions.
  • It is in emerging markets (EM) that the risks are the greatest, while perhaps not from the pandemic itself, but from its economic and social consequences. Because of a seasonality effect, Covid-19 may progress more slowly in EM than it does in rich countries, but this is irrelevant: EM are already suffering from major capital outflows, a squeeze in USD funding and collapsing commodity prices. To illustrate the severity of the problem: more than 80 countries have submitted a request to access a USD50bn emergency finance package set up 3 weeks ago by the IMF. International organisations are expected to put together a USD1tr program for EM, but this will fall short of what is required. Since most of them cannot borrow in their own currency, nobody will be there to bail them out (their governments, banks, companies, households). As economies shut down, the risk of social unrest – violence and looting – will increase.The Inside Track March 2020