If you want to know where to go, it’d be useful to know where are you now. How else are you going to tell which direction to go? This can be very well said about the global economy right these days – everyone knows where they want to go but we are not sure where we really are.
The COVID pandemic brought two important developments to the global economy – enormous policy interventions and acceleration in technological changes. This second aspect is more of a structural nature and today I will focus more on the first, cyclical one. The mainstream view is that we are recovering from the pandemic, this recovery has been briskier than feared and while could be hampered by returning virus variants, generally we are trending towards more stable – and durable – economic growth. This assumes we have just witnessed a recession and therefore the new (and hopefully lengthy) economy cycle has begun. But is that really the case?
A quick recovery from the pandemic recession was possible thank to huge increases in public debt
Recessions are painful because they are destructive. Demand declines, causing business failures and unemployment. But this opens ground for new business and paves the way for a fresh cycle. That way inefficient agents are eliminated from the field, allowing for productivity growth. The problem is that none of that happened in 2020. Yes, unemployment soared sharply but mostly due to administrative restrictions that forced business to halt their operations. Because governments forced companies to limit their activities, they felt obliged to compensate them. The effects are clear when we look at the fiscal metrics. Debt to GDP ratios surged from high single percentage points in developing nations (often relying on external financing) to more than 20 percentage points for US and Japan in 2020 alone. Incidentally, US is at the extremes of economic interventionism. The aid packages drove personal incomes to the extent where they are higher than they would be should the pandemic never happened!
Not surprisingly, strong demand followed. In the United States, retail sales is currently some 25% above levels from early 2019 which is way above pre-pandemic trend. Other developed economies see a more measured rebound in demand but in most cases it’s already above early 2020 levels. At the same time, the supply side is facing issues. The complexities from 2020 lockdowns are being compounded by fresh restrictions, especially in Asia, leading to parts shortages and cost increases. The semiconductors issue is the flagship one but actually the list of problems is very long and contains things like surging commodity prices (a by product of super expansive monetary policies), skyrocketing freight costs and covid-related expenditures. This is very unusual for the early stage of recovery when producers normally have excess capacity and new demand leads to higher output without associated prices pressures.
Put together excessive demand and supply constraints and you have a situation where a debt-financed policy interventionism does not create much higher output but gives a rise to price pressures
Put together excessive demand and supply constraints and you have a situation where a debt-financed policy interventionism does not create much higher output but gives a rise to price pressures. Furthermore, because the whole stimulus has been financed with debt, central banks are under huge pressure to maintain lower than optimal interest rates, affecting capital allocation in a very negative way which in turn is critical for long-term growth.
Interested in this article?
The full text is available in the September ’21 issue of Credit Manager Magazine.
Author of the article:
PhD of Economics at the University of Warsaw, graduate of London
Metropolitan University on a British Council scholarship, licensed Investment Advisor. For years, Chief Economist of the XTB brokerage house, previously incl. advisor to the Minister of Finance. Repeatedly awarded with the titles of Economist and Analyst of the Year, and also distinguished as the best forecasting currency rates in Bloomberg’s global rankings. He currently uses BigData methods in his work, both in market analysis and business analysis. Regular guest of television and radio programs on economic issues.