Even if the virus were to go away tomorrow, disappearing as a source of uncertainty, we are not talking about a recovery where employment returns quickly to pre-crisis levels.
As restrictive measures to combat the coronavirus are gradually loosened by governments in Europe, the rising dissatisfaction with the lockdown is gradually dissipating. If one were to only look at stock markets globally, their rise would suggest all is fine. Yet, as more and more bonds move into negative yield territory, the bond market is telling a far more cautious, concerned story. One of globally record high indebtedness and falling prices. That is a recipe for corporate bankruptcy, as we have already seen with numerous well-known names in various industries in recent weeks, Hertz in car rental being but one notable example. In the end, no amount of central bank liquidity will be able to make up for companies’ lack of revenue or overleveraged balance sheets.
Coronavirus the catalyst, debt the main underlying issue
We have long argued that the coronavirus was but a catalyst to the current global downturn, but that the real risk factor was record high indebtedness globally. I would argue that the onset of the virus only accelerated the economic downturn.
Considering the levels of uncertainty, we are dealing with, I have never been a proponent of a V-shaped economic recovery. To me at least, a far more realistic expectation would be for a gradual, uneven recovery, bearing in mind the risks of a second wave of the coronavirus, which many experts warn of; experts in Central, Eastern and South East Europe (CESEE) who have certainly done their jobs well in containing the spread of the coronavirus. Until we all learn to live with the coronavirus, sentiment is unlikely to fully recover. Yet, even if the virus were to go away tomorrow, disappearing as a source of uncertainty, we are not talking about a recovery where employment returns quickly to pre-crisis levels.
Uncertainty clouds recovery prospects
A recent study by the San Francisco Federal Reserve suggests the long-term (a period of 40 years) economic consequences of pandemics include an increase in precautionary savings. As this logically drives demand lower, private sector investment heads in the same direction. Since this adversely impacts productivity growth, which in the long-term is the main driver of GDP growth, economic growth is also slower than it would otherwise be in the long-term.
My discussions with clients and other small businesses indicate that one element dominates their thinking – uncertainty. Every business owner is concerned how their revenues will perform after reopening because that depends on the sentiment of consumers. The latest EU sentiment indicators point to a sharp drop in consumer sentiment and an even sharper drop in employment expectations. If consumers are not willing to spend, any recovery in economic activity can only be gradual and uneven.
The combination of rising unemployment, an uncertain outlook for earnings for those who remain employed and record high levels of indebtedness at the global level in addition to coronavirus induced worry all point to a slow recovery once economies are able to reopen more meaningfully.
Slowing global trade and Sino-American tensions to impact CESEE
From the perspective of CESEE, the impact of falling global trade on the German economy are an additional concern. Clearly, rising political and trade tensions between the US and China add further layers of complexity to this concern. CESEE is reliant on the ability of German companies to continue exporting support growth at home; that is what being part of their supply chains brings to CESEE economies.
This is where the Franco-German agreement on May 18 to support an EUR500bn recovery fund at EU-level and subsequent European Commission proposal are so important in providing hope of stronger and more balanced growth in the eurozone and EU in the medium term.
EU fiscal package is potentially game changing…
Namely, a fiscal response to the crisis which remains at the level of member states alone would entrench economic divergence in the EU, adding unneeded strain on the eurozone. That is because the wealthiest nations are more able to support their economies than the less well off, as European Commission data showing almost half of the state aid dispensed by member states relates to Germany alone clearly suggests.
And while Germany will undoubtedly feel the impact on its export performance of lower global trade and slower economic growth in China, a significant portion of its trade surplus is generated within the eurozone. Germany, in other words, needs economically healthy fellow eurozone member states to be able to prosper. We always knew German industry and political elites were aware of this, but it nonetheless is pleasing to hear figures such as Wolfgang Schäuble support Chancellor Merkel in arguing for a European-wide fiscal response to the coronavirus. After all, getting the electorate in countries such as Germany to support this approach will require heavy political lifting after the morality narratives which formed the basis of the approach to dealing with the previous financial crisis.
…but requires heavy political lifting to succeed
In a world of heightened uncertainty, characterised by record-high levels of debt, a very deep recession, an as-yet-to-be resolved coronavirus health issue and rising Sino-American tensions, it is improbable to expect a quick, V-shaped recovery, even as stock markets’ performances since the sharp and deep declines of mid-March and the end of May 2020 would beg to differ. The one positive, looking from Eastern Europe, is the Franco-German agreement of 18 May to launch an EUR500bn recovery fund. This is because it signals a coordinated effort, financed by all EU member states, to bring about an economic recovery and reduce macroeconomic imbalances within the EU. That will take time to define and implement. One more reason to hope for a V-shaped recovery, but not to expect it.