Prospects for the US and Global Economy through a post-election crystal ball
Both the US and EU have made unprecedented monetary and fiscal mechanisms available to cope with the shutdown of their economies between March to May and beyond. This cash will help stimulate the global economy as a whole, but money has to be paid back and the Western world will take on the latest debt level since the end of World War II.
In a Zoom debate organised by the American Chamber of Commerce in Portugal (AmCham) and presided over by AmCham President, António Martins da Costa and moderated by Leslie Rubio COO of Citi Portugal, Catherine L. Mann, Global Chief Economist at Citi said: “The crystal ball is quite foggy, and there are some questions as to whether the clouds will clear or not. Analysts have to be very careful at looking at quarterly data. Financial markets in particular like to look at short-term changes on the horizon data, and the quarter to quarter data no matter which country you are looking at are going look pretty good.”
This is because, she said, the second quarter for most countries was so, so deep in terms of recession. It was unprecedented in terms of the contraction of the economies. However, from that the only way to go is up. “What we’re already seeing from the third quarter data looks like a terrific rebound”.
The financial markets are using that information and projecting it forward to subsequent quarters and coming to the conclusion that the worst of Covid is behind us and 2021 is going to be good. However she cautions that assessment and the model outcomes that use quarter to quarter changes in their assessments.
“I am cautious because I see the momentum fading, and even stall. The question is when does an economy get back to the pre-Covid levels of GDP? We asked 64 economists around the world and there seem to be two economies that the economists are relatively optimistic about seeing a robust rebound – China and the United States,” said the City economist.
“When we asked the rest of the economists around the world, they are not so sanguine with 30% of the economists extending the recovery further out in time. Europe is not seeing GDP returning until 2022. Japan and the UK later in 2022. Mexico and other large economies in Latin America not until 2024-2025,” she added.
That movement out to 2022-2025 creates a fragility in the global economy while putting a premium on the US and China to effective domestic demand. If the global economy is moving out its calendar, then neither of those countries can look to trade as a source of growth.
None of the economists consulted by Citi see the employment rate returning to the pre-Covid timetable, so unemployment may remain high even though GDP returns back to the pre-Covid benchmark. Moreover, none of this will return the global economy back to the trajectory seen at the start of 2020.
In fact, by 2021 it leaves the world with five percent points of GDP lost and not recovered. This happened with the global financial crisis where the lost GDP was never made up for in the recovery to the trajectory seen before that crisis, and the burden will be on the younger generations with higher inequalities.
Regarding consumption, which is a crucial component for demand, when people couldn’t go out to restaurants, theatres, shops and cinemas, they spent online, and then with the easing of restrictions the pent up demand led to a boom in retail, thereby overestimating the strength of consumer demand.
Consumer services data is all dramatically lower in terms of the prospect for recovery, partly because of fear of Covid, the second wave and because of continuing restrictions in restaurants as well as travel restrictions.
“Business investment in general has collapsed. Why would a business engage in investment if they didn’t think there would be a return in demand until 2022 or beyond. The expectation is that it will be quite weak,” Mann warned.
One area that is very strong, however, is IT and prospects in that domain going forward are very positive. “Trade is fragile when you have an asynchronous pathway to a return to pre-Covid GDP levels. We downgraded 2021 global growth by 30 base points,” she adds.
Fiscal and monetary policy in March was appropriate to the degree of contraction and damage to the economies. Many countries are putting into place extended fiscal policy prospects. At this point it’s about life support to small and sometimes large businesses and employees in what has been a very appropriate initial response.
But at some point these have to pivot towards the private sector, with some motivation for the private sector to invest. There have been dramatic monetary policy moves from many countries regarding monetary policy. The question is at what point do the monetary policy authorities engaging in an accommodative policy for so long, and the work we have done reveals that the monetary policy transmission to the financial markets is extremely effective, with a rebound in equity markets, spread compression, an extended period of issuing a lot of additional debt, and the expectation that the interest rates will remain low for a long period going forward, both for sovereign and non-financial corporates. But, she asks, at what point is this transmission from the monetary policy to the financial markets overwhelming a transmission from the financial market to the real economy?
“In advance of Covid, there was already a disconnect between the monetary policy which was very strong for the financial markets which were very weak but are exuberant in the face of a much more sanguine globe economy, and we would like to see an adjustment with a more robust real economy as opposed to just the financial markets,” she said.
The US elections
Mann says that the trade picture from the current administration which is focused on unilateralism and equating bi-lateral balances, is an approach that uses currencies as a tool and financial sanctions in what is very much a de-globalisation approach which not only involves China, but many countries.
The approach from Joe Biden, she believes, will be a return to multilateralism, with an appreciation of the advantages of globalisation, not just in the economic frame, but also in political terms too and for foreign policy.
Regarding China, there will be continued tension, but the approach with a Biden administration would be to engage in other countries that have similar concerns about China’s technology in particular and issues around intellectual property, security, foreign ownership.
The second change would be in regard to fiscal policy. The two candidates have a very different approach on how to create multipliers and to engage the private sector. In climate, particularly, Biden’s administration would have a much more climate focus to it. The multipliers have to be large, the private sector has to be engaged, since the private companies are the ones who have to do the heavy lifting in order to adapt, mitigate and innovate.
Economist and former finance minister Jorge Braga de Macedo made three key observations on trade, one through narrative economics and the backdrop of the two economic crises. The second was to look at the future through the tool of self-fulfilling expectations. The third point was to look at the global south. Portugal and Europe look south as much as they look west.
“The first crisis (2007-2013) was a major surprise to everyone. The question was that if the imbalance was so great, why did nobody notice? Politicians believed that bankers were engineers. The perception of epidemiologists has changed brutally. First, they were seen as heroes and now they are seen as out of touch.” In other words, the various professions go through travails when things cannot be explained so well. Some professions, when we use the crystal ball, will get off lightly and others not.
“The second point about self-fulfilling expectations is that if you discount the future in the long term, and you are going to have the ability to continue the progress that you have, you have to have three conditions that must hold up: no rigidity in labour markets, the presence of sufficient scale economies with technology that is sufficient for scaling up,” Braga de Macedo explained.
“At the moment it is unclear whether the exuberance of the financial markets is a good sign or not.”
On the global south, Africa is experiencing a very dramatic interruption in its progress, but the worry is Southern Africa, which at one point was the most developed part of Africa, but is now in a really difficult situation, while Angola, Zambia and Namibia have extremely high debt levels with a strong possibility of having to restructure their debts. A solution that would only look at the North Atlantic was already in 2008 seen as inadequate, and is not, in the words of former Brazilian president Inácio Lula da Silva, “A white crisis with blue eyes”and that the “crystal ball should be global rather than just North Atlantic”.
João Moreira Rato, who managed the Portuguese debt office and is chairman of Banco CTT, said a lot of the fiscal and monetary policy instruments that had been developed during the global financial crisis, were used in a big way for this crisis over the past few months.
Between February and March the markets fell close to 34% in one month (in the global financial crisis they fell 40% in six months).
“The monetary and fiscal authorities of multiple countries snapped into action and from a monetary policy point of view the Fed increased its balance sheet to amounts that far exceeded the global financial crisis,” he said.
After the last financial crisis US$4.5Bn was made available, but by the end of May 2020 the Fed made US$7Bn available or 35% of US GDP.
The ECB balance sheet started the year with €4.6Bn in assets and now stands at €6Bn in assets which is a staggering 50% of the Euro Zone’s GDP.
Fiscal policy was equally large, with the budget deficit for the US projected by the fiscal budget for this year around US$3.3Tn or close to 60% of US GDP. This is triple the deficit seen in 2019 and the largest deficit since 1945.
The Federal debt held by the public was 35% of GDP in 2017, and 79% in 2019 and is expected to reach 98% of GDP this year and 107% of GDP in 2023.
This new fiscal policy also brought new instruments with them not seen before, such as the Payroll Protection Programme in the US, widened unemployment eligibility criteria while in Europe there was the Recovery and Resilience Facility with around €750Bn of which €312Bn will be in grants, so the way the problem is financed and structured is new.
The question for Moreira Rato is if there is a new fiscal stimulus programme in the US, the election would influence how the package would look and the composition of the next senate will also play a role.
“All of these substantial fiscal and monetary policies should be good for world growth going forward,” he concluded.