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LRB, Vol. 42 No. 8 · 16 April 2020
Adam Tooze on the pandemic’s consequences for the world economy
In March, as Europe and the US began to apprehend the scale of the
Covid-19 pandemic, investors panicked. Financial markets plunged. The
rout was so severe that on several occasions in the second and third
week of March, normal market functioning was in question. The prices of
US Treasuries, the ultimate safe asset for investors all over the world,
swung wildly as fund managers, scrambling for cash, sold everything they
could sell. In the foreign exchange market, through which more than $6
trillion normally swirl every day, the traffic was all one way: out of
every currency in the world, into dollars. No market can function for
long like that. Sterling plunged. Even gold was sold off. This was not a
banking crisis like the one in 2008, but, had it not been for the
spectacular intervention carried out by the US Federal Reserve, the Bank
of England and the European Central Bank, we would now be facing not
only the ravages of Covid-19 and the disastrous social and economic
consequences of the lockdown, but a financial heart attack as well.
Instead, we are experiencing a shockwave of credit contraction.
Production and employment have shrunk dramatically. Huge programmes of
government spending have been set in motion, not to create new jobs but
to sustain the economy on life-support. The challenge isn’t merely
technical. This is a global crisis, which affects virtually every
community on the planet. And it has exposed stark differences between
the major economic blocs, such that it is now more difficult than ever
to understand how the thing we call the world economy actually fits
together.
The three great centres of production, exchange and corporate activity
are the US, China and the Eurozone. These economic hubs are tied
together through flows of trade, organised through complex supply chains
that span the globe. Each of the three hubs has a hinterland extending
into neighbouring regions in Latin America, East Central Europe, Africa
and across Asia. They are all stitched into a global financial system
that uses the US dollar as its currency of trade and credit. Each of the
three hubs has characteristic weaknesses. The worry about China is the
sustainability of its debt-fuelled economic growth. The basic weaknesses
of the Eurozone are that it still doesn’t have a backstop for its
rickety banking system and that it lacks a shared fiscal capacity;
what’s more, Italy’s finances are so weak that they continually threaten
to upset European solidarity. In the US, the national institutions of
economic policy actually work: they demonstrated this in 2008 and are
doing so again now. The Fed and the Treasury exert a huge influence not
only over the US economy but the entire global system. The question is
how they stand in relation to a profoundly divided American society and
how their technocratic style of policymaking is received by the
know-nothing nationalist right wing of the Republican Party and its
champion in the White House.
Over recent years, each of these weaknesses has at various times seized
the attention of the fund managers and business leaders who direct
global business, and the experts and technicians who advise them. It
isn’t a secret that China’s debt bubble, Europe’s divisions and
America’s irrational political culture pose a challenge to the
functioning of what we know as the world economy. What caused the panic
last month was the realisation that Covid-19 has exposed all three
weaknesses simultaneously. Indeed, in Europe and the US the failure of
government has been so severe that we now face a public health
catastrophe and an economic disaster at the same time. And to make
matters worse, Donald Trump appears tempted to juggle the two.
Since 2008, the world economy has come to depend to a disconcerting
degree on government stimulus. No one can pretend that our reality bears
much resemblance to the pristine market models so popular in the 1980s
and 1990s. But anyone who took those at face value was missing the
point. All along, the state was actually involved, whether as a creator
of markets, or as a distributor and enforcer of property rights. What is
new is that the central banks are now permanently on call, adding
further stimulus whenever growth flags. And they have been called on
regularly because productivity growth has been so slow. At the same
time, in an age of austerity, we have not been able to count on
politicians to deliver adequate fiscal stimulus. The EU has until the
current moment been deaf to any calls to loosen the purse strings. The
Republicans play political football with the American budget. Only
Beijing appears to hold all the strings – industrial policy, fiscal and
monetary stimulus – in its hands.
The continuous injection of monetary stimulus by central banks confers
differing degrees of profit and risk on its very unequal beneficiaries.
In the US and Europe after 2008 stock markets roared ahead of earned
incomes, exacerbating inequality. All over the world businesses borrowed
in dollars, taking advantage of America’s deep financial markets and low
interest rates. But that exposed them to risks. The first shock came in
2013 – the so-called ‘taper tantrum’ triggered by the Fed chair Ben
Bernanke’s suggestion that America’s central bank might be about to take
its foot off the accelerator. For many emerging markets 2013 was the
point when growth slowed and their currencies began to lose ground.
In 2014 oil producers were hit by the first big slump in energy prices.
Oil prices restabilised only in 2016, after Opec and Russia reached an
uneasy agreement. Before that deal could be put in place, the world
economy weathered the first real setback to China’s recent run of
economic success. In 2015 the Shanghai stock market plunged and a
trillion dollars fled China, depleting its immense reserves by a
quarter. At the same moment the Eurozone was racked by its struggle with
the left-wing government in Greece. This time not only the Chinese but
the ECB as well reacted with a massive monetary stimulus. This delivered
support to their economies, but because the Fed was beginning to edge up
US interest rates precisely as the Europeans, Japanese and Chinese were
adding stimulus, the effect was to cause the dollar to appreciate. This
exerted pressure on those businesses and governments round the world
that had taken up dollar credits, which now cost more in their local
currencies. For the same reason a strong US dollar was also bad for US
exporters. The mini-recession in US manufacturing that hit industrial
regions like Michigan and Wisconsin was an underappreciated factor in
setting the stage for Trump’s surprise victory in 2016.
When Trump took over the White House in January 2017 there was anxious
talk about the threat of populism. The GOP, dominant in Congress since
2010, had been throwing spanners in the works of America’s hegemonic
machine: opposing stimulus, threatening to default on America’s debt,
sabotaging quota reform at the IMF. With Trump at the helm, was the US
national political system about to throw off any aspiration to global
leadership and stabilisation? True to his election promises, the first
order of business was to declare a trade war on Nafta, the EU and China.
This was very disruptive to sectors like vehicle manufacturing and
agriculture, which are highly internationalised. Even more alarming was
the way that tariff competition was shading into talk of systemic
rivalry: would tech firms like Huawei or Apple be able to continue
pursuing their global ambitions? America’s allies faced tough choices.
From the point of view of a bewildered EU, both Trump’s America and
Xi’s China looked like they were putting the priority of globalisation
in question.
By this time last year, a miasma of uncertainty was clouding global
markets. Investment was retreating. As in 2015, it was highly networked
global manufacturing that felt the recessionary pressure. For global
manufacturing hubs such as South Korea or Germany, the outlook was
bleak. And in the background, filling the reports of the IMF, were
worries about the huge mountain of debt that had piled up since 2008.
Trillions of dollars would in due course have to be repaid. What would
happen if financial conditions suddenly tightened?
True conservatives, as distinct from those merely wedded to the religion
of the stock market, welcomed the prospect of a shakeout. It was time
for a purge, time to slim down the businesses that had gorged on too
much cheap funding, time for a return to discipline. This, they
believed, was the way out of the weird alternate reality created by
monetary stimulus since 2008. Instead, in the summer of 2019 the central
banks once again stepped into the ring. Harried by Trump, the Fed
pivoted back to expansion. Over howls of protest from German
conservatives, Mario Draghi, on his way out of the door at the ECB,
launched a new round of quantitative easing. The risk of recession had
concentrated minds in Washington and Beijing. The warring over Huawei
continued, as did dark talk of strategic competition, but China and the
US agreed a trade deal.
As 2020 began, the self-confidence of the technocrats remained intact.
The chief preoccupation in Europe wasn’t the immediate economic
situation, but the possibility of striking a new Green Deal. Climate
change and the energy transition were a huge, urgent challenge that
would further unmoor the alignments of the Cold War. It was China, not
the US, which looked like a potential partner. Trump and his party
simply denied the science. The 2020 UN Climate Change Conference, COP26
(scheduled to take place in Glasgow in November, but now postponed), was
a date with destiny, a moment to renew the vows made in the Paris
Agreement of 2015.
Then news of a new threat began to trickle out. On 31 December 2019
China informed the World Health Organisation of a novel virus. Its
lethality, and the fact that it could be passed from human to human,
were quickly confirmed. But Trump and his adherents had no more time for
the ‘Wuhan virus’ than they did for climate change. On the stump at
Davos on 22 January he scornfully waved away questions about it. He
trusted his new friends in Beijing; America had the situation under
control. But the markets were worried. On 23 January the Chinese
leadership began an unprecedented lockdown: a cordon sanitaire was
thrown around Wuhan, a city of 11 million people in Hubei province.
Hubei may not have been a familiar name to many people outside China.
But it is squarely on the map of global investors: 9 per cent of China’s
car industry – the largest in the world – is located there. While health
experts struggled to get politicians to take Covid-19 seriously,
Samsung, Nissan and Jaguar Land Rover were struggling to maintain
production because they couldn’t get vital parts from China. Over the
weeks that followed, bankers were among the first to join the new breed
of amateur epidemiologists.
How to gauge the threat? The obvious model was Sars in 2003, and it was
a reassuring one: China may have botched the first steps of its response
to Covid-19, but it had experience with these things and would soon
regain its grip. The Maoist overtones of Xi Jinping’s people’s war
against the virus were intimidating, but the markets were comfortable
with the Faustian pact they had made with the Chinese Communist Party’s
authoritarianism. It was, if anything, a relief that the virus had
displaced from the headlines other troubling news about China, such as
the state’s repressive actions in Xinjiang and Hong Kong.
In the course of February, economic forecasters began adjusting their
predictions downwards by 0.1 or 0.2 per cent. The worry at this point
was still the way the shutdown in China might impact global economic
growth, not the spread of the virus itself. China’s immediate neighbours
– South Korea, Japan, Taiwan – were all doing an exemplary job in
containing its spread. The US continued to report a tiny number of
cases. It had also done a derisory number of tests, but the significance
of that fact wasn’t obvious at first. On 14 February the IMF highlighted
the risk that the virus might spread to a developing country with an
under-resourced medical system; it didn’t imagine that Covid-19 would
overrun another major hub of the world economy. The meeting of the G20
finance ministers in the cloistered calm of Riyadh over the weekend of
22 and 23 February was a routine affair. All Trump’s minions wanted to
talk about were the lessons in entrepreneurialism that Europe’s laggards
might learn from America.
That same weekend, however, the news from Europe hit home. Beijing might
be winning its war against Covid-19, but in Italy the containment
strategy had failed. As the quarantined area stretched to include Milan,
the weakest link in the Eurozone was about to lose half of its national
output. Given the impasse over banking risks and a common fiscal policy,
how would Europe rise to this public health challenge? The signs were
not encouraging. France displayed a degree of strategic vision; its
finance minister, Bruno Le Maire, seconded by Mark Carney at the Bank of
England, urged joint action. But Le Maire’s German counterpart dragged
his feet. It was set to be a typical Eurozone fiasco.
Hard on the heels of the Italian shock came the realisation that
something was terribly wrong in the US itself. America has a formidable
public health apparatus, and had well-laid plans for dealing with a
pandemic. But, as became increasingly clear, the Centres for Disease
Control and Prevention and the Food and Drug Administration had
disastrously botched the deployment of a test for the virus. Trump
remained obstinately unconcerned. As financial markets began to show
signs of real nervousness, he advised investors to ‘buy the dip’ and
lashed out at China and the Democrats for fearmongering. The interplay
between news about Covid-19 and the latest movements of Wall Street are
not incidental to Trump’s politics. The markets, along with TV ratings,
are one of the few tests of his performance the president takes seriously.
Meanwhile, people who actually do the sums were arriving at terrifying
conclusions. If this was a true pandemic the entire world economy was
heading over a cliff. Industry, services and the transport network that
connects them would come to a standstill. The common denominator in this
system is energy. As 2020 began, amid the clamour about climate change,
the major oil producers had reason to believe they were entering the
endgame for fossil fuels. Anticipating a big fall in demand because of
the shutdown in China, Riyadh spent February pleading with Moscow for a
cut in production. The Russians refused. Who, after all, would benefit
if they and the Saudis cut output? It would be America’s upstart shale
industry – on which the hawks in Washington DC rest their hopes of
‘energy dominance’. Faced with that prospect, Moscow was only too happy
to see America’s oil industry broken on the anvil of the pandemic. On
Saturday, 7 March Riyadh announced that it was opening the taps. Prices
plunged.
It was over that weekend that confidence in the market finally snapped.
The historic collapse in oil prices drove home the magnitude of the
coronavirus shock. As trading began in Asia on the morning of Monday, 8
March it was clear that a massive sell-off was underway. Over the next
two weeks markets collapsed. Everything sold. The dollar surged,
threatening to crush those who had borrowed dollars. To halt the wave of
panic-stricken selling, the Fed has propped up every major domestic
credit market. At the same time it has extended dollar liquidity to the
major centres of global finance through the network of liquidity swap
lines, which enable an inner circle of 14 central banks to swap their
currencies for dollars. In addition, central banks around the world will
now be allowed to borrow against Treasuries they hold in their foreign
exchange reserves – anything to prevent central banks selling them off.
After initial hesitation, the ECB has unleashed a huge asset-buying
programme. Both the ECB and the Fed are making interventions at a far
greater rate than at any time since 2008. For the Bank of England, the
critical moment came on 17-18 March. As the UK government floundered for
a policy, sterling plunged and the gilt market became disorderly. To
stabilise prices and push down yields the bank adopted a massive
discretionary bond-buying programme. In 2012 Mario Draghi’s admission
that the ECB would do ‘whatever it takes’ to save the euro was the
climax of more than two years of political and economic struggle. This
time around it was the first principle of central bank intervention.
The massive response of the central banks has stopped the panic. But we
are only at the start of the shutdown. Every day brings news of
corporate downgrades, which will progressively tighten the supply of
credit. The recessionary spiral is only just beginning. In the US the
unemployment numbers released on 26 March and 2 April were unlike
anything seen before: 3.3 million people registered for benefits in the
first week and 6.6 million in the second. Even worse is expected in the
days and weeks to come.
Forecasting at this point is little more than a guessing game. What is
clear is that the virus has become a brutal test of the ability to
formulate, design and implement a coherent response to crisis. One
measure of success will be the economic cost, as measured in jobs lost
and GDP foregone. The other will be Covid-19 deaths per head of population.
The strategy of hitting the epidemic hard and fast, then seeking to
curtail further outbreaks over the longer term – ‘the hammer and the
dance’, it has been called – is what has actually been achieved so far
in China, South Korea, Hong Kong, Taiwan and Singapore. As laid out in
Xi’s address to the Politburo on 3 February, China’s response has
amounted to a comprehensive mobilisation of the entire technical,
economic, political and social apparatus of the regime. Its effort to
enforce social distancing involved an army of supervisors, monitors and
paramilitary police forces. Scaled to the size of a city like London or
New York, the equivalent would be a force of fifty thousand underlings –
something like the entire uniformed strength of the NYPD including
auxiliaries – devoted exclusively to controlling the epidemic. South
Korea, Singapore and Taiwan have deployed more high-tech, less
suppressive approaches. All these countries have markedly slowed the
epidemic and begun the return to normality. How far this return can
proceed depends largely on the locomotive power of the Chinese economy.
So far China’s stimulus has been muted, especially when compared to its
heroic effort in 2008. The country today is richer but more constrained
than it was then. The anxieties that dogged its policymakers before
Covid-19 have not gone away. They still have to contend with a fragile
banking system, over-indebted corporations and the burden of
unproductive infrastructure – and they remain haunted by the memory of
2015, when the Chinese currency was under serious pressure.
But these are good problems to have. In the West the landscape is
darker. Europe is faced not with a single disaster, but a series of
them, each on the scale of Hubei. By confining the worst of the outbreak
to a single province, China was able to marshal its medical resources
and deploy them strategically. Imagine if the EU had been able to
scramble 15,000 medical personnel into Italy. But Europe has never had
those resources, and in any case the spread of the epidemic will now not
permit such a deployment. The crisis is being fought nation by nation,
with whatever resources are available. Those are defined by the limited
fiscal capacities of each member state. The fear is that the deep
weaknesses in the construction of the Eurozone will be exposed. Germany,
where the medical impact of the crisis has so far been far less severe
than elsewhere, is affording itself a vastly larger stimulus than Italy
dares contemplate. Pre-existing divisions will be compounded. The
Netherlands and Germany have resisted a push led by the French,
Italians, Spaniards and Portuguese to issue joint corona bonds. The only
reason there hasn’t been an immediate return of the sovereign debt
crisis is that the ECB has stepped in. This impasse is not what the ECB
wants: its new president, Christine Lagarde, has repeatedly made clear
her support for corona bonds, as has the rest of the ECB council. It
isn’t what markets want either. But a coterie of Northern European
politicians don’t think they can ask more of their electorates: even in
a pandemic, as the infection sweeps across their borders, they cling to
ideas of national risk and national liability. Yet it is a
self-fulfilling prophecy, since no one has had the courage to make the
argument, to explain and sell the proposal.
From the point of view of Europe, it is a dispiriting stalemate. From
the point of view of the wider world, what matters is that Europe does
not unleash a sovereign debt crisis. It must also be hoped that there
won’t be a further widening of the gap between Europe’s exports and
imports. The scale of the stimulus launched by Germany looks impressive
on paper and ought to provide support to the exports of its trading
partners. But by far the largest items in the German response are credit
guarantees rather than actual spending, and it remains to be seen how
far this will stimulate overall demand.
The options for the EU are grim. Those facing the US may be even worse.
To fight the implosion of the economy Congress passed a truly remarkable
$2 trillion stimulus package – far larger than the resources mobilised
in 2008-9, and arranged far more quickly. The cheques to be sent to most
families in America are a watered down and temporary form of universal
basic income. The loan schemes include provisions to protect workers who
are still in their jobs, and to cap the excessive management
compensation and share buy-backs with which corporate America has been
rewarding the wealthiest in society. But more radical and systemic
proposals, which might actually have gone some way to covering the
trillions of dollars in lost income suffered as a result of the
shutdown, were stymied. No doubt such proposals fell victim to the
bargaining between Nancy Pelosi, the Speaker of the House, and her
Republican counterparts, but the truth is that they were unrealistic
given the workings of America’s administrative machine, whose
inadequacies are themselves a result of America’s divided politics. Why,
for instance, does the US not have a national unemployment insurance
system? To avoid attacks by conservatives, states and judges. Instead,
it makes do with a patchwork of state-level systems, many of which are
carefully designed to hold the ‘recipiency rate’ below 20 per cent of
those who should in principle qualify for benefits. It is not a system
on which you would want to rely when your economy is on life-support.
The crisis once again confirms the position of the Federal Reserve at
the centre of economic governance. There is a new mechanism for
co-operation between the Fed and the Treasury that can absorb up to $450
billion in losses on Fed lending. Given that most loans will be repaid,
this provides the Fed with enormous firepower. But it cannot address
what is actually the decisive force in the crisis, namely the epidemic.
Less than 10 per cent of the stimulus spending is for the healthcare
sector, yet funds are desperately needed to patch up a system which,
even as it is driven beyond maximum capacity, is threatened with
financial collapse. America’s best hospitals are good at high-tech,
high-fee medicine. But fighting the coronavirus requires comprehensive
suppression and mass treatment of respiratory disorders. That is not
what America’s overly bureaucratic system is designed to deliver. States
like California and cities like New York are rich and relatively well
equipped to respond to the emergency. But next in line are impoverished,
beaten-up New Orleans, and Detroit, only recently escaped from
bankruptcy. Individuals are resorting to solutions of their own. As the
epidemic exploded in New York, Manhattan’s Upper East Side emptied out,
as the rich fled to their beach houses or country estates in the hills
upstate. In red states there has been a run on ammunition stores. It’s
not for killing the virus: the Twitter feeds of the gun lobby warn of
marauding bands of prisoners being released by liberal governors from
America’s overcrowded, unsanitary prisons.
Meanwhile, Trump has turned the allocation of the US’s strategic reserve
of life-saving ventilators into a reality TV show, which, he boasts, is
attracting more viewers than the season finale of The Bachelor. He
conjured the idea that the US would be ‘opened up and just raring to go’
by Easter and was then forced to backtrack. He oscillates between
draconian threats to cordon off New York State, New Jersey and
Connecticut, and impatient demands that America ‘open up’ as soon as
possible. Once again his inadequacies have been exposed. But deeper
forces are at work. Heavy-hitting conservative voices and leading
businessmen have pushed the president in this direction. The issue isn’t
whether or not to pursue ‘herd immunity’. What prompts all the talk of
alternative strategies is the sheer difficulty of imagining how the US
can make a lockdown work, either economically or politically. Trying to
fight the virus with lockdowns and social distancing painfully exposes
America’s weaknesses. The president and his advisers are impatient to
play instead to the country’s strengths, which in their self-serving way
they identify with business, not with public health. But as the
administration’s own experts have warned, unless testing and tracing are
ramped up enormously, there is the risk of an uncontrolled epidemic that
will overwhelm America’s hospitals. Added to which, seven million
elderly Americans live in counties where there are no intensive care beds.
What we are witnessing in the American response to the crisis, more than
the flame-out of Trump, is the gulf between the competence of the
American government machine in managing global finance and the Punch and
Judy show of its politics. That tension has been more and more glaring
since at least the 1990s, but the virus has exposed it as never before.
It has forced an apparent choice between economic performance and mass
death which, not just in America, is profoundly shocking to the
prevailing common sense.
In 1992 Bill Clinton’s chief political adviser, James Carville, had one
message: it’s the economy, stupid. At the time, this sounded like the
voice of power and reason. Clearly, the current pandemic upends that
simple assertion of the priority of economic policy. But, as the Asian
states have demonstrated, it need not have been a fundamental
overturning. In the well-ordered responses of China and South Korea the
economy has temporarily taken a back seat, but their focus on public
health and public order is, it turns out, the best way back to business
as usual. If you swiftly declare an emergency and are prepared to
interrupt business as usual, both the medical and economic costs of
confronting the virus appear more reasonable, and the conventional
priorities of modern politics remain basically in place.
As the Europeans and Americans have discovered, once you lose control
all the options are bad: shut down the economy for an unforeseeable
duration, or hundreds of thousands die. Trump hasn’t mastered the
challenge; instead, he expresses through his vacillations and erratic
utterances the impossibility of doing so by any means that won’t cause a
lot of pain. In the guise of Trump the economy appears not so much as a
superego laying down the law, but as an irrepressible impulse that
insists we satisfy its demands regardless of the cost, a symptom not of
realism but of derangement. Trump thus personifies something that is in
fact common to Europe and the US: a lack of leadership at the level
appropriate to dealing with a pandemic. Instead, the job has devolved to
regional governors in the US and national governments in Europe, to
desperately overstretched medical services, on the one hand, and the
technicians of economic policy and social relief, on the other.
Meanwhile, hundreds of millions of individuals and their families cope
as best they can. As with climate change, we are left praying for a deus
ex machina in the form of a scientific breakthrough.
And once the crisis is over? What then? How do we imagine the restart?
Before he was forced to retreat, Trump evoked the image of churches
filling at Easter. Will the world economy rise from the dead? Are we
going to rely once more on the genius of modern logistics and the
techniques of dollar-finance to stitch the world economy back together
again? It will be harder than before. Any fantasy of convergence that we
might have entertained after the ‘fall of communism’ has surely by now
been dispelled. We will somehow have to patch together China’s one-party
authoritarianism, Europe’s national welfarism and whatever it is the
United States will be in the wake of this disaster. But in any case, for
those of us in Europe and America these questions are premature. The
worst is just beginning.
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