The views and opinions expressed in this article are those of the thought leader and not those of CeFPro.
By Brandon Davies, Non Executive Director, Obillex Limited and Lintel Financial Services Limited
The Covid 19 pandemic is a real exogenous shock to the economies of the world as it is truly global and unlike the 2007 – 2009 credit crisis and financial crisis, does not have its origins in the financial system.
Shocks to an economy from whatever source tend, in my view, to do two things in that they:
• Create real change
• Accelerate change that was already underway.
The latter changes are easier to comment on so I will start there, with what I think is a certainty, the more rapid adoption of new IT and communications technologies.
Technology has changed our lives, allowing us to continue as much as can, without leaving home; We are getting used to ordering goods online and now many more of us are ordering groceries online also, booking our doctor’s appointment or even
a consultation with our doctor over the internet. We attend virtual exercise classes and my students at Buckingham University are attending virtual lectures and tutorials with far less face to face meetings. These changes to our lives, as I am sure there are many more examples, will not end with the discovery of an effective vaccine for Covid 19, as many aspects of our new living and working environments have changed permanently.
My guestimate would be that we have accelerated these already existing trends in IT and technology adoption by around 5 years, but of course given ourselves something of an additional shock as we will need to adapt to changes in the work many of us do as a result.
We have also got used to working from home, we have relocated jobs away from city centre offices, that we will no longer need in the quantity we did before Covid 19, as we now organize our work around Zoom meetings and Teams working.
What broad conclusions can we draw from this changed economy?
There will be less jobs in the service sectors of call centres and shops. Alexa and not real people will staff the former and the high street shops will give further ground to Amazon and other online retailers.
Physical transport will lose out to the internet, runways and aeroplanes for business use will give ground to 5G and fibre optic cable. As indeed also will cars, busses and railways, meaning that our thoughts and our conversations will move but we won’t have to. All of these developments are going to lower costs of production. Covid 19 will in part be a productivity shock, but in a good way, though as well as productivity there will also from this angle be deflationary changes as there will be from the unemployment it produces.
National Infrastructures will need to change to react to these changes, such as a third runway for Heathrow in London
now looks a lot less likely to be profitable. Instead, increased investment in high speed, high capacity communications looks to be a significant enabler for this changed world.
What about the security aftermath?
Countries were already realizing that the wars of the 21st century would be different from those of the last century. You no longer need to bomb your opponent when you can bring their economy to its knees by infecting it with a virus, be that a computer virus or the real thing. Rogue states will not be the only actors in this space, criminals and terrorists will be at least equal threats, and possibly more so as in the latter case at the very least they won’t need to bother with developing a vaccine.
Aircraft carriers will give way to cyber security infrastructure both defensive and aggressive, something that was underway in the cyber space already prior to the Covid 19 pandemic. However, new is that health security will become a top defence issue. This is not just for the security of the nation, safeguarding citizens. This will affect industrial policy as well, with an impact on labor as seeking news drugs, personal protection equipment and ventilators among many other items will become national security issues.
Does this mean the end of globalization?
Not in itself as countries will care where a new and long list of security related products come from and by and large will seek domestic manufacture. However, the list of products will still be a relatively short one compared to the size of international trade, though we cannot discount the possibility of governments with a protectionist agenda will exploit the situation to raise trade barriers and import taxes in general.
The bigger effect will, I think, come from industry itself. Global supply chains and ‘just in time’ supply may have led to great efficiency but these supply chains have proved very fragile. Companies will seek to diversify sources of supply and to manufacture more in house and closer to their end markets. A policy that will be encouraged by new and more automated production methods such as the printing of parts by machines that can be software programmed to print many different parts, a technology that greatly lowers the cost of production for relatively small numbers of units produced.
Politics will need to change
Populations across the world are much better educated and as a result far less differential than they used to be. Leadership will need to consult not just communicate to populations who will be asked to surrender elements of their personal freedom and certainly personal data to track virus outbreaks in the future. Some countries are better placed to adopt and accept these changes. The UK, for example, is not well set up politically to achieve this but if the data collection, tracking and tracing of personal movements were put under the National Health Service and not the Home Office then this could possibly be a way forward.
Recovery and Macro-economic aftermath.
Recession is expected but “V”, “U”, “W”, “L”, what shape will recovery take? If indeed there is one. Let me be bold, I think “U” recovery as a best guess, based on not expecting behavior to return to its “normal” pre Covid 19 state. Moreover, I expect the micro economic changes outlined above to cause some significant short-term disruption. So I think a “V” very unlikely especially as governments are not leading us to expect a sudden reopening of industry and commerce to previous levels, even if a vaccine is found. A “W” would imply that there is a second wave that cannot be contained by track and trace and would result in a second lock down, which must be a real possibility if insufficient resources are put in to it and / or the necessary phone software is rejected by a significant part of the population. An “L” would imply no recovery at all, which given the level of fiscal and monetary stimulus coming from governments and central banks is, I think unlikely, but not impossible.
So what about government deficits, which will be huge. Firstly, the cost of funding these deficits will not be great. The UK 10year Gilt (as of May 2020) trades such as to give the investor a return of around 0.3% nearly 1.0% below where it traded a year ago. It is impossible to say today what Debt/GDP will be in 1 year’s time, as both Debt and GDP are likely to change significantly from their pre-Covid numbers. However, both the Bank of England and the US Federal Reserve are currently giving unlimited support to their government bond markets and in practice giving support broadly to securities issuers and bank borrowers we will be well into money printing, no matter how much they claim otherwise, though in truth we have been doing that on a smaller scale for some time now.
Will this prove inflationary?
Possibly, but Covid 19 is a demand and supply shock so the net effect is difficult to tell. Personally, my belief is there will be a rise in inflation over time mainly because I believe there will be toleration for governments and central banks at least allow inflation above target for a period of time before reacting in the belief it can be restrained if necessary. In practice, given where we are currently, I do not see how governments and regulators have much choice but to throw everything they can at their economies to re-start them and ensure the recovery is sufficiently fuelled.
What about the Euro area?
The European Central Bank (ECB) will in my view join in
the money printing, as I believe is already happening, the expansion over the last decade in the ECB balance sheet has pretty much matched that of the US Federal Reserve and the Bank of England, they have found plenty of room for manoeuvre despite the apparent constrained remit, there will be political rumblings but far less than if they fail to support the southern Euro area economies*
What about emerging markets?
Much emerging market debt, whether of governments or the private sector corporations, is denominated in the US$. With the $ being the reserve currency and a safe haven in difficult times, defaults could easily become widespread, aggravated in a number of countries by a fall in demand for commodities and especially oil. In addition to widespread devaluations I suspect there may be the need for a more general addressing of debt problems; could we see a 21st Century version of ‘Brady Bonds’?
So here you have the output of my ‘crystal ball’, with plenty to discuss, plenty to challenge and much still unknown or to be decided. Certainty is, for the time being at least, the new norm.
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