In 2008-09 we had a financial crisis; a credit crisis that required immense levels of government intervention in global financial markets. In the case of the UK, this included hundreds of billions of pounds in quantitative easing and an effective elimination of positive interest rates. Several UK banks required direct injections of capital and one (Northern Rock) even collapsed entirely. The fear of a massive domino effect across the economy required the UK government to act rapidly to prop up the remaining banks, bailing them out to stop them following the same fate as Northern Rock. The financial crisis lead to massive unemployment and eventually caused a number of coutries to suffer a sovereign debt crisis, where a number of countries began to default on their debt and face soraing borrowing costs.
If you fast forward to 2020, we’ve had an immense healthcare crisis; a global pandemic beyond the scope and scale of anything in living memory. Our economic and financial system might have been flashing the occasional warning light prior to 2020, but the big economic problem is undoubtedly going to come from the series of government measures designed to combat the pandemic which have deliberately mandated a recession. The elimination of a significant portion of economic activity (hospitality, leisure and retail), as well social and business travel, and the on-going weakness in commercial and retail rental sectors is created an enormous economic shock.
We can debate the degree to which these measures need to be implemented but I genuinely believe that our government has had no choice in intervening to try and implement social distancing and other measures designed to slow the spread of the virus. The result of all of this, however, has been that this is the first government-mandated recession in history. Traditionally, government intervention in markets has been designed to spark economic activity – to increase GDP and improve prosperity by doing so, but their response to this crisis has required the provision of enormous fiscal liquidity in the absence of economic activity.
This liquidity has taken the form of cash handouts through the furlough scheme, a major deferral of corporate tax payments, a stamp duty holiday, further vast amounts of quantitative easing and even discussions around negative interest rates.
This is entirely different to what the government was trying to achieve in the 2008 recession – and in many ways feels much more dangerous. Governments around the world are now actively preventing economic activity and paying people to be unproductive. The consequences of this are very clear; we, as an economic system, will exit this recession with a debt mountain of an entirely different scale to anything we ever saw after the 2008 recession.
Investors have a rather short-term memory about debt. If you look back through this blog, you’ll find a few articles dating as far back as 2015 talking about the Greek sovereign debt crisis which had been rumbling on since 2009. The crisis, which saw the Greek government ’realise’ that it had underreported debt and deficit levels led to a massive crisis of confidence in the Greek economy once actual deficit spending was acknowledged. The Greek government then had to rapidly increase taxes and decimated spending, triggering riots and protests across the country that lasted several years. Despite these measures the Greek government required three bailout loans worth tens of billions of euros, and had to negotiate a 50% default on their debt owed to private banks.
Of course, the problems facing Greece back then were also reflected in a number of other countries but to a lesser extent; Portugal, Spain, Italy and Ireland all faced variations of the same problems and underwent individual sovereign debt crises of their own.
Despite this, back in the present day, government bond yields are at an all-time low, despite governments borrowing hand over fist to prop up their flatlining economies and try to prevent unemployment shooting the lights out. Since the beginning of 2020, UK Government debt has increased from £1.8tn to about £2.1tn – now being worth over 100% of GDP and showing little sign of slowing down. Despite this, a ten year gilt yields just 0.3% – hardly crisis pricing.
In my opinion, this situation cannot last forever and at some point in the next few years, we’re going to see major problems in the sovereign debt markets as debt investors begin to wake up to the risks of currency devaluation and economic stagnation. Yields on bonds will begin to rise as demand falls and as a consequence governments will have two choices on how to fund their fiscal deficits; either devalue their currency to meaningless paper by printing money to buy up the debt themselves, or reduce spending to balance their budgets.
This, in turn, is likely to lead to significant economic challenges as an economy that has been forcibly shut down struggles to reopen. I don’t believe that business travel, office use and retail space will ever return to what they once were – even before the pandemic, the rise of technology was changing the structure of our economies and the pandemic has simply accelerated many of the changes that were most apparent. How many of us want to go to the local supermarket or clothing store now we’ve discovered the ease of home delivery? How about paying £20 a ticket to see a film you can watch from the comfort of your own home?
Of course, to some extent, the novelty of these things will always remain – I for one genuinely miss going to the cinema and taking my fiancé out for dinner, but my point is that I’ve also realised that I can live quite happily without doing these things quite as frequently. My habits have changed and as a result, I don’t believe that some sectors will ever see the same levels of spending after this crisis has finished, requiring businesses in those sectors to downsize; perhaps permanently.
As a result, huge swathes of the population will find themselves economically disposed if jobs are not replaced. We’ve seen the problems that this economic dispossession brings; the human cost is severe and with it comes the risk of severe and prolonged social unrest and upheaval. To prevent this, the government could always subsidise these sectors as it is now and in fact, I believe the demand from society will largely be to do so. The problem, of course, is that do this, governments will have to continue their deficit spending but if demand for debt instruments falls, they may well find themselves incapable of acquiring sufficient funds to do so.
Governments will then face a start and troubling dilemma; either allow the sectors to fail, in which case unemployment soars and social unrest increases, or they start slashing spending in some areas to enable them to reduce their borrowing requirements and spend money to issue the subsidies, which in truth, is also unlikely to go down well.
There is a third option; keep running their quantitative easing and expansionary fiscal policies to buy up the debt. The problem here is that this policy devalues the domestic currency; in theory, this helps exports due to products being cheaper for buyers in foreign currencies but when the entire planet is devaluing their currency, how long can you devalue currencies before they all become worthless? In addition, if one country halts the devaluation of their currency, domestic investors from that country are much less likely to value foreign bonds as the relative value of the bonds and their interest payments would decrease over time. If the country that halts devaluation and reduces foreign bond investment was a sufficiently large purchaser of foreign debt (say, China), then this would likely to have a noticable impact on sovereign debt markets.
Having painted this rather gloomy picture, I should say that I don’t believe that these problems are likely to affect every country equally; those countries with high employment, a strong currency, a strong tax base and effective rule of law will face less problems than those without these things.
Governments that use the money they are borrowing to invest sensibly will come out of this crisis far better than those the subsidise economic stagnation. Retraining and upskilling workers from shut down industries could help to pivot the economy towards leadership in technology, renewable energy, environmental sustainability, food and health security. Just as in the 1930’s America, government borrowing could be used for a massive programme of public works and social investment, building new schools and hospitals, training new medical staff and teachers, improving conditions in care homes and supporting sustainable agriculture practices.
The challenge will be trying to implement these measures at the same time as attempting to protect the population from the virus. At the moment, I see some headlines in the UK about this but relatively little tangible focus. Hopefully, 2021 and our upcoming budget will change that.