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What are the challenges facing the world economy today?

  • Published at 10:47 pm May 6th, 2020
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Will global business recover? BIGSTOCK

Covid-19 may push the financial system over the edge

The first economic data is available from Europe and the United States that provides information on the overall economic impact of Covid-19.  

It is not a pretty picture. This article discusses the outlook for the industrial world based on the recent national accounts releases for the first quarter of 2020, the IMF World Economic Outlook April 2020 and other recent economic data.

Looking back on the IMF analysis for 2020, it appears to be too optimistic. The first quarter projection for the advanced countries is for a decline of 1%; whereas the Eurozone zone declined 3.4% and the American economy declined 1.2%.  

This suggests that the advanced economies declined 2.3% in the first quarter, a much greater decline than the WEO assumed. (These are quarter to quarter changes, not annualized.)

Further bad news: The American economy experienced a 7.5% drop in household consumption in March 2020 and continuing increases in unemployment reaching more than 20% of the labour force over six weeks up to the end of April.  

The apparel stores reported a 50% decline in sales. Many of the great stores of America are close to bankruptcy. These include JR Crew, JC Penny, Neiman Marcus, and Gap.  

The retail sector seems to be concentrating more and more on Amazon, Walmart, and Target. Even Amazon reported a bad quarter despite a sharp increase in sales. The shale oil and gas business in the US cannot survive at present oil prices.

With the full force of the down turn, a decline of 10-15% of second quarter GDP of the advanced economies is reasonable; greater than the WEO forecast of a decline of 9%. Adjusting for the 3rd and 4th quarters with the assumption of a fairly strong recovery in the second half of the year we estimate that for the year as a whole the advanced economies will decline by 9-10% compared to the WEO forecast of a 6.1% decline. 

The first quarter decline indicates that the decline of the world advanced economies will be greater than expected and this will certainly cause the rest of the world economy to perform poorly.

Another difficult point is the forecast or assumption about the world oil price. Like everyone else the WEO did not force the drop of the oil price to below $20/barrel. The oil price will certainly recover to a higher level, but the volatility suggests the energy economy of the world will be unstable.

Remarkably Mr Powell, chairman of the United States Federal Reserve, made the following statement that seems to me to describe the situation the world faces precisely and darkly:

“It is heartbreaking, frankly, to see that all are threatened now,” Mr Powell said. “Everyone is suffering here, but those who are least able to bear it are the ones who are losing their jobs and losing their incomes and have little cushion to protect them.” This is even more true in Bangladesh than the US.

Powell also stressed the importance of greater expenditures by the Federal government to get the US through this crisis. The ECB has expressed the same willingness to do whatever is necessary. The Bank of Japan and the Bank of England have taken similar stances. 

The world trading system is in an uncertain position. Critical to the stability of this vital component of the world economic system: Less contentious arguments about trade; moving towards trade agreements among the industrial nations;  removing subsidies; protecting intellectual property rights; enforce reasonable environmental rules; and providing for worker rights.  

The world trading system will also be dependent on a strong supply of dollars; a shortage of dollars will cause the dollar to increase in strength and raise prices in other countries. Currently the Federal Reserve is taking action to increase the availability of dollars; this will provide respite for the financial system.  

But returning to a smooth working of the world trading system is absolutely imperative for a strong recovery from the Covid-19 induced slow down of the global economy

How will the world economy come out of this we do not know. Such a sudden, large change in the economy has never taken place before. As restrictions are lifted and business restarts, how will demand grow to make employment and production possible? This is the great unknown. There is great uncertainty about how rapidly demand for automobiles will restart.  

Most persons buying an automobile take on considerable debt to pay for the purchase. Will the banks make loans readily available when they are uncertain about employment prospects? Will people start to travel again and enable hotels to go back into business?  Will banks went information on changes of employment status for credit card holders?  

The airlines want to go back to work, but who is ready to fly? What kind of tests and visa requirements will be imposed on travellers?  Construction of housing can start only if the banks are making loans for such purpose.  

The university education system is going to go through serious rethinking as to organization, financing, teaching methods, and subject matter. How will this change the cost of education?

Every country is going to be burdened with large increases in public debt. What is the burden that this will place on the world economy? It appears that public debt will have to increase to keep interest rates low as central banks continue to fund the deficits of government and partially fund the debt of corporations.  

The recession of 2008-2009 forced the world financial system to maintain low interest rates as countries were not prepared to raise the taxes necessary to pay the interest in a market where central banks failed to take up the burden.  

Now the situation is worse. There is, what I consider an innocence, that we can continue to build up more and more debt at low interest rates. Many worry that Covid-19 will push the financial system over the edge, interest rates will rise and the only way to lower them will be to increase inflation or to allow the recession induced by the spread of Covid-19 to continue.  

There are difficult days ahead.

Forrest Cookson is an economist who has served as the first president of AmCham, and has been a consultant for Bangladesh Bureau of Statistics.

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