The Pandemic Economy: An Interview from China's Netease

The Chinese financial website Netease reached out to me with some questions about the economic impact of the COVID-19 pandemic, and posted the interview today. Here is the original conversation in English:

1. Some people hold the view that we are now suffering a new round of Great Depression, which will be even worse than 1930s. Do you agree with this comment? How do you evaluate the influence of the coronavirus on the world economy?

The Great Depression is an appropriate analogy, I am sad to say. The global economic outlook already was slowing, as a long expansion matured, before the coronavirus hit. So we already were hitting headwinds, which made us that much more vulnerable to the economic slowdown caused by the pandemic. Unemployment has already risen dramatically, but despite that I think we are still numb and that there is much more pain to come. Until we have a vaccine and better understanding of how to treat COVID-19, the economy will not be able to fully spring back to life. We still don't know how long that will be -and the longer it takes, the more economic dominoes will fall.

Debt is a big, big one. The International Monetary Fund and smart analysts whose views I respect have already been warning that record global debt levels have left the world extremely vulnerable to a recession. Falling revenues mean that more and more companies will have a hard time keeping up with their debt obligations. Nearly $11 trillion in corporate debt around the world matures over the next four years --over $2 trillion a year-- and will be much harder to refinance in this environment. We are likely to see a spike in corporate debt defaults as well as distressed consumer lending. As long as consumers are struggling, businesses, landlords, and creditors will too. So policy makers need to be working now to restructure and forgive some of that debt, because the longer they wait, the bigger the cost will be and the more chaotic things will be as businesses fail, taking banks down with them.

All of this creates a vicious downward circle: the worse people think it will be, the less they spend or invest. So decisive policy action to support the jobless, restructure debt, and --the one bright spot-- to partner with the private sector to support the innovation that is appearing amidst the crisis-- will play a big part in determining just how bad things will be and for how long.

Many analysts believe that it will take a few years for economic activity to recover fully.

2. The IMF has forecast that the global GDP growth rate will become -3 percent this year. How do you think about this forecast? Will this increase market panic? How should major economies respond to economic recession?

That forecast may turn out to be optimistic, as it assumes the pandemic will wind down and economies come back to life in the second half of the year and that's not 100 percent certain by any means. It's also important to remember that this is an average, based on projections that emerging market countries will suffer considerably more than wealthier countries. The United States already is at a real unemployment rate (which is much higher than the official level) of over 20 percent --the highest level since 1934.

But the truth is there's no way to forecast accurately, since we don't know how long it will take to create a vaccine or how long it will be until economies can fully re-open. We also do not know what will happen as the next flu season begins this fall, as many people expect another wave of infections. Remember that the 1918 flu pandemic lasted two full years. My great-grandfather died during the second wave, in November 1918. Much of this depends on how responsible citizens are in wearing masks, washing hands, and avoiding crowds. In the West, where there is a dangerous disregard for others in society, this is a major issue. There is some progress testing some drugs and more understanding of the virus than we had a few months ago, but we have much more to learn before we can safely control it.

The outcome depends on how policy makers react. Will they support people who have lost their jobs? Will they address the monetary imbalances that are hurting the real economy and helping speculators? In the United States, there has been a lot of justified outrage at how big companies with access to credit lines and other sources of capital took a lot of the money that Congress authorized to support small and medium sized businesses. People also have been upset that companies that used most of their free cash flow to buy back their shares now want government bailouts.

3. The oil price has fluctuated during the past months and became negative this week. What do you think about oil price trends? Does the reduction agreement mean that the "crude oil price war" has come to an end? How do you view global demand for crude oil in the future?

We cannot assume that anything has come to an end in this crazy situation, but I suspect that the size of the negative price shock and oil supplies overwhelming storage capacity will cause a lot of production cutbacks. This is a terrible time to be having a spat about production levels and that will come back to bite big oil producers. Even if production is at more sensible levels, global demand will not support prices at levels where they were just a few months ago. Many smaller oil producers will not survive. Given the need to move to cleaner energy is not the worst possible outcome, both in terms of greenhouse gas emissions and related pollution issues which studies have shown make people more vulnerable to respiratory viruses. Energy companies have received huge subsidies for decades, but as other alternatives --many of which create more jobs-- have become feasible, governments not only need to stop subsidizing dirty fuels but also must factor in the health and environmental negative externalities they create.

The policy outcome I would like to see is that governments take advantage of low prices to institute a carbon tax. Consumers would still be paying less than before. The revenue would help put a dent (however small) in the rapidly growing fiscal deficits. The tax would send a message encouraging people to use cleaner transportation options, whether hybrids, electric cars, ride shares, public transport or bicycles. And it could be redirected toward new job training and/or transition benefits for oil industry employees.

4. Global manufacturing industries have been shrinking. How should we protect manufacturing companies in the world? For foreign trade companies, how should they survive in this disaster? How should China cope with the pressure on trade?

As bad as things have been for manufacturers, service industries have been hit even harder. And for people to buy manufactured goods, they need income. So we need a whole-of-economy approach.

One of the things that could be positive for manufacturing is that the pandemic has shown problems with the "just in time" supply chain management that had become so popular. Businesses will need to re-think that, which could lead to larger re-stocking orders in the short term and help with the recovery.

We will be seeing a dramatic re-shaping of trade patterns around the world On policy issues, I could not disagree more with the nationalist impulses to close borders and restrict foreign trade. And having traveled around the world, I personally love and benefit from being able to get things from far-away destinations that I would not have been able to get before globalization. But as someone who is profoundly concerned about climate change, I will be happy to see goods traveling shorter distances and think that is a positive trend. I would like to see labeling of goods to reflect their carbon footprint so consumers can make better prices.

As countries re-shore manufacturing, prices of many goods will rise in higher-wage destinations since they will be more expensive to manufacture. This will increase the use of automation and additive printing to bring costs down. Countries will have to put in place policy frameworks to ensure that more citizens can afford higher prices. This means addressing economic inequalities that the pandemic has brutally exposed and made harder to ignore.

The silver lining for China could be that this is an opportunity to address a long-term challenge: to bring into better balance investment and consumption. China's policy response should be a laser focus on domestic consumption. Measures to boost lower and middle class jobs and incomes will be a crucial part of this effort.

5. Will the epidemic enhance the anti-globalization trend? Some countries have banned rice exports. Do you think we will fall into a food crisis?

Unfortunately, yes, the epidemic is already adding to anti-globalization. There will be food shortages. After I heard that some countries were halting rice exports, over the weekend I went to the local supermarket, run by Pakistani immigrants, where I get basmati rice. They said there had been a brief delay in deliveries, but so far so good. I'm not counting on that to last, however.

So far, the most dramatic disruption to food supplies has been in the interruption of planting, harvests, and processing because of worker illness. In the United States, slaughterhouses have been closing or cutting way back their meat processing operations because so many workers are getting sick.

The pandemic also has hurt distribution networks. My family is from Wisconsin in the Midwest, nicknamed "America's Dairyland" for its dairy farms and cheese production. There has been such sad video of farmers pouring milk onto the ground because they had no way to get it to customers, and the cows need to be milked. What's especially sad is that there will be tremendous waste alongside the shortages, at a time when hunger is increasing. I read another story of an egg farmer who donated 2,500 surplus eggs to a charity, and they were all gone in minutes.

6. The Federal Reserve is committed to using its full range of tools to support the U.S. economy, and President Trump signed a US $ 2 trillion economic stimulus plan. Do you think this will work? Do you think the infinite QE is the best rescue plan for the market?

Some elements of quantitative easing are necessary but it is long past time to put in counter-measures to deal with the unintended side effects, like market bubbles. The huge surge in government borrowing means that raising interest rates would quickly add even more to the budget deficit. But the Fed's tools are limited: there are problems with what insiders call the "transmission mechanism," or how to get liquidity into the real economy instead of just financial assets. That policy failing is part of what got us into this mess, making us that much more financially vulnerable to a pandemic. Congress needs to put in place counter measures against a major side effect: that QE is helping speculators more than the real economy, workers and business owners.

Right now the US stock market is only 16 percent off of its record high which is ridiculous given the economic realities. But market logic is that the Fed will do whatever it takes to support the markets. This completely destroys the conventional "wisdom" --which is not so wise-- that says the stock market reflects expectations for future economic growth that will be returned to shareholders through dividends. The reality is quite the opposite: for quite some time the markets have reflected only speculators' expectations of further loose monetary policy. And the worse economic expectations are, the more money will be printed, and the more money goes into speculation. Unfortunately, most of that money is not going into the real economy. And that means ultimately this house of cards is extremely unstable.

US tax policy makes this dynamic worse because it subsidizes market speculation, both through a lower rate for stock market investments and through a tax deduction for risky margin investing. The 2017 cut in corporate tax rates, to 21 percent, still left companies paying higher taxes than people who simply stick their money in the stock market. Even the highest "long term" capital gains tax rate --for stocks held more than a year, which is not very long term by most measures -- is 20 percent for high income earners. There have been some calls for increases in the capital gains tax rate, but there need to be more and much louder. It is crazy that it seems that every time the market drops sharply, the Fed lowers rates. But they don't do emergency rate hikes when markets "melt up." That is a mistake: central banks need to pay attention to asset inflation as well as price levels in the rest of the economy.

This article is part of my LinkedIn newsletter series, “Around My Mind” – a regular walk through the ideas, events, people, and places that kick my synapses into action, sparking sometimes surprising or counter-intuitive connections. 

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