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Pillager of the world: The economic impact of Covid 19

The Covid 19 pandemic has ravaged the world economy since February. On the 9th of March, we published forecasts assessing the likely impact of the outbreak going forward under various scenarios.

Due to the very fast spread of the Covid 19 and the extreme measures enacted across the world to contain it, our forecasts have become outdated in record time. So, we will publish a series of Deprcon Special Issues updating those forecasts. This is the first of those updates.

“Out of the depths I cry to you”

It’s safe to say that the world economy has “met its maker”. The Covid 19 virus is the perfect weapon designed for maximum economic destruction. It forces decision makers to either shut-down the economy for an extended period of time, at an almost unfathomably severe cost; or try to keep the economy running, at the risk of further contagion and widespread human suffering and death—and then watch as the economy collapses anyway.

The optimal response for the economy and the society seems to be “test early and quarantine”, which was applied most successfully in South Korea. Most of the European countries and the U.S. missed their window of opportunity and were consequently forced to enact draconian suppression measures.

What many seem unable to understand—and what we outlined in the Q-Review 1/2020: The Black Swan report—is that you simply cannot just shut down an economy for a while and then turn it back on like a light-switch.  Yes, after a lockdown, an economy will rebound, briefly. But the massive layoffs now observed in all countries—forced by catastrophic negative shocks to consumption and production—have effects that will accumulate in national and global economies.

The worldwide disruption of commerce and production are unprecedented in at least a century and can only be compared to times of global depression or war. Alas, we are only at the early stages of the economic crisis put in motion by the Covid 19 pandemic!

The (likely) path forward

In our most likely scenario, we expect to see the following:

  1. Some governments will be very prudent and active in suppressing and testing the spread of the Covid 19, while some will drag their feet worsening the global outbreak.
  2. The pandemic will reach its global peak in May.
  3. Global travel restrictions will be slowly relaxed from mid-summer on.
  4. The massive stimulus measures enacted by governments and central banks will provide support for the global economy at the initial stage after the Covid 19 outbreak peaks (late Q2, Q3).
  5. Yet, the flood of corporate bankruptcies, driven by collapsing economic activity, and over-whelming loan losses will push the European banking sector into a crisis by fall, which will metastasize globally due to the high concentration of systemically important banks in Europe.
  6. The Eurozone breakup commences in the fall at the latest.
  7. The Chinese economy will ‘land hard’ due to collapsing global demand and declining economic activity.
  8. The global economy plunges into depression.

As shown in the table below, the Eurozone and Finnish economies, unsurprisingly, will take the worst blow, with GDP crashing by over 20 percent in both. As we expect the Eurozone to fracture, those estimates are naturally only speculative. The US would also take a severe hit, with the GDP plummeting by over 15 percent decline during the next three years.

covid virus economy
Table. Yearly growth forecasts of the real GDP growth for the Eurozone, the US and Finland. Source: GnS Economics, OECD

It is crucial to understand that the estimates presented above are wholly dependent on the assumption that we get the epidemic under control. It should also be acknowledged that if the European banking sector and/or the Eurozone implode already before summer, estimates for the 2020 will be materially worse.

This is it!

We have been warning about the fragility of the global economy since March of 2017. This past January it became obvious that the Covid 19 epidemic would have a severe impact on the global economy and the world’s over-levered and highly speculative financial markets.

The Fed, other central banks, and global governments have basically thrown everything they have against the economic fallout caused by the Covid 19. The Fed has effectively become the financial market as it now backstops not just repo and U.S. Treasury markets, but also corporate commercial-paper and municipal bond markets and short-term money-markets. There is now not much left of the once-great “free markets” in the U.S. 

Of course, European bond markets have been moribund for years after the ECB commandeered them for political purposes in 2012.  Gigantic swap-lines between the Fed and European central banks provide additional dollar liquidity to that banking system. 

While the massive macro response of the U.S. leadership may prove to be excessive, and possibly irreversible, it is at least somewhat understandable, as the consequences of the bursting of the financial bubble would surely be devastating.  But we do wonder whether U.S. leaders realize that they have become their former worst enemy: The (Financial) Socialistic Republic of the United States?

And, in the end, it all is likely to be in vain. When the flood of corporate bankruptcies begin, there is no power in the world sufficient to keep the U.S. financial markets and the European banking sector from collapsing. There just is no escape.

This is it!

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