The shock to the global economy from Covid-19 has been both faster and more severe than the 2008 global financial crisis (GFC) and even the Great Depression.
Now, markets are down 35% expect US GDP to fall by an annualised rate of 6% in the first quarter, and by 24% to 30% in the second. US Treasury Secretary Steve Mnuchin has warned that the unemployment rate could skyrocket to above 20% (twice the peak level during the GFC).
But the best-case scenario assumes several conditions.
cross-border swap lines to address the massive dollar liquidity shortage in global markets, but we now need more facilities to encourage banks to lend to illiquid but still-solvent small and medium-size enterprises.
But these deficit-financed interventions must be fully monetised. If they are financed through standard government debt, interest rates would rise sharply, and the recovery would be smothered in its cradle. Given the circumstances, interventions long proposed by leftists of the Modern Monetary Theory school, including helicopter drops, have become mainstream.
Moreover, the fiscal response could hit a wall if the monetisation of massive deficits starts to produce high inflation, especially if a series of virus-related negative supply shocks reduces potential growth. And many countries simply cannot undertake such borrowing in their own currency. Who will bail out governments, corporations, banks, and households in emerging markets?
In any case, even if the pandemic and the economic fallout were brought under control, the global economy could still be subject to a number of “white swan
Similarly, as I have argued previously, markets are vastly underestimating the risk of a war between the US and Iran this year; the deterioration of Sino-American relations is accelerating as each side blames the other for the scale of the Covid-19 pandemic. The current crisis is likely to accelerate the ongoing balkanisation and unraveling of the global economy in the months and years ahead.
This trifecta of risks – uncontained pandemics, insufficient economic-policy arsenals, and geopolitical white swans – will be enough to tip the global economy into persistent depression and a runaway financial-market meltdown. After the 2008 crash, a forceful (though delayed) response pulled the global economy back from the abyss. We may not be so lucky this time.
Nouriel Roubini, Professor of Economics at New York University's Stern School of Business and Chairman of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank. His website is NourielRoubini.com.
Copyright: Project Syndicate, 2020