The pandemic has caused some degree of disruption to most economies in the world, much as every crisis does. Equally, not every economy has been affected in an even and consistent way. Some countries have been affected worse than others. Some economies have bounced back better than others. The intensity and duration of the disruption is influenced heavily by differing social and political conditions, which reflect the underlying cultural norms of the different societies. As the pandemic progresses, we can already start to see the contours of an emerging future. It allows us to speculate about how that may develop as time goes on.
COVID originated in the Far East and these societies were the first to react. The initial reaction was one of literally shutting down society and economic activity as far as possible. By and large, this strategy proved to be successful, mainly because the societies involved normally contained a relatively high degree of central control. As the virus spread across Europe and North America, various governments reacted with varying degrees of competence. This meant that the virus was not quite as well contained as it had been in the Far East. The effect of this was to keep economic activity at lower levels than had been experienced previously.
The governments in Europe and North America responded to the economic deep freeze in the private sector with a very large fiscal stimulus. The method varied from nation to nation, but the intention was similar - to keep afloat households during a period of acute reductions in earnings. In Europe, the main intention was to fund employers so that they could continue to pay salaries. In the US, the main strategy was to pay the economic actors directly - funds paid to companies to support profits and to households to cover their expenses.
This is where things start to get interesting. A good percentage of the stimulus funds were saved, both by households and corporates. Both sectors have increased their holdings of precautionary balances - their 'rainy day money'. However, not all of the stimulus has been saved and consumption - especially the consumption of on-line sales - has held up. This has had an interesting impact on the foreign balance. On the one hand, reduced levels of economic activity in the US has held back exports, whilst, on the other hand, the fiscal stimulus has helped to pull in greater levels of imports. Especially imports from China. As a corollary, Chinese sales into the US has helped to increase economic activity in China to such a degree that China can actually expect economic growth this year.
We have now reached a point where the US has seen the return of the twin deficits - the external deficit and the fiscal deficit - and is now reliant upon a net inflow of finance to sustain these. This is of very great significance because it is marking a point at which the US moves from being a creditor nation to becoming a debtor nation. Potentially, this is not a happy place for America.
It could be possible that the US attempts to address these deficits, However, the consequences would be somewhat untoward. The fiscal deficit could be addressed through a large increase in taxation, but that would risk capital flight. Alternatively, spending could be pared back. But where? Defence? Social programmes? These choices presume a political system in broad agreement, whereas we see one that is largely gridlocked. The future prospects are even worse. As America ages, then, if the political promises for pensions and healthcare are to be maintained, then the fiscal deficit will grow even further than it is today.
All of this is dependent upon the willingness of overseas actors to finance the debt. That would suggest the continued support of the rules based economic infrastructure that supports such financing. In which case, the scope for addressing the external deficit becomes much more limited. The two are linked. For example, President Trump's trade war with China and the resultant imposition of tariffs on Chinese goods had two effects. First, China retaliated by imposing tit-for-tat tariffs on American goods entering China. Second, with more subtlety, Chinese surpluses with the US are no longer recycled into US Treasuries. They are channelled into emerging market sovereign debt. This is a potential problem for the US that could have a significant impact upon the future.
It would seem that the twin deficits are likely to be a feature for some time to come. At this point we might ask what that means? We take the view that this is a situation broadly analogous to that of Great Britain a century ago. From the British perspective, it marked the start of a half century of decline. Relative decline at first, and then absolute decline. If we are right, then we ought to start thinking about what might be the American equivalent of the Suez Crisis and look out for the formative elements in mid-century. A more interesting question revolves around how Washington would react in the face of a national humiliation? The pandemic has accelerated this process, which was under way at the start of the year, but it is an interesting consequence of COVID-19.
Stephen Aguilar-Millan
© The European Futures Observatory 2020
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