Condivergence: Pandemic, polarisation and magic money

This article first appeared in Forum, The Edge Malaysia Weekly, on December 28, 2020 - January 10, 2021.
Condivergence: Pandemic, polarisation and magic money
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2020 has been an exhausting year. The astrologers predicted a year of great change, with the Great Conjunction of the planets Jupiter and Saturn, which last happened in 1226. No wonder we witnessed changes this year that were astounding in scale, surprise and seriousness.

The pandemic was the first surprise. Who would have expected that it would break out, infecting more than 76.8 million people, killing more than 1.69 million worldwide and bringing the world economy to a massive standstill? Who would have expected that the most medically advanced countries would be the worst hit by infections and deaths?

After 9/11, the US went to war over less than 3,000 deaths. Today, more than that are dying from Covid-19 every single day. One can understand the anger among the American people, but far more incomprehensible is the incompetence and indifference to deaths that made this happen.

The difference between the performance of the US and East Asia in battling the pandemic was not denial or even competence, but between attitudes on high-tech and low-tech.

The US looked for a high-tech solution via vaccines delivered at Operation Warp Speed, whereas East Asians just used low-tech such as wearing masks and keeping social distancing, helped by targeted testing and widespread trust between people and their governments, irrespective of ideology.

True, vaccines arrived earlier than expected, but like a mask, it works better when almost all are vaccinated. As we know, if both parties are wearing masks, the chances of being infected are reduced to 1.5%. Because vaccines are far more expensive, if the masses are not vaccinated, the few who are will still be exposed, as the effectiveness is between 70% and 95%.

Furthermore, the virus is mutating all the time.

The second distinctive feature of 2020 was polarisation. Views split dramatically between families, communities and nations and at geopolitical levels. Divorce rates are up in 2020, and although protests receded after the peak earlier in the year, owing to lockdowns, they revived in the second half.

Geopolitical tensions have increased, with higher US sanctions imposed on Chinese individuals and companies, while the war of words between China and Australia has reached toxic levels. The US election only showed how deeply divided the country has become. The incoming administration of US President-elect Joe Biden will have its hands full working on how to heal and repair the damage between communities domestically, and with global friends and allies that President Donald Trump alienated.

The third surprise was the power of magic money. 2019 was a boom year for stock markets and you would have thought that, with global GDP down roughly 5% this year, the stock markets would be hurt badly because of lower profits. Instead, after a drop in March, stocks recovered and, as at Dec 15, both advanced and emerging MSCI stock indices were up 12.1% and 12.3% respectively. Tech stocks have done particularly well, with the Nasdaq Composite and Shenzhen Composite up 40.4% and 31% respectively. Every commodity index is up for the year except for Brent oil (-23.7%). The rich did particularly well in a pandemic year, but even middle-class retail investors have come out punting in stock markets.

How important is central bank money to the defence against Covid-19?

Up to Dec 15 this year, the four top central banks increased their balance sheet by 41.5%, or US$8.2 trillion (RM33.3 trillion), to US$27.9 trillion, or roughly 31% of world GDP. This is equivalent to nearly three quarters of total worldwide fiscal and monetary stimulus spending of US$11 trillion to US$12 trillion to combat the pandemic. Central banks have proven to be very important bulwarks against financial crises, but simple liquidity provisions do not solve structural issues.

The first thing to remember is that central bank quantitative easing (QE) is more a prerogative of reserve currency (rich) countries, rather than emerging-market economy (EME) central banks. EME central banks cannot expand balance sheets and domestic liquidity too much without capital outflows, risking a run on foreign exchange reserves.

Reserve currency central banks can expand liquidity because they effectively push towards a weakening of the reserve currency, which was what happened with the US dollar, yen and euro. Because so much debt is denominated in dollars, EMEs actually benefit from a weaker dollar. A strong dollar exchange rate actually tightens global liquidity, so a weaker dollar at the present moment is helpful for EMEs to recover from the pandemic.

Monetary creation in a crisis has magical elements to it.

The structural issue facing most economies is that the pandemic has pushed more business online, creating not only inequality of income and wealth, but also of health risks for poorer workers who have to be physically exposed to all the high-risk jobs that are more vulnerable to infection. And with little medical insurance, if they get sick, they would fall further into debt, entering into a downward spiral of poverty.

The World Bank has estimated that the Covid-19 pandemic may “push an additional 88 million to 115 million people into extreme poverty this year, with the total rising to as many as 150 million by 2021, depending on the severity of the economic contraction. Extreme poverty, defined as living on less than US$1.90 a day, is likely to affect between 9.1% and 9.4% of the world’s population in 2020”.

On the other hand, central bank monetary creation is lifting up asset prices, particularly stock market prices. For example, bank shares declined sharply in March 2020, but are currently back to pre-pandemic levels, even though non-performing loans are bound to be significantly higher.

The McKinsey 2020 Banking Review suggests the test presented for banks by the pandemic will evolve in two stages. Stage one is where the non-performing loans will surface until late 2021, but most banks will survive that. Stage two is when the banks may suffer erosion in revenue, which may amount to US$3.7 trillion in a base-case scenario, where payments and other income may be lost to online platforms.

This is why central banks and regulatory authorities are getting tougher on the tech giants, with the Chinese authorities showing concern over monopoly profits. The European authorities are beginning to impose taxes on the tech companies, and considering anti-trust regulations.

Nevertheless, I do not see the age of magic central bank money disappearing anytime soon. The appointment of former US Federal Reserve chairman Janet Yellen as Biden’s Treasury secretary is not just the first time a woman has held that position, but also the first time in US history that a central banker has become minister of finance. This is important for the rest of the world because of the unique status of the US dollar.

At the heart of the money issue is whether finance serves the real economy or the other way around. The Treasury position is much more political, having the power of taxation, spending and also influence on monetary and wealth policies.

If central bank money is wasted only on short-term expenditure that does nothing to lift the long-term productivity of the economy, such as retraining of labour or better infrastructure, then magic money will be wasted. Inflation will return in one form or another. If, however, the long-term productivity of the economy is lifted by tough reform measures, then money will work its magic to help attract more money. Economic historians will therefore look to Yellen to design a New Green Deal, reminiscent of the 1930s New Deal, which pushed job creation and lifted the US economy out of its liquidity trap. In the 1930s, the conservatives argued for a return to the gold standard and pushed for balanced budgets. Keynes pushed for government spending to increase aggregate demand.

Following Keynes, Franklin Delano Roosevelt won a landslide second term in 1936 because of the economic and job recovery. Therefore, Yellen has a precedent on following the New Deal model, and since Biden has promised action on climate change, the Yellen stimulus is likely to be a New Green Deal and a Job Deal. The only downside is whether the Republicans will block everything for the sake of politics.

My bet is that Biden will push for a strong fiscal stimulus in 2021, which means that — coupled with the normal recovery from the pandemic — there could be much better economic performance than expected. This is probably why stock markets are more buoyant in anticipation of better income flows.

On that more optimistic note, may 2021 be happier, more prosperous and safer for everyone.


Tan Sri Andrew Sheng is a former central banker and financial regulator. The views expressed  are entirely his own.

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