COVID-19 has quickly become a massive demand shock. About 68% of the U.S. economy is driven by consumer spending. When consumers stay home en masse, the damage is rapid. Businesses shutter and employees are laid off. We saw the first inkling of what is to come in this week’s steep rise in filings for unemployment insurance.
The mood in Washington has become more urgent, as the government considers a package that may exceed $1 trillion in size. It may include a payroll tax holiday, direct cash payments to U.S. residents, and subsidies to the small businesses and industries most affected by the slowdown. But there remains disagreement on specifics, which is delaying passage.
Continually growing headline estimates of the size of upcoming interventions reflect legislators’ growing concern about the damage COVID-19 is causing. Gone are the days of principled objections to increased deficit spending; the debate has focused on how much stimulus to implement and how soon it can be done. Long-term U.S. interest rates reflect an expectation that the budget will be busted.
Leaders of every developed market realize the importance of fiscal stimulus to weather the COVID-19 disruption, and they are responding in force. The U.K. launched a £330 billion program of loan guarantees in addition to targeted measures for small businesses and companies in the hospitality sector. France pledged €45 billion of aid and €300 billion of loan guarantees and is exploring measures as extreme as nationalizing key businesses. Spain is offering €100 in loan guarantees thus far, with Prime Minister Pedro Sánchez sagely summarizing the loss: “2020 will not have 12 months,” as the disruption will squander months of potential output.
Eurozone member states have individually pledged a total of €1 trillion in aid, and still, their largest fiscal weapon remains unused. Chartered in 2012 during the depths of Europe’s sovereign debt crisis, the European Stability Mechanism (ESM) provides an emergency backstop to countries in need of a bailout. If EU members agree to reviving ESM issuances, more than €400 billion of supplemental loans could rapidly be made available to EU nations.
Asian nations that faced the virus first have shown the value of a strong response. Monetary policymakers got the message clearly, while elected leaders are starting to rise to the challenges ahead. While it will be expensive, it is not as costly as inaction.
Emerging Troubles
The Chinese Year of the Rat, 2020, was meant to be a year of prosperity. Instead, it has brought a great deal of humanitarian and economic challenge. COVID-19 has spread to over 160 countries and territories around the globe, causing serious disruptions across markets and to all forms of economic activity. Though advanced economies are now at the epicenter of outbreak, emerging markets (EMs) have also been hit hard.
Disruptions across EMs are growing. With major demand centers (advanced economies) moving closer to recession, EMs’ resiliency will be tested. Commodity- or natural-resource-rich EMs are hit with the double shock of coronavirus and falling commodity prices (not just oil). Several of those already struggling to cope with rising protectionism are facing a sharp drop in export earnings. Weaker exports will not only weigh on each economy’s external sector but also on domestic demand, as cutbacks in production result in losses of work.
To make matters worse, the U.S. dollar has been strengthening. EM currencies have weakened amid the outbreak and are likely to remain under pressure given the uncertainty around economic prospects. Businesses and governments would face significant challenges in servicing their dollar-denominated debt. Several emerging markets are reportedly struggling to acquire the dollars needed to service their obligations, given the uncertainty of the value of local currency.
The widespread selloff is causing a sharp reversal in capital flows from relatively risky EM assets into safe haven assets like the dollar. According to the Institute of International Finance, EMs have recorded about $55 billion in capital outflows in less than two months, double the pace of withdrawals seen during the 2008 crisis.