Investors are convinced that the COVID pandemic is temporary and a return to normality is inevitable. What gets us into trouble, as Mark Twain knew, is “What we know for sure that just ain’t so!”
As is increasingly evident, the costs of COVID and the U.S. response have profound implications for the upbeat outlook supporting elevated financial asset prices.
The pandemic hit a weakened U.S. economy that has never fully recovered from 2008. Only massive government intervention prevented collapse. But government support has increased public debt significantly. This will rise further due to continuing U.S. budget deficits, likely to average 4.2% of GDP through 2031, well above the 50-year average of 3.3%. Federal debt held by the public is projected to climb to 107% of GDP (surpassing its historical high) in 2031.
This debt will have to be paid for either by higher taxes, cuts in spending, Federal Reserve funded government borrowing or a mixture of these, which will affect growth and prices.
The U.S. government response has consequences. Increased housing prices, due to expansionary monetary policies, will flow through into higher rents and inflation. Improved benefits, which is inching towards some form of permanent universal basic income, may alter labor markets.
Cost structures within the U.S. economy have increased. Surviving businesses have crisis liabilities. Deferral of rents and debt payments or assistance structured as new loans have increased indebtedness, which will need to be met. Many firms, especially in the travel industry, granted credits rather than refunding prepayments. When these are utilized, the costs of providing the service will be not be offset by new revenue. Firms will need to recover these pandemic losses.
All businesses face changed operating conditions. Restarting requires spending; for example, airlines face costs of recommissioning airplanes and recertifying furloughed staff. There are costs associated with meeting COVID public health orders, as well as occupational health and safety regulations. These will result in either higher prices or lower earnings.
Demand in some sectors may decline. Travel, especially international, will require pre-flight testing, vaccination certificates, expensive insurance, possible quarantine costs and changing entry and exit restrictions. Lower volumes and occupancy or venue limits will reduce economies of scale, which will pressure prices.
Mobility restrictions, which are likely to remain for some time, will create labor and skill shortages. This will affect wages and also the ability for businesses to operate normally.
Higher shipping costs and delays also may continue. The loss of belly freight capacity due to fewer scheduled passenger flights will only correct slowly. Shipping will continue to be affected by shortages and difficulty in sourcing crews, who are mainly from poor emerging nations with low vaccination rates and affected by mobility restrictions.
Slow rates of vaccination in emerging countries mean that COVID outbreaks, like that in China’s Ningbo port, will quickly paralyze production and flow of goods. This also assumes no major resurgences of COVID or new variants, which could create new interruptions.
Aside from the pandemic, pre-existing conditions continue to affect recovery. The Sino-American economic war, with its trade restrictions and sanctions, is not going away. Climate change and extreme weather are adding to insurance and other costs. Disruption of production and transport links will become more regular. Perhaps 20% or more of global GDP could be lost by 2100 due to climate change, including infrastructure damage, lost property values, lower agricultural and labor productivity, and losses in biodiversity and human health.
Already, resource shortages are accelerating. Water and food shortages manifest in higher prices. Higher energy prices reflect underinvestment and mismanagement of the transition to lower emissions. None of these factors will be corrected soon and will continue to weigh on growth and inflation.
The neglected reality is that the pandemic and other crises must be paid for — by reduced business earnings, lower household incomes, or both. This can be explicit through both higher taxes and austerity. Alternatively, it will be implicit in the form of lower growth and inflation — reducing consumers’ purchasing power.
The current overvaluation of assets assumes confidence in policymakers. But options for dealing with many of these issues are limited. For starters, you can’t print commodities, truck drivers and semiconductors like you can print money. Central bankers’ control looks increasingly fragile. At some point, loss of credibility will be the tipping point.
Economist Rudiger Dornbusch observed: “Things take longer to happen than you think they will, and then they happen faster than you thought they could.” Investors’ FOMO — the fear of missing out — might turn into FOGO — the fear of getting out.
Satyajit Das is a former banker. He is the author of ” A Banquet of Consequences – Reloaded: How we got into this mess we’re in and why we need to act now.” (Penguin Random House Australia, 2021).