How the US and the World’s Countries will avoid the Economic Armageddon caused by the Lockdown of Coronavirus Pandemic

The terrifying economic downturn that the developed economies of the world are gradually facing, especially that of the US, due to the Covid-19 (Coronavirus) pandemic is much worse than the global financial crisis of 2008 caused by the collapse of the US investment bank  Lehman  Brothers  Holdings  Inc. This is because the current crisis is at the same time hitting demand side and creating insurmountable problems in supply side.

by Trust Economics https://trusteconomics.eu

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The terrifying problems that lead to financial Armageddon

The climate of uncertainty and the necessarily imposed restrictions, which in many developed countries of the Western world such as Euro zone member countries, the UK, the US states (New York, California, etc.) reach the point of curfew of citizens-quarantine and lockdown, cause violent changes in citizens’ consumer habits, resulting in drastic ally and/or disappearing in several cases the demand from entire sectors of the economy, such as tourism, air transport and in many service sectors.

On the era of Huge Recession
Photo by the site www.prospect.org

At the same time very, strong problems are being caused on the supply side due to the strong problem in production. As in China, both in the EU and later in the UK and in the US, production in many industries was interrupted due to the protection of their workers while exacerbating serious problems in supply chains from abroad and mainly from China.

The simultaneous collapse of demand and supply side equally is the most nightmarhastic scenario for both economists and politicians, due to the incredibly bad situations they will be asked to manage.

The collapse of GDP, the drastic increase in unemployment rates, the dramatic increase in business failures, particularly in small and medium-sized enterprises, the drastic increase in non-performing loans for real estate and business loans, the lack of resources for small and medium-sized enterprises, and the social security funds resulting in huge deficits in those that will cause next reductions in pensions, the rapid increase in governmental revenue deficits due to a decrease in tax revenues and, more generally, the downturn in consumption due to the Covid-19 pandemic are the peaks of the iceberg.

Unfortunately, the size of the ‘black hole’ to be created in the annual federal and state budgets equally cannot be accurately predicted in advance, because much will depend on how big the resulting decrease in GDP will be and how long will last the threat of the quarantine-lockdown by the Coronavirus pandemic.

It all depends on the duration of the crisis and the quarantine in which the major economies of the world are located. If the quarantine crisis is short most of the above-mentioned problems will be corrected. But if the quarantine crisis lasts longer than a year then we are talking that the global economy should restart with a new “New Deal” and write off debts of governments, businesses and households.

The misguided fiscal tactics and strategies of governments

The actions of governments and central banks of the flooded economies (for more details please read the analysis entitled «Governments and Central Banks react while the World Economy enters in a Recession coma»,  Trust Economics) in the provision of large and brave fiscal packages and huge amounts of liquidity to economies (misguided this one-sided policy to demand-side according to our opinion) although it seems to be the only weapon they possess but will not be able to make the positive difference if they are not used at the appropriate timing (more details will be mentioned in subsequent sections).

President Trump Signs the Families First Coronavirus Response Act
Photo by the White House from Washington DC
licensed Public Domain

In addition, the fact that demand and supply to the economy are being hit at the same time, the positive difference that will be caused by the provision of these fiscal packages (announced only on the demand side) will be very small.

Moreover, the economic policies that tend to be implemented do not take into account the economic quagmire to which emerging economies will sooner or later undergo due to the non-consumption and absorption of their exported products from the developed economies and the non exports activity of the developed economies to the developing economies, making it even more difficult to recover developed economies and the world economy in general.

Monetary policy in the EU from ECB has reached its limits since 2019, with its quantitative easing packages and near-zero interest rates. As a result, there is no room for maneuver in the creation of artificial growth in the Eurozone.

The abolition of the rules of the Stability and Growth Pact that tied the governments of Euro zone member countries last week by Commission in order to create ample fiscal space for governments to cope with the coming recession it’s not enough.

The FED,  for its part, and within a week, has devalued its monetary policy by zeroing in on its key lending rate in an effort to provide undivided liquidity but in an economy that will gradually begin to enter in quarantine and  lockdown status,  creating a climate of frightening uncertainty in the small and medium-sized businesses of the US about what will dawn tomorrow.

The US Federal Government makes the same mistake as the EU Commission by providing brave fiscal packages by unilaterally supporting demand and causing a huge increase in the government budget deficit and the US government debt in general.

Businesses gazing into the abyss of bankruptcy

The overwhelming proportion of small and medium-sized enterprises worldwide and especially in developed economies will experience dramatic situations from the free fall in their sales and the damage to their working capital and since a large proportion of these companies are heavily indebted, making them candidates for immediate bankruptcy.

In such a case, unemployment will soar, debts to social security funds and debts to the state will skyrocket without ignoring the damage to any of businesses suppliers.

In the US the real risk lies in US corporate bonds, which have tripled from $2trillion in 2008 to more than $6trillion today. This is because, after the financial crisis of 2008, a risk-taking incentive was created, resulting in many US companies pumping huge amounts of cheap liquidity by issuing bonds. Part of this excess liquidity was used:

  1. To repurchase their shares, thus contributing to the rise of stock markets.
  2. In the over-indebtedness of the businesses.
  3. With business leverage ratios presented as the highest in the last twenty years.

Given the problem in production and the transition to compulsory reduced business activity, it is very likely that the tsunami of defaults of heavily indebted companies in the US will occur because they will not be able to proceed with the re-financing of their debt at a time of high risk-off on the part of investors.

The huge drop in stock market indexes worldwide reflects the tremor of a generalized credit crisis (-12% the Dow Jones index at March 16, 2020 with a stock market loss of $24trillion in total so far to 2020).

Rising yields on government 10-year bonds in emerging markets show that investors have liquidated and transferred their funds to the safe havens of higher-rated government bonds.

The continued appreciation of the $US reflects the financing pressure caused by unthinkable debt size in $US and of zero liquidity. Another reason the US government to support in fiscal terms (wrongly in the view of Trust Economics) unilaterally the demand side of the economy.

Coronavirus (Covid-19)

The sound fiscal policies that will pull the U.S. economy and other developed economies out of the terrifying recession

What is certain is that governmental financial interventions will change depending on the problems that will arise during the lockdown crisis and will have to be adjusted according to what appears threatening each time for the economy.

The US economy and, more generally, the economies of the developed countries which are affected by the duration of the quarantine and lockdown crisis caused by the Covid-19 (Coronavirus)) pandemic, will have to take a temporary and necessarily different approach, which will increasingly rely on state intervention and for the creation of an economic defence whose primary purpose will be to contain at all costs the dramatic fall in GDP and consumption respectively which is expected to be caused.

In order to better understand the sound fiscal policies to be implemented by the Federal Government of the United States and in proportion by the governments of the other countries affected, we will present them according to the duration of the crisis. More specifically:

  • Duration of the quarantine-lockdown crisis < 1,5 months

For businesses (i.e. SA, Ltd, personal businesses, freelancers etc.) affected by quarantine-lockdown crisis

1. Deferred debt obligations, as regards debt interest rates. Elongation and re-financing of the business loans which will have to consider the new business and economic shaped data (they must price using the recession data of 2020 in their calculations). The burden that will arise for this period should be diffused in the distant future and in such a way that it is not felt by the undertakings.

2. Provision of state guarantees on any business loans and until the economy to return to normality so that these business loans are not categorized as non-performing loans which would then increase the percentage of red loans in the portfolios of financial institutions by creating next a need for their re-capitalisation with state funds.

3. State funding for 100% of the part of the contributions paid by businesses as employers to the social security and pension funds of their employees for the specific months of the crisis.

4. Full deferral of corporate tax liabilities during the crisis.

For employees working in businesses affected by the quarantine-lockdown crisis

1. Income support for employees who have either been made redundant or forced to accept leaving holiday from the company with the amount of this income support reaching 60% of their net salary.

2. State aid for the full payment of contributions to social security and pension funds, contributions corresponding to the salaries of the employees concerned.

3. The total income support to be given by the government to these employees it should reach 80% of their total labour cost (aid allowance + employee’s social security contributions to their pension funds).

4. Freeze their loan liabilities for the period of quarantine-crisis. With the termination of the crisis-quarantine the financial institutions will have to lengthening and re-financing of their loans and with whatever burden arises for that period (crisis) to be diffused in the future without excessive burden in relation to the new employee’s income.

5. Strengthening the protection net for the unemployed whose proportion is expected to increase dramatically during and after the end of the quarantine-lockdown crisis.

  • Duration of quarantine-lockdown crisis > 1,5 months

For businesses (SA, Ltd, personal businesses, freelancers etc.) affected by the quarantine-lockdown crisis

1. Since the US Government and, more generally, the most governments of the developed countries can borrow at negative interest rates and then grant income support to businesses affected by the prolonged quarantine-lockdown crisis, state aid to enterprises will be should cover 90% of the sales revenue (month-on-month basis) that these companies had in 2019.

In this way, the US government and governments in general of the other countries will be able to contain the dramatic free fall in GDP in their economy due to the prolonged duration of the quarantine crisis.

2. With this size of governmental income support to businesses next the businesses will undertake the responsibility to service their own loans which in this case will have already been elongated and re-financed on the basis of the new economic data as well as their obligations to the social security and pension funds of their employees without any longer the need for a government guarantee and income support equally to businesses in order to service their own obligations and as we described them in the above section; businesses which in this case will now operate under new reduced functionality.

3. In turn, the specific businesses affected by the prolonged crisis quarantine-lockdown and as they will now operate under reduced functionality (the size of the functionality will be determined by the industry where these companies operate for example cafes, quarantine restaurants will have zero functionality), they should convert most of the full-time employment contracts for which gave forced leave from work to part-time employment contracts.

In this way the majority of those businesses will be able to adjust to the lowest levels of production-functionality and operating costs each time, without drastically limiting their sales revenues (since the government financial aid will now use to pop up 90% of the revenues from the month-on-month sales that they had during 2019).

In turn, these companies now undertake the responsibility to pay the wages and income allowances as well as the respective social security contributions to their employees and not the government which under the pressure of quarantine forced the businesses to give them a necessity leave.

For employees working in companies affected by the quarantine-lockdown crisis

In this case too for the specific category of employees, it holds what we have also mentioned in the event that the lockdown crisis lasts less than < 1,5 months duration, except that in this situation the governmental income aid of employees’ wages and their corresponding social security contributions will now be paid by the companies and not by the government.

The income/wage support of companies to their employees who are under the status of forced leave should necessarily reflect the new part-time employment contracts for these employees.

The government in turn and in this case should increase its protection net for the unemployed by possible lengthening unemployment benefits provision period as holds the duration of the quarantine crisis.

Alex Azar signing a public health emergency declaration
Photo by Office of Secretary of the US Department of Health & Human Services, licensed Public Domain

The right action that the U.S. government and the governments that afflict countries should take in general regardless of the duration of the lockdown-quarantine crisis.

In any case, for the US government to properly cope with this economic Armageddon which now appears menacingly and from the first day of the enforcement-quarantine and lockdown-in most sectors of the economy should therefore:

The Federal Government of the United States and the governments of the respective states and, more generally, the governments of developed countries that are equally affected by the quarantine crisis caused by the Coronavirus pandemic, due to the excessive borrowing that will need to undertake which in turn this excessive borrowing will skyrocket both the Federal Government’s debt and the corresponding budget deficit of the annual federal government budget will have:

1. To prepare and implement in very short time a strict cost/benefit analysis program in their entire Federal and state services equally while technologically upgrading their remaining services. In addition, they will have to make a massive outsourcing of their federal and state services respectively and wherever this is possible.

Abolished state services also mean mass redundancies of civil servants who will in turn be enrolled in the unemployment fund to receive unemployment benefit and to be trained-educated further. Then, after the end of the quarantine-lockdown period these dismissed civil servants will have to look for work in the private sector.

The reason why these policies should be implemented is the abolition of unnecessary governmental and state services that burden the annual federal state budget. The ultimate objective of the US Federal and State governments equally should be that the total public expenditure in their respective annual state budgets should never exceed 15% of their annual GDP.

2. Subsequently, the total tax rates of indirect and direct taxes to the economy with the emphasis on those relating to businesses should be adjusted violently downwards and to such a level that they always account for 15% of GDP of annual public expenditure. In fact, regardless of the size of the annual GDP, the public expenditures will be maintained by almost equivalent fiscal value measures. This policy has two main benefits.

3. Drastic reductions in tax rates, especially those relating to businesses and consumption will drastically increase the disposable income of households for consumption and businesses for investment respectively when the quarantine crisis ends.

At the end of quarantine period, the US Federal Government will be able to borrow and grant $1000 to each American citizen to further boost demand and supply respectively that will cause a rebound in the country’s GDP.

4. At the same time, the positive (surplus) budget gap that will be created by a drastic reduction in annual government spending (<15% of GDP) will balance or reduce the drastic increase in federal government debt and the corresponding increase in the budget deficit in the annual federal government budget due to the excessive borrowing that will be required by the US federal government to support the economy in the first place and to contain the expected free fall in GDP (with the measures we have presented above), due to the imposed quarantine and lockdown measures .

But these economic strategies and policies will have to be implemented from the beginning of the crisis and regardless of how long the quarantine and lockdown crisis on the economy will last.

It is a major mistake for the US government and, more generally, all governments affected by quarantine and lockdown measures to maintain the current tax structure and/or extend the period of repayment of business taxes and debt obligations for six-nine months.

These negative effects are summed up in the emergence of stagnant inflation, a dramatic increase in public debt, a tsunami of business defaults, a dramatic increase in unemployment, economic stagnation and weakening productivity etc.

Trust Economics is a specialized independent economic research, analysis & consultancy business. Our team provides ingenious analysis in the macroeconomics & microeconomics field equally, in the field of financial markets, regional and sectoral analysis equally, forecasts, consultancy, specialized studies-research/projects.

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