The Biggest Threat to the Global Recovery Lies Beneath This Dome
No person, on their deathbed, ever said, “I wish I had spent more time at the office.” No finance minister, in their memoirs, ever expressed regret that their government spent too much money coming out of a crisis. And yet, with the world's other major economies committed to significant government spending next year, the United States Congress has balked, posing perhaps the single greatest risk to the global recovery.
Futures markets suggest rising concerns about a contested U.S. election that revisits the November 2000 drama around Bush v. Gore, but investors might focus more of their attention to America’s fiscal policy amid partisan tensions that will not abate after a vote. The longer it takes and the smaller the package, the more painful the path to normal.
VIX FUTURES
Source: Bloomberg. As of September 24, 2020.
First, a little context around what has already been a massive policy response to the pandemic lockdown. With businesses shuttered, planes grounded and consumers frightened inside, the world's central banks slashed rates and expanded balance sheets. The Fed was perhaps the most dazzling in the breadth and speed of its response, but the European Central Bank delivered a creative response considering a political construct that rarely accommodates creativity.
And governments did their part. So far, China’s official fiscal deficit may reach 3.6% of GDP this year, although actual support for the recovery could double that. The European Union suspended the rules for fiscal deficits and its member states delivered an impressive combination of fresh spending, tax deferrals and liquidity guarantees even before approving the path-breaking €750 billion recovery fund.
At the height of the crisis, even President Donald Trump and House Speaker Nancy Pelosi found common ground on packages totaling $2.4 trillion in direct fiscal support on top of earlier spending. The Congressional Budget Office projects spending this year will reach 16% of GDP for the fiscal year that ends next month, the largest since 1945.
The problem comes next year. The Organization of Economic Cooperation and Development’s fresh assessment of the global economy predicts a decline in global GDP of 4.5% this year, with a rebound of 5.0% next year and most countries still not recovering their 2019 output levels. But it warns that even these dreary forecasts depend on governments avoiding “premature budgetary tightening at a time when economies are still fragile.”
OECD’S ANALYSIS OF THE FISCAL RESPONSE AFTER THE FINANCIAL CRISIS
Note: The underlying government balance represents cyclically adjusted government net lending, excluding net one-off operations. A positive number represents fiscal tightening and a negative number represents fiscal easing. Difference between GDP and trend illustrates the output gap. LHS: Shows the 17 members of the euro area that are also members of the OECD.
Source: OECD Economic Outlook database; OECD calculations.
Elsewhere, the news is promising. Even with its snappy rebound, China’s fiscal policy should remain supportive next year. Japan’s new Prime Minister Yoshihide Suga signaled his readiness to back a third extra budget to respond to COVID-19, even with this year’s deficit nearing 10% of GDP and overall debt closing in on 250%.
France’s spending plans could keep next year’s deficit near 7% of GDP, down after what will likely be 10% this year. The United Kingdom’s budget is looking uncertain for next year, but even Germany’s famous commitment to balanced budgets has been postponed yet another year after a deficit of more than 7% this year.
Economists and politicians will argue legitimately over what the right number is for the United States, and how to balance the support between spending that puts money into people’s pockets and tax incentives. House Democrats passed a $3 trillion plan in May, while Senate Republicans fell short of backing a much smaller package this month. A bipartisan group of self-declared “Problem Solvers” in the House have coalesced around a package of $2 trillion, but the chances of any significant new support are dwindling as political acrimony rises around the confirmation of a new Supreme Court justice.
These delays are not just about the pain to those facing evictions or bankruptcies. They are about permanent damage to America’s growth prospects—and the world recovery could suffer too. While economic downturns have generally been viewed as inevitable and fleeting, studies increasingly suggest that recessions leave permanent scars and undermine future growth potential.
“A bipartisan group of self-declared ‘Problem Solvers’ in the House have coalesced around a package of $2 trillion, but the chances of any significant new support are dwindling as political acrimony rises around the confirmation of a new Supreme Court justice.”
Thus, the effort to close deficits before the recovery is fully entrenched carries long-term consequences, which the OECD’s report underscores in its review of fiscal policy that tightened too quickly after the Global Financial Crisis. Government debts have soared, to be sure, but they will never be repaid by economies facing weak and halting recoveries.
While everyone continues talking about stimulus in Washington (including, apparently, Pelosi and Treasury Secretary Steven Mnuchin), markets still expect something will come, even if it’s after the election or once a new Congressional session kicks off. But improving economic data will make it more difficult to argue that generous spending remains crucial. Moreover, if Republicans are looking for a new leader after the election, many of them will be polishing their credentials as fiscal hawks, which could slow or shrink whatever is eventually approved.
The danger is rising that whatever arrives will come too little and too late.
