Stephen Roach explains why the negative impact on supply and demand will not end when the pandemic does

Stephen Roach explains why the negative impact on supply and demand will not end when the pandemic does

The outlook for economic and financial markets hinges on the interplay between two cycles – the COVID-19 cycle and the business cycle. Notwithstanding the true miracles of modern science that we are now witnessing, the post-pandemic economy is in need of more than just a vaccine. Extraordinary damage was done by last spring’s lockdown. Now, a second and more horrific wave of the coronavirus is at hand – not dissimilar to the course of the 1918-20 influenza outbreak.

In the United States, the adverse economic repercussions are evident in mounting jobless claims in early December and a sharp decline in retail sales in November. With partial lockdowns now in place in about three-quarters of US states, a decline in economic activity in early 2021 seems likely.

The history of the US business cycle warned us of the possibility of a double dip. Eight of the last 11 recessions featured just such a pattern. Yet financial markets still made a big bet on a V-shaped recovery. Investors were lulled into a false sense of complacency by reading too much into the dead-count bounce of a 33% annualised surge in real GDP in the third quarter, as initial lockdowns were lifted. But reopening after a sudden stop hardly qualifies as a self-sustaining economic recovery. It is more like a fatigued swimmer gasping for air after a deep dive.

The source of the coming economic relapse hardly comes as a surprise. It is the echo effect of the first wave of COVID-19. Despite extraordinary breakthroughs in vaccines, therapeutics, and treatment protocols, the second wave is far worse than the first in terms of infection, hospitalisation, and death rates. While the new restrictions on economic activity are not as tight as those last April, they are already having an adverse impact on aggregate economic activity. The double dip of early 2021 will be a painful reminder of the lingering vulnerability of the US business cycle in the aftermath of a major recessionary shock.

The longer-term consequences of the COVID-19 cycle are likely to be more severe. While mass vaccination points to an end to the pandemic itself (one hopes by late 2021), it does not provide immunity against lasting economic damage. Recent research on the impact of 19 major pandemics dating back to the fourteenth century – each with death counts in excess of 100,000 – highlights the long shadow of the economic carnage. Real rates of return on “safe” European assets – a measure of the interplay between aggregate supply and demand – were found to be depressed for several decades following these earlier horrific outbreaks.

The long shadow of the COVID-19 cycle looms as well. Lost in the celebration of an imminent V-shaped economic recovery have been many hints of lasting damage. In the US, employment is still 9.8 million jobs below its pre-pandemic peak, and consumer expenditures on services – restrained by persistent and understandable fears of face-to-face interaction – have recouped only 66% of the plunge that occurred during the March-April lockdown.

Moreover, a second wave of partial lockdowns will only reinforce dislocations that are now painfully evident in most major US cities, including excess office and public-transit capacity, along with the devastation of hospitality, entertainment, and retail businesses. The permanent destruction to aggregate supply and demand, in conjunction with fundamental shifts in behavioral norms, aligns the long-shadow contour of the COVID-19 cycle with comparable patterns in the aftermath of earlier major pandemics.

The interplay between the short-term dynamics of the US business cycle and the longer-term pattern of the COVID-19 cycle bears critically on the current policy debate. Yet hope is widespread that this time is different – that creative new policy strategies can offer new solutions to old economic problems.

That is certainly true of so-called Modern Monetary Theory, which supposedly gives fiscal authorities open-ended license to binge on debt. But MMT is neither modern nor a theory. What is new is something far more basic: the supposed death of inflation. As long as inflation remains subdued, goes the argument, then both monetary and fiscal authorities can ignore the risks of higher borrowing costs and work in tandem in providing relief for a pandemic-stricken real economy.

But nothing in economics is forever – not even the death of inflation. Here is where it gets especially tricky.

US inflation is hardly immune to further dollar depreciation, which seems increasingly likely, given a sharp deterioration in the US current-account deficit, the strengthening of the euro, and the weak-dollar bias of a Federal Reserve that remains wedded to zero-interest rates. Supply-chain disruptions – reversing the powerful disinflationary forces of globalisation – should also boost underlying inflation. And, of course, there are painful memories of policy mistakes made in the late 1960s and early 1970s, when overly accommodative monetary policy set the stage for a wrenching and lasting acceleration of inflation. How different is today’s seemingly enlightened penchant for open-ended quantitative easing?

The confluence of the pandemic cycle and the business cycle – the second wave of COVID-19 and a double-dip in the US economy – has left US policymakers with little choice but to approve another relief package, this time for $900 billion. Never mind, argues MMT, if that puts US federal debt on the cusp of exceeding the previous record of 108% of GDP, reached in 1946, in the immediate aftermath of World War II.

Yet back then, the mounting debt overhang was finessed by a reflationary surge in GDP, which caused the debt-to-GDP ratio to plummet to 47% by 1957. “All” it took was a 6.4% average consumer inflation rate from 1946 to 1951. Maybe that is all it will take this time as well. But what might that spell for interest rates, debt service, and incredibly frothy financial markets? Don’t look to MMT for an easy answer.


Stephen S. Roach is a faculty member at Yale University and the author of Unbalanced: The Codependency of America and China. Copyright: Project Syndicate, 2020, published here with permission.

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26 Comments

Hmmm. I am no great brain. I read to understand the general.feel.of the collective thoughts and the ideas and theories of the smart and the learned.

I sit here with an itch. Inflation. It itches. Will it explode on us quickly? Is it low for a long time? What is the definition of long?

Inflation is doing just fine, thanks, exclusively fanning the flames of the housing ponzi.

Roach, while eminently educated and well qualified, seems to believe that predicting future events and how they play out is as easy as looking back at past events. The US economy is large, no denying that, but the world is now far less reliant on it than previously. Certainly things are grim there but that doesn't necessarily translate into D&G for the rest of the world and certainly not for NZ.
China, India and ASEAN pact countries will soon surpass the US economically. In a BBC article it was predicted that could start happening as soon as 2025. Growth will be tepid for a while in NZ but a depression and runaway inflation, imo, is neither imminent nor likely.
https://www.bbc.com/news/world-asia-china-55454146

I agree: by end of the decade China in particular, and Asia in more general terms, will be far more important and relevant than the US.

USA will not be "surpassed in GDP terms, til 2028 according to most recent forecast.
Also, in ppp terms, China will not overtake at all.
Lastly, the USA and EU will be highly unlikely to emerge from double dip recession til July or later. These 2 blocks make up 56% of GDP and Japan, the third block is also in deep shit, with virtually nil GDP growth. But of course this all just DaG and NZ will be fine and dandy.

Who actually gives a rats @rse about the US. Our economic future lies with the RCEP and TPP nations, neither trade agreements which US is part of. The EU admittedly is struggling and takes a fair chunk of our exports but that's not insurmountable - nor irreplaceable, Russia is untapped and so is the Middle East. NZs main exports are primary produce, which is always in demand. I wasn't looking to the short term ('21) but further down the track ('23-'25)

I’m guessing most of the western world...the world would be a lot scarier place without a strong US and China roaming the pacific

I was speaking from an economic point of view. In case you haven't noticed China is already roaming the Pacific with an open cheque book and the US don't give a hoot and Australia can't do sh1t

You’re joking right!
The financial system is just that... a system. One part fails it affects the others... agree US power waning over time but is sill no.1 economy

For now yes - in future probably not. check the link I posted

Talking to family in the UK it sounds a mess. My brother in law has children in expensive private schools, they have spent five weeks at school this year, friends are shut out of work, people have lost jobs, friends have parted. They have a bubble and they can add I think one more, they are basically trapped.

Brother in law was meant to be in Scotland for New Year with family and has had to cancel, the place is going to take a long time to recover, worries me re lamb exports to UK.

At least my friends in the States can just ignore it, one just tested positive, didn't even notice.

So we haven’t done too badly then.
Went early, went hard so hasn’t been a ongoing drawn out saga of lockdowns.
Yes, at a cost especially to tourism related activities and government coffers - and yes, FHB and retirees depending on TDs to supplement super - but in the main the economy has done well, unemployment kept surprisingly low, and there have been numerous Covid winners with mortgage interest rate decrease and rapidly appreciating house values.
One can consider one’s self and moan, but the reality we will be the envy of many countries in terms of minimising impacts of Covid, restrictions taken, and the economy.

This time it will be different.
Rflmao

Stephen Roach like most critics of MMT is only displaying the fact that he has never studied the subject and works on a superficial level of what he thinks that it says.
He should be far more concerned about the levels of private sector debt that are being developed by a banking sector that creates far more money than currency issuing governments ever do.
Let us remember that the GFC was caused by private sector debt levels that became unsustainable and which then caused a banking collapse where governments then had to come to the rescue.

Yep exactly.
Prior to covid I was picking a GFC Mark II in 2022, that would take down the housing market.
Because of the extraordinary response of governments to covid that can might have been kicked down the road a year or two.

I see a slow vaccine rollout as the biggest risk. In the UK just 616,000 people have received the first vaccine jab since the December the 8th. They have not used even a small fraction of the vaccines made available by Pfizer. By my calculations they are going to have to undertake 2.8m to 4.3m jabs per week to use the vaccines BioNTech/Pfizer and Oxford University/AstraZeneca are contracted to supply within the 6 month window vaccines remain viable.

https://coronavirus.data.gov.uk/details/healthcare

The other key issue is the proportion of the population that now needs to be vaccinated to achieve population immunity. That proportion will be higher with the new variant.
KeithW

As Stephen Roach says:
"But nothing in economics is forever – not even the death of inflation."
KeithW

There is a great deal of inflation in asset prices and it is leading to increases in inequality and poverty. We are relying too much on monetary policy to provide an economic stimulus. We have trapped ourselves in an neo-liberal mindset of government deficits always being a bad thing. Money created by the government can be used far more beneficially for the country than that created by the banks which just ends up inflating house prices.

Is the very real reduction in the value of wages about to be reversed?

Yep... no free lunch people...
P.S. how immune are they hegemony Aus banks from European and US bank crunch!
I see shareholders of European Union banks leaving in droves due to capital restrictions on dividends...

The compensation coming from China (for creating & spreading the SARS2) will buoy up the global economy of course.

It looks like they are prepared to go to war, in an attempt to conceal any involvement.