The nightmare scenario is one where the virus continues to suffocate the global economy for a year or more.ISABEL INFANTES/AFP/Getty Images
Over the past three weeks, governments around the world have embarked on one of the greatest peacetime borrowing binges in history.
In many countries – including Canada, the United States, Germany and Britain – policy makers have launched massive stimulus programs to help sustain economies under attack from the novel coronavirus. To fund more than US$5-trillion in relief packages, governments are issuing epic amounts of debt.
Most big economies will see government borrowing leap higher as a result of the virus, says Gavyn Davies, chairman of Fulcrum Asset Management in London. He expects ratios of public debt to gross domestic product to jump by 10 to 20 percentage points. In Canada, a move of that magnitude would propel general government debt, including both federal and provincial borrowing, to around 100 per cent of GDP, while in the United States it would boost the ratio above 120 per cent.
As COVID-19 continues to spread, some provinces have used emergency powers to enforce physical distancing by closing “non-essential" businesses. Companies whose employees work from home, or who use digital storefronts, can continue to do so. But in many provinces, only services deemed essential will have physical locations open. These include:
- Food and liquor: Grocery and convenience stores, restaurants (take out and delivery only). Pet-food stores included. Liquor stores are open on special hours.
- Utilities: Energy, water, telecom and garbage-collection services will continue to run.
- Shelters: Services will continue for homeless people and survivors of domestic violence.
- Banks: Financial services are on every province’s essential list, but some banks may have reduced or changed hours at branches.
- Government services: Health care and online higher education will continue, but public schools are closed.
- Transportation: Public transit, taxis and postal delivery are running, as are transportation sectors needed for supply chains.
Read the full list of essential services in Ontario, Quebec, B.C., Alberta, Saskatchewan, Manitoba, PEI and Newfoundland and Labrador.
You can also read The Globe and Mail’s digest of the latest news about COVID-19′s spread around the world and sign up for the Coronavirus Update newsletter.
Can the world afford this avalanche of new borrowing? For now, the answer is yes. So long as interest rates remain low and economies return to something approaching normality within a few months, developed countries should find the additional burden to be tolerable. Most will remain considerably less indebted than Japan, which for years has sustained stratospheric levels of public borrowing, with government debt well in excess of 200 per cent of GDP.
One big uncertainty hovers over these calculations, however: What happens if the world does not return to normalcy within, say, six months? If so, governments will find themselves writing enormous cheques every month to sustain comatose economies. If that happens, all bets are off.
For now, though, worrying about such possibilities misses the point. Confronted by an overwhelming emergency, governments have little choice but to engage in deficit spending on a giant scale.
In fact, the urgent question isn’t whether these countries can afford to take on more debt. It’s whether they’re taking on enough debt to fund the stimulus programs necessary to avert an even deeper downturn.
Analysts at Bank of America describe the massive US$2-trillion stimulus package passed by U.S. Congress in March as the “bare minimum.” Scott Minerd, chief investment officer at Guggenheim Partners, told Reuters he expects more support will be needed for the U.S. economy. If so, Canada is likely to be caught short as well.
Lockdowns and quarantines needed to fight the virus have already sent unemployment soaring. In Canada, more than two million Canadians filed for unemployment benefits in the last half of March. Meanwhile, in the United States, almost 10 million people have filed for benefits over the past two weeks.
The pain is not going to let up. If private-sector forecasters are right, economic output in the second quarter will shrivel at a 15-per-cent to 35-per-cent annualized rate in Canada and the United States. This would be a far deeper downturn than anything that occurred during the financial crisis.
General government debt to GDP ratio
In select OECD countries
250%
Japan
200
150
Italy
U.S.
100
France
Canada
Britain
Germany
50
0
2000
2005
2010
2015
2018
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: imf
General government debt to GDP ratio
In select OECD countries
250%
Japan
200
150
Italy
U.S.
100
France
Canada
Britain
Germany
50
0
2000
2005
2010
2015
2018
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: imf
General government debt to GDP ratio
In select OECD countries
250%
Japan
200
150
Italy
U.S.
100
France
Canada
Britain
Germany
50
0
2000
2005
2010
2015
2018
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: imf
Capital Economics is warning clients that the global slowdown is shaping up as the sharpest and deepest global slowdown since the Second World War. Harvard University economist Kenneth Rogoff goes even further: He told Barron’s that the depth of the global downturn could be as bad as anything in the past century and a half.
Without relief, many households will go bust. Their incomes will shrink or vanish, and they will default on mortgages, rent payments and car bills. Meanwhile, many restaurants, retail stores, travel operators, malls, hotels and airlines will tumble into bankruptcy. With all those employers gone, many workers will not have jobs to go back to when the virus does come under control. The slump could stretch on for years and turn into a full-on depression.
Generous government support can help prevent this ugly scenario by ensuring we still have a functioning economy whenever life does return to normal. For most economists, the logic is inarguable: No matter how expensive an outpouring of government aid may seem right now, it is cheaper than dealing with a depression down the road.
Still, the size of the necessary relief programs is staggering. In the United States, for instance, the federal deficit will hit 13 per cent of GDP this year, according to credit rater Fitch. That would blow away the previous record of 9.8 per cent, which occurred during the darkest days of the financial crisis, in 2009.
In Canada, the fiscal programs already unveiled by federal and provincial governments amount to 13 per cent of GDP, Capital Economics calculates. But even that enormous flood of government cash may not be enough to save everyone.
Stephen Brown, senior Canada economist at Capital Economics, points out that 10 per cent of the 13,330 Canadian restaurants that replied to a recent survey indicated they were closing their doors permanently in March. A further 18 per cent said they were likely to go out of business this month. If the imploding restaurant business is any gauge, Canada’s economy may be in need of even more support, and all the government debt that implies.
Should we worry about the long-term effects of this new borrowing? Without question, the new debt will leave taxpayers with a significantly larger burden to carry in years to come.
But so long as financial conditions remain similar to today’s, the burden should not be overwhelming. “The Canadian government has the space to deliver stimulus on this scale,” DBRS researchers assured investors in a report this week. “The federal government is entering the crisis with a modest fiscal deficit, relatively low levels of debt, and funding costs that are negative in real terms.”
The biggest ally of deficit spenders everywhere is today’s shockingly low interest rates. When Canada and other major industrialized economies can borrow money for 10 years at considerably less than 1 per cent a year, the real burden of carrying additional debt becomes exceedingly small – or even negative, as DBRS notes. At these rates, lenders are essentially begging Canada and other advanced countries to borrow more.
The low rates set up some favourable math. Once the world gets past the worst of the pandemic, and growth returns to more normal levels, the economies in most industrialized countries should expand substantially faster than the interest rate on their debt. This means the size of their government debt should shrink steadily as a portion of GDP. In Canada, for instance, it makes perfect sense to borrow at 0.7 per cent (the current yield on 10-year Canada bonds) to support an economy capable of growing at 3 per cent or more.
Coronavirus guide: Updates and essential resources about the COVID-19 pandemic
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Remember, too, that today’s emergency measures are temporary. Unlike proposals for spending on new social programs, the need for most of the new stimulus programs will melt away as soon as the threat from the virus eases.
To be sure, there are risks, particularly in poorer parts of the world. In some emerging economies, a rapid run-up in debt could result in a crisis if investors begin to worry about possible defaults, or if bondholders start to fear that hard-pressed governments will inflate their way out of the problem.
In more advanced economies, though, one has to squint hard to see any immediate problem. Judging from today’s ultralow yields on Canadian, U.S., German and British government bonds, investors are desperate for safe assets. They are clamouring to buy government bonds from big industrialized economies and that demand is not likely to dry up any time soon.
All this argues strongly that the current borrowing binge should turn out well – so long as things get back to normal in relatively short order.
The nightmare scenario is one where the virus continues to suffocate the global economy for a year or more.
“What would be the effect of the Treasury continuing to add trillions of dollars each quarter to the deficit (which was already running at $1-trillion even before the virus hit) and of the Fed continuing to pump trillions more into the monetary system?" asked Howard Marks, the widely followed co-chairman of Oaktree Capital Management, in a commentary this week.
Mr. Marks puts forward a couple of tentative possibilities: Maybe a burst of inflation because of all that money printing. Maybe a shift away from the U.S. dollar as the world’s reserve currency because of worries over the U.S. economy’s rapidly expanding debt load.
At the very least, he suggests, the next few months will stoke debate around Modern Monetary Theory, the heterodox school of economics that argues government debt and deficits don’t matter. While highly contentious, MMT has helped to focus attention on central banks’ increasingly aggressive interventions in debt markets.
The largest example of those interventions are the massive bond-buying operations launched by the European Central Bank and the U.S. Federal Reserve since the financial crisis. By hoovering up domestic bonds, these central banks are creating artificial demand for bonds and thereby driving down interest rates (which move in the opposite direction to bond prices).
bond yields
10-year government bond yields,
as of noon Eastern, Friday
Italy
1.531%
Canada
0.683%
U.S.
0.574%
Britain
0.313%
0.078%
France
-0.009%
Japan
-0.439%
Germany
JOHN SOPINSKI/THE GLOBE AND MAIL
SOURCE: marketwatch
bond yields
10-year government bond yields, as of noon Eastern, Friday
Italy
1.531%
Canada
0.683%
U.S.
0.574%
Britain
0.313%
0.078%
France
-0.009%
Japan
-0.439%
Germany
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: marketwatch
bond yields
10-year government bond yields, as of noon Eastern, Friday
Italy
1.531%
Canada
0.683%
U.S.
0.574%
Britain
0.313%
0.078%
France
-0.009%
Japan
-0.439%
Germany
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: marketwatch
To some eyes, bond buying by central banks – or quantitative easing, as it’s known in the jargon – commits the unpardonable sin of blurring the distinction between fiscal and monetary policy. After all, it consists of one arm of government creating money in order to buy debt issued by another arm of government. That looks perilously close to a shell game in which central banks monetize government debt and distort markets.
Defenders of central bankers argue that is not entirely accurate. They say the bank interventions stop short of rigging the game. Rather than holding all the cards, central banks still own only a fraction of government bonds. (In March, for instance, the Fed held about 12 per cent of all U.S. Treasury securities, considerably less than foreign investors and also less than the U.S. Social Security system.) In addition, central banks typically vow the interventions are temporary. They promise to eventually reverse most, if not all, of their bond buying.
Maybe so. But those reversals show no signs of happening in the foreseeable future. Central banks’ balance sheets are expanding furiously as they gobble up government bonds and other forms of debt. The Federal Reserve’s balance sheet has already swelled to US$5.7-trillion from just less than US$4-trillion before the pandemic hit. It could swell to as much as US$10-trillion – roughly half the size of the U.S. economy – over the next few months, according to Capital Economics.
Some commentators believe debt-challenged governments may eventually be forced to go even further and turn to “helicopter money," a manoeuvre in which central banks would simply create money, without issuing any corresponding debt, and government would funnel the new cash to people and businesses. It is an attractive idea in theory. However, doing so would mark a new level of desperation. It would be a sign that governments are out of alternatives.
Fortunately, we’re not at that point yet. Governments still have the capacity to borrow and will make full use of that power in the weeks and months ahead. But until we win the battle against COVID-19, and revive our battered economies, we are in uncharted territory. Best to not rule anything out.
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Ian McGugan