A look at the global economic situation
Robert Fauver, former US sherpa
12 March 2020 (published on 23 March 2020)
Special supplement to G7 United States: The 2020 Summit,
John Kirton and Madeline Koch, with Christopher Sands, eds., GT Media, 2020
On 12 March 2020, Robert Fauver spoke to John Kirton about the current economic situation in the United States and its G7 partners. An edited version of this interview will appear in G7 United States: The 2020 Summit, to be published in time for the leaders' summit by videconference scheduled for 8–10 June.
Q: Let's go back to before the COVID-19 outbreak arrived. What were the trends and prospects for economic growth in the United States and each of its G7 partner countries?
At the beginning of 2020, the prospects were for solid, strong, non-inflationary real growth in gross national product throughout the G7 countries. We in the United States were expecting a modest pickup. We were looking at between 2.25% or 2.5% growth this year, with continued record unemployment levels. We were setting historic records for all minority groups, for women, for Blacks, for Hispanics – the lowest unemployment rates recorded in the history of recording for those subgroups. So the non-inflationary growth outlook in the United States was quite strong.
Europe was beginning to strengthen. Germany was starting to look a bit stronger. There were still some doubts about France and Italy but, in broad strokes, the European continent was looking to be at least as strong as it had been in 2019, if not marginally stronger.
Japan was hoping for a marvellous experience with the summer Olympics and influx of multiple millions of tourists and tourist dollars. So the outlook for a half to one per cent real growth in Japan was quite solid and quite widely believed.
The Canadian economy was expected to be half a per cent stronger in 2020 than it was in 2019. I was slightly more optimistic than the International Monetary Fund in part because I saw a stronger US growth and there are obvious spillover effects in U.S.-Canadian trade.
All of that, of course, has fallen by the wayside.
Q: How is the COVID pandemic affecting the economies and financial systems of the United States and each of its G7 partners?
It is a day-by-day question. There are two distinctive pieces to the puzzle. In financial terms – that is, banking systems and financial flows of money – there is very little effect. In terms of stock market and equity evaluations, we are seeing drops of 10% on top of what was a 20% drop. We've seen something on the order of a 25–30% loss of equity value since the beginning of the crisis. Presumably all the factors that led to a strong stock market two months ago are still in play. So one could suspect that when the crisis has past and we return to a sustainable growth path, most if not all of the lost equity value will come back. Most people think it has been a bit of an overreaction, but markets tend to overreact so there's no surprise there. We have trigger mechanisms if the markets drop too fast so they pause trading for 15 minutes. For several days we've hit those triggers. Those trigger mechanisms have proven to be a useful tool.
On the financial side, it's equity value lost but banking systems, lendable assets and borrowing capabilities are all strong. Our banks went into this crisis in good financial shape so nobody yet has expressed any concern about the banking system per se.
Interest rates are near zero. Short-term rates and long-term rates for treasuries are below 1%. So refinancing is a possibility. There is a flight to quality, so bond refinancing should be easily done in three to six months. There is plenty of liquidity in the system. The US Federal Reserve has made noises that it would keep liquidity levels quite strong. So I'm not worried about the problem of refinancing outstanding debt. And at these low interest rates, the debt service problem is nowhere near what it was 10 years ago.
Q: What about macroeconomic growth?
On the real side, we are seeing a cascade of cancelled events. This ranges from airline cancellations, international travel cancellations, cruise ships, tour groups, conventions and much more. From the beginning you'll see macro effects on the tourist industry, whether it's airlines or railroads or cruise ships or bus lines. The second stage is hotels and leisure activity events. The third stage is restaurants, restaurant supply and food distribution. So we'll see a cascading on the real side from lack of citizen participation in daily life. If you're no longer able to go to meetings, go to conventions or go out to restaurants, that whole service sector will have a significant reduction in business, in revenues, in employment and in salaries. The saddest part is the people probably worst hit will be workers in the service industry who are on the lower paid end, aside from tips, to begin with, who probably have the lightest fall-back of savings and systems for protection. One of the things that the White House has tried to do is get Congress to focus on increased unemployment benefits for those laid off in sectors specifically affected by the virus. They have focused on, among other things, a temporary suspension in social security payments, which for employees would be a 6.5% savings in take-home pay. For those who keep their jobs, that's a significant injection of liquidity. But unfortunately there's a major squabble with the Democrats over how to go about this. We have not managed to step away from politics. We're still slinging mud in both directions and therefore we are dragging our feet on how we are responding through congressional legislation.
Q: What about the trade component of the US economy?
One of the lessons to be learned from this pandemic is the over-reliance on the globalisation of supply chains. It may be a learning curve that is flat and nobody pays attention. It may be a learning curve that is relatively steep and production processes move back onshore for a lot of countries, not just the United States. We are seeing the beginning of a return to work of the factories in China and the stories from China suggest that they're moving back towards full production. This leaves unanswered the demand side of that equation, but at least it would appear as though they are able to restart their factories. Apple has reported that it is restarting production in its factories. From the supply side overseas, especially China, it looks as though within the next 30 days or so that they will be back generally to where they were before the virus struck. The demand side is going to be weaker in the near term because people will not be consuming as much as they were before.
Q: What about the impact of COVID on the banking and financial systems in other G7 members?
I read with interest the G7 finance statement on 3 March. It was a pretty empty set of commitments, other than the normal 'we'll maintain low inflation growth', etc. It was sorely lacking in detail. A lot of the challenge in this is a micro structural issue, not a macroeconomic global one. Pieces of the economy will be in trouble, and need more targeted support than necessarily growth-inducing macroeconomic approaches. Liquidity, for example, is not an issue for the Europeans or for North America or Japan. Interest rates are near zero around the world, so it's not an interest rate or liquidity issue. I think it's an aggregate demand issue. It's in selected sectors. In Italy, they've essentially closed the whole economy. Restaurants are closed, shops other than food are closed, bars are closed. The whole industry of providing services from food to hotels to bars is at a standstill. I suspect that will spread to the rest of the continent. Merkel expects 75% of the population to be affected by the virus. That's a very high number. Affected can mean many things: you can be exposed to it and not get it; you can be exposed to it and get a mild case of it. But clearly there will be further reductions.
Q: What measures have the United States and its G7 partners taken individually in response?
Clearly the Fed has made a public commitment to provide all the necessary liquidity and interest rate lowering that it can do. It has taken away all concerns of liquidity and financial market issues, so the monetary side reaction has been quick and decisive. The fiscal side is coming. The president announced that he would postpone payments of income tax, which are due on 15 April, kicking the due date payment to 15 June. This would inject something like $300 billion of liquidity into the economy. He can do that on his own through presidential decree. The other measures he has said he would like to do – the temporary cessation of the social security tax, some targeted low-interest loans to small businesses directly affected by the crisis – he is asking Congress for additional money. Given the way Congress acts, that will be slower coming. But in play, at least, is what he can do on his own.
Q: Do you see a package emerging in Congress that has enough of the right things?
That's the $64 million question. Nancy Pelosi has been extremely critical of the administration's response to the virus, despite the Centers for Disease Control and National Institutes of Health saying they've done everything they should have done. She was critical when the administration barred any flights from China, which she called racist and anti-immigrant. And yet many people have agreed ex post that this move prevented a major spread of bringing the virus in from China. There has not been sort of 'this is an emergency and we need to act together'. There have been a number of leading Democrats who have hopefully said this is Trump's Katrina, so they're looking for him to fail. That complicates the negotiating process. There is not yet a meeting of the minds on how to target support for those parts of the economy that really need it.
Q: Can the Congress meet virtually and vote virtually?
They would need to change their operating rules. You cannot vote in absentee. They would need to have an in-person vote to change the rules of the House and the Senate before they left. They could. They can set their own rules. Will they undertake such actions? Very good question.
Q: Does Japan's monetary and fiscal policy response look good enough for now?
I would like to see something more on the fiscal side. It takes the Japanese a little longer to act. My information suggests they're working on a package. They're heavily focused on what to do about the Olympics. They have sunk so much money into this thing, and they are counting on the stimulus it gives. They can postpone it for a year, if the Olympic Committee would agree to it, but even then there would be huge financial losses. They need more than that. They need to focus on the fiscal side.
Q: What about oil prices?
The Saudis could not have picked a worse time to go after the Russians. I don't think they expected to be doing this right in the middle of a financial mess. They're trying to break the back of two things. They're trying to break the back of the Russian supply by driving the price down. But they also would like to break the back of fracking in the United States. The Saudis have a two-pronged approach. It's having some effect at the pump. How long the oil price stays down is hard to tell. It depends how long the Saudis want to run full spigot.
The effect on low- and moderate-income Americans and others around the world may be positive, if governments allow the price pass-through. At least in the United States we get a pretty direct pass-through of lower prices. I don't think the Europeans allow to prices to fall that quickly. They tend to go for the tax side instead.
Q: Back to the G7 communiqué from the finance ministers and central bank governors on 3 March. Did it do enough of the right thing?
I was disappointed that it did not include concrete steps. It was the normal 'we'll maintain liquidity, we'll keep non-inflationary growth going'. It was the sort of tune that is repeated in normal times. These are abnormal times and need a more focused and sharpened set of commitments.
Q: If you were writing the communiqué on behalf of your treasury secretary, what would have you added?
I would have added something on the fiscal side that said we are looking to formulate specific relief on taxes and fiscal stimulus to those sectors particularly hard hit by the virus.
I would have said we are currently looking at travel, tourism, airlines, cruise ships, etc., but we remain open to more as the spread on the micro level continues. I would have left it as an open-ended comment. I would have not said 'we will' help the cruise industry but 'we are looking at' doing that.
Q: At what point does the plunging stock market require immediate financial stability reassurance?
I would not support direct intervention into the stock market or equity markets any place in the world but I would support a central bank either making a coordinated or solo statement as to the financial stability and security of financial institutions, drawing a clear distinction between the financial system and equity markets. I think the part of the market that needs reassurance is the financial system, not equity markets.
Q: Looking ahead to June, how can the G7 leaders at their summit best help?
Hopefully the peak of the pandemic will have been passed by then. A number of commentators suggest it could take two to three months, from the beginning to get over the hump and onto the downward trend. I think it would be useful to have a joint G7 statement that we are talking to each other, we're coordinating information on best practices, on how to handle the sickness when it appears in hospitals, we are sharing the information from NIH and CDC and sophisticated US firms, we are in the process of clearing a vaccine and we are in the process of clearing a shot that will to help reduce the effects, both of which have been produced by private labs. It would be mentally and psychologically useful to have a joint statement of a soothing nature as to how we're working together and sharing information and keeping each other apprised.
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Robert Fauver is president of Fauver Associates, LLC. He spent 32 years as a career public servant in the United States working in the Treasury, State Department, White House and National Intelligence Council. He was President Bill Clinton's sherpa for the G7 summits of 1993 and 1994 and special assistant to the president for national security. He designed trade penalties for India and Pakistan following their testing of nuclear weapons and negotiated the yen-dollar negotiations that led to the beginning of liberalisation and internationalisation of Tokyo's financial markets.
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