History moves not in a line, but in tipping points. Investors often focus on the short-term business cycle, assuming the current economic and political infrastructure will remain in place. There are decades where nothing happens; and there are weeks where decades happen – Lenin said with reference to the Russian revolution.
The Covid-19 pandemic and its policy responses call capitalism into question: should taxpayers bail out firms where shareholders got large dividends but paid little in taxes? Who will pick up the public debt tab?
The answers to these questions bring an acceleration in history, pushing forward economic policy ideas as well as geopolitical developments which have been in the making over the past decade.
Capitalism and globalisation have failed to distribute wealth efficiently. Growth rates have declined since the post-war period, for structural reasons well-known as secular stagnation. Yet as the economic pie grew slower, returns on capital continued to exceed the ones on labour. Median real wages have stagnated over the past thirty years, while corporate profits and wealth inequality soared. Corporations and rentiers shaped the economic system to their advantage, with loose tax systems and anti-trust laws tolerating monopolies, as G. Zucman and J. Tepper point out in The Hidden Wealth of Nations and The Myth of Capitalism.
With individual gains but socialized losses, capitalism is no longer capitalism.
Like for the 2008 financial crisis, this year’s pandemic has shown that the current economic system based on limited liability firms operating solely for the shareholder ultimately rests upon the responsibility of national balance sheets. The need for public intervention to bail-out the private sector was already evident from central banks quantitative easing programmes. With government bailing out entire sectors, the transition towards state intervention is even more explicit.
The airline industry is a case in point. Many airline bosses walked away with cash but left their planes and employees grounded. EasyJet’s founder paid himself a £60mn dividend in March. Richard Branson, owner of Virgin Atlantic and a resident of low-tax BVI, asked the UK for a £500mn bailout and Australia for another £700mn.
Taxpayers and investors are likely to pick up the tab. Governments are likely to impose restrictions on equity buybacks or dividends, while strategic sectors and firms, or large employers, may benefit from increased protection.
Public debt levels will grow as a result and government debt will become riskier. Many developed countries will see their debt levels exceed 100% of gdp, including France and the UK. This will expose bondholders to negative returns against inflation in the future. Some won’t be able to repay: the IMF and World Bank called for debt relief for 76 of the poorest nations, including their bi-lateral loans.
Central banks will continue to act, to limit the rise in funding costs due to rising public debt. The Fed recently announced an additional $2.3tn in asset purchases, including some high yield rated debt. The Bank of England, boosted its facility to directly fund HM Treasury, a move towards debt monetization. While only the Bank of Japan currently engages in controlling the whole yield curve, this may become the norm in other countries: a new paper by the New York Federal Reserve discusses how the Fed controlled long-dated Treasury yields in the 1940s. Losing their independence, central banks will likely remain locked into these programmes for the foreseeable future, going from a buyer of last resort to the buyer of first resort.
This pandemic will leave the world with more debt, persistent inequality and evidence of poor governance by global institutions. Who will emerge to solve these problems? Will countries coordinate or get into an every-man-for-himself fight? Monetary policy has provided a palliative so far, but it can’t solve structural issues like lack of productivity or supply disruptions.
Absent structural solutions, the result will be a combination of monetary debasement, populism and social unrest. This is not a new phenomenon. The best-case scenario is a beautiful deleveraging, where public debt levels gradually retrace to sustainability and inflation is contained. But history suggests otherwise. The late Roman empire shaved silver coins as it disintegrated; Henry VIII replaced silver coins with copper to pay for wars against France and
Scotland; the British empire allowed double-digit inflation to erode bondholders’ wealth following the War of Independence; the Weimar Republic precipitated an inflation spiral. In the worst-case scenario, history shows that when nation-states take control of the economy, money ceases to be a store of value – it becomes a mere instrument to ensure their survival.
Our open society based on free markets needs change to survive. Taxpayers will question corporates who receive low-interest loans today and assess their behavior in the future.
Bondholders forced into low bond yields may eventually balk at the rise of inflation. Central banks’ liquidity won’t be able to lift all boats in sovereign and corporate debt. In sum, the crisis will be an opportunity to reform capitalism and bail-out mechanics, giving a share of the upside to all stakeholders. But the process won’t be orderly: some firms and countries will emerge as winners, others will have tougher times.
To read the original article, published on April 16, 2020, please visit algebris.com