Malign global forces are shaping the latest phase of our pandemic recovery

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The last few months have confirmed that Phase Three of the global recovery from the COVID-19 pandemic is now well underway. Phase One involved the distribution of emergency financial support on an unprecedented scale. This rapid intervention saved millions of jobs and businesses. Phase Two was the cautious withdrawal of this financial support. Policymakers generally erred on the side of overdistributing pandemic support. And it was this decision that now frames Phase Three. Having engineered a rapid economic recovery and unleashed inflation, how does the world economy now bring price growth back under control? Overlay the huge humanitarian and economic fallout from a war in Ukraine and these are hard decisions for policymakers. They will end political careers, and forge new ones.

UK-based Times readers will recognise the unpleasant attributes of Phase Three at the petrol pump, on opening energy bills and at the supermarket. However, the UK is not alone. Petrol prices have become a huge political issue in the United States heading into November’s mid-term elections. President Joe Biden’s approval ratings are now regularly below those any other recent US President at the same stage of their tenure. This includes Donald Trump. Energy prices across mainland Europe have soared amidst speculation that Russian gas supplies will not restart after last week’s maintenance shutdown of the Nord Stream One pipeline. The potential for a deep manufacturing recession in Germany later in the year looms large should gas supplies be heavily restricted. Fast-increasing food prices are of extraordinary significance across developing economies. In Sri Lanka – where President Rajapaska has recently resigned and fled to Singapore – the World Food Program now estimates that more than 1-in-4 Sri Lankans are now food insecure because of food prices that have rocketed by 80% over the last year.

The risk for the world economy is that what has begun as a cost-of-living squeeze can quickly spillover into other sectors. The global economic slowdown has begun to hit the world’s second largest economy – China – itself still grappling with how rigorously to pursue its Zero Covid policy. There are increasing reports of hundreds of thousands of mortgages – linked to unfinished properties – being left unpaid and creating growing arrears for the Chinese retail banking sector. A huge property bubble which has pushed property values in major Chinese cities to more than thirty times annual incomes – compared to just over 10 in London – is looking increasingly precarious.

Whilst it is easy to blame such economic events on the domestic choices of politicians and central bankers, the reality is this cocktail of events are impacting all economies to a greater or lesser extent. This will provide little solace for those impacted, nor protection from criticism for those in positions of power. So, what are these global forces and how have they managed to create such a troubling backdrop? Four main forces have coalesced.

Firstly, the ongoing disruption of a pandemic and its disruption of a deeply integrated global economy. It would be naïve to think that it is possible to stop, and then rapidly restart, large parts of the world without putting sand in the wheels of both product and labour markets. Shutting down complex, cross-border trading systems left economic factors of production in the wrong place and led to workers reappraising their priorities. Whilst these frictions were probably inevitable, they have been amplified by ongoing social-distancing restrictions at ports across the world. Airport hubs, which have faced heightened demand from holidaymakers, have also had to cope with the additional freight volumes from businesses trying to avoid sky-high shipping rates.

Secondly, the war in Ukraine has led to a rush to secure increasingly scarce energy, food and fertiliser supplies. Whilst the direct impact of Russian and Ukrainian production is relatively modest, there has been a race to secure supplies from alternative producers heading into the Northern Hemisphere winter. Understandable uncertainty of how the war evolves and endures has enabled traders and suppliers to raise prices – hitting the poorest consumers and poorest countries the hardest. This regressive impact stems from the fact that poor households and poor regions spend a disproportionately high amount of their disposable income on energy and food. 

This effect has been amplified by a third factor – the strength of the US Dollar. For commodities that are largely priced in dollars, their cost has increased disproportionately as a wide range of currencies have lost ground against the US Dollar. This has meant that even large G20 economies have seen sharply increased import costs. Inflation is now running, officially at least, at 64% in Argentina and 74% in Turkey. In part this is a flight by investors to the safety of US Dollars as global growth slows, but it also represents a Federal Reserve that plans to raise US interest rates far faster than had been envisaged at the start of the year. These higher US interest rates remain a huge attraction to what remain yield-hungry global investors.  

Fourthly, it should not be ignored that the stresses now being experienced by the world economy are themselves a function of how rapid the economic recovery has been.  Huge demand emerged for durable goods such as housing materials, second-hand cars and electronics as households were unable to consume services such as hospitality, entertainment, and tourism. This would have introduced higher prices for consumer goods even in normal economic times. This impact was simply accentuated by the scale of income protection measures deployed during the pandemic.

And so, this brings us to the legacy of this period of economic history. The risk is that pandemic economics becomes framed through the prism of inflation and social unrest that looks set to characterise Phase Three, whilst the avoidance of mass unemployment, hardship and widespread company failures – a very real prospect at onset of the pandemic – is marginalised. Accurately interpreting the economics of this tumultuous period will be essential for successfully dealing with the next crisis, whenever and wherever it emerges.

Simon French

Managing Director, Chief Economist

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