Indebted

After the disease, the debt.

By the end of this year, the mature economies of Europe and the US are expected to accumulate debts equivalent to 120 percent of their respective GDPs. Should their economies massively contract despite the debt-funded “stimulus” programs, the indebtedness could be higher.

The emerging economies hard-hit by the pandemic are likewise expected to accumulate debt. With everyone rushing to borrow, lending institutions will be hard-pressed to raise the funds. With most economies hobbled by the plague, raising money for lending will not be easy.

This mad rush to borrow is unlike what we saw in the seventies. At that time, the financial institutions were awash with funds – mainly petrodollars deposited by the oil-producing countries after the OPEC managed to force a spike in fuel prices.

Since the spike in fuel prices caused a recession in the industrial economies, there was not much demand for the funds accumulated by the oil exporters. The banks were groaning under the weight of huge deposits for which interest will have to be paid.

To solve that problem, developing countries were encouraged to contract sovereign debt at low interest rates to spur their own economic growth. Thus was planted the debt bomb. By the eighties, as interest rates climbed, the developing countries found it hard to service their debts. Their economies did not grow fast enough to outpace the debt.

Today, we have a very different situation. With the collapse in oil prices, there is not enough petrodollars available for lending.

Following the law of supply and demand, lenders could exploit the surge in borrowing to raise interest rates. Rising interest rates, however, will deepen the economic depression we are now expecting.

In 2007, I was serving on the board of the DBP. As recession was deepening in the industrial economies, I recall we instructed our analysts to closely observe the credit card repayments in the US. We expected the fissure to begin when consumers begin defaulting on their credit card debts.

Instead, the breakdown began among the investment banks that put a lot of money in the subprime mortgage market. Banks were reckless in lending money to people who did not have enough to service their borrowing. They were reckless because it was easy to pass on the risks to investment banks that speculated on derivatives.

When Lehman Brothers collapsed, a large financial tsunami circled the globe. The recession was deep and brutal.

Today, the situation is perhaps a thousand times more challenging.

A financial breakdown could happen anywhere as the major economies contract both simultaneously and on an unprecedented scale. In the US, where unemployment is conservatively expected to rise to 19 percent over the next few weeks, a spike in credit card defaults is nearly a given.

More dangerous than credit card defaults is the possibility of large corporate defaults. The airline industry, for instance, is bleeding in the billions each day. Nearly every airline company will need government relief in some form. The volume of air travel we saw earlier this year will not be restored for two years at the very least.

Companies involved in tourism, hospitality, sports and entertainment will be on life support for years. Should they default, banks will be left holding virtually worthless assets. At the dictate of prudence, banks must now degrade most of their accounts to subprime and provision for them.

When this pandemic descended upon all of us, it first threatened to overwhelm and collapse the health systems. Lockdowns were imposed everywhere to protect the health systems. This response has been largely successful, although it brought about a huge recession.

This recession will be more severe than usual. Several large economies are expected to contract by as much as 30 percent in the second and third quarters.

This recession will continue for much longer as bankruptcies pile up and as supply chains are disrupted everywhere. The only secure businesses, it seems, are those that process food or produce medicines.

Unless a severe second wave of infections have happened, we can now say the world has been largely successful in protecting their health systems. In the face of a brutal recession, protecting the financial system becomes the second task.

Because of all the uncertainty pervading, it is understandable that the banks will be more conservative in their lending. If lending is choked off, the recession will feed on itself. To resolve this, governments have offered to guarantee loans. This is necessary but also risky. Should defaults continue, governments would find themselves assuming unsustainable contingent liabilities.

The health of our pension system also needs to be double-checked. With the collapse in stock prices, the assets of our pension systems have surely been debased. Notwithstanding, the pension systems are now under pressure to provide more economic aid to their members in the form of short-term loans. Many of these loans are made to jobs that might not be there when the economy reopens.

In the first weeks of the pandemic, issues relating to the health emergency took first priority. Today, as we try to imagine a way to normalize economic activity, all the second- and third-generation problems challenge us.

The coronavirus that has tormented all of humanity for months now will not leave us to many months ahead. The most optimistic scenario sees the development of an effective vaccine early next year. Then it will have not be mass-produced and competently deployed.

In sum, we will need over two years to properly deploy an antidote to this virus. That is, if a vaccine is indeed developed.