Economy

Piling Up Public Debt, Risks Of A COVID Economic Consensus

The pandemic has prompted financial authorities to take a more relaxed approach to debts. For Latin America, overspending in response to the crisis may take them back to the poverty pits of the past.

Street scene in Guadalajara, Mexico
Street scene in Guadalajara, Mexico
Fernando Fernández*

-Analysis-

The world is engaged in a dangerous experiment. When the 2008 financial crisis hit, central banks abandoned their manuals on traditional monetary policy to become the chief protagonists of an economic stabilization approach. They guaranteed infinite liquidity at historically minimal prices, and embarked on monetary expansion so sustained and spectacular as to be far more than just "unconventional."

Then, just when it seemed matters were resuming their ordinary course and central bank lending sheets were starting to balance, the pandemic arrived, bringing with another wave of monetary expansion. This time, it has spread to emerging economies and came with unprecedented fiscal expansion. The financial markets approved, as did the economy's traditional overseers. Figures from the International Monetary Fund (IMF) show that national public spending increased in 2020 by more than 10 percentage points on average, and public debt increased by 30 GDP points.

Interest rates at record lows and maximum-level public spending is now common in all regions of the world. These are deemed to be the right political response to our current extraordinary social circumstances. In emerging countries, such expansive policies previously fueled inflation, impeded external financing and provoked repayment crises, the power of the almighty U.S. dollar, financial bubbles, banking crises and long recessions.

The right political response to our current extraordinary social circumstances?

Now, it all seems different. It's as if the world — including markets, economists and politicians — wanted to free itself from the curse implicit in the title of Reinhart-Rogoff's paper Growth in a Time of Debt. They seem to think everything, even economic policy, would be different in the "new normal." The truth is that monetary orthodoxy has evidently changed, judging by the actions of the U.S. Federal Reserve and the European Central Bank to dictate neutral or negative interest rates and a monetary free-for-all, supposedly to combat entrenched stagnation. The same goes for fiscal orthodoxy.

The guardians of orthodox economics, represented symbolically by IMF overseers, are now eagerly telling governments to spends so as to alleviate the pandemic's social and economic effects. They are even chiding governments like Mexico's, whose interventions remain cautious in fiscal terms as the country remains mindful of its traditional vulnerability to external conditions. Their argument appears simple and irrefutable: With such low interest rates, the costs of public debt are practically nil and it is almost irresponsible not to take advantage of them to meet the immense social demands, infrastructure deficits and health needs.

The new consensus in Washington and in Cambridge, Massachusetts, is that zero or negative interest rates would, over decades, dilute Latin America's traditional problems with repaying public debt. This means that the unstoppable forces of globalization, digitalization and aging populations will dissipate inflation concerns. Low rates would mean permanent availability of capital, while growing global competition would eliminate any wage increases not based on increased productivity.

Food distribution in Mexico — Photo: PPI/ZUMA

The lesson from this time is that aggregate demand policies can be applied for a long time without provoking inflation. The message to governments is clear and direct: Solve the problems and start spending — without limits. This is no populist slogan. It is what the new economic orthodoxy is recommending. It's the new "truth," so only irresponsible, ignorant or even wicked governments could resist its application. The old limits to public deficits or debt are relics of another time, and fiscal modernity wants more autonomy and discretionary powers.

The problem with this idyllic vision of the new normal is that any mistakes could prove very costly. If, for some reason, problems of inflation or financing difficulties were to return, Latin America would be left in a very vulnerable position. Its elevated public spending needs are structural, recurrent and difficult to curb. Its public debt is approaching the levels of advanced economies, but its debt markets are less liquid and reliable.

The IMF estimates this debt will reach 80% of the regional GDP in 2021, which is the highest level among emerging economies. There is no guarantee that the interest rates at which the region is financing itself will continue. The structural forces driving disinflation are neither permanent nor irreversible, and they can lose momentum.

We have seen this before and the result won't be much different this time: It will be another lost decade.

Nor would it be prudent to rely on risk premiums that are always kept down by massive and indefinite debt purchasing by the U.S. Federal Reserve or the European Central Bank. Benevolent regulators are keeping markets complacent as they believe, at least for now, that the best policy is to postpone credit risks while there is a pandemic. The danger is not just to postpone repayment problems and hope that the economic recovery will ensure they will have nothing more than liquidity issues. The problem is if investors convert to this new orthodoxy, which assumes that risk has disappeared, that there's no danger of insolvency, and that present risk premiums are indefinitely sustainable.

The danger is to think debt is not a problem because it can always be reabsorbed, restructured, defaulted on or liquidated. We have seen this before and the result won't be much different this time: It will be another lost decade.

Latin America is the region worst affected by the coronavirus. The regional output will have fallen 5% in 2020, increasing poverty and inequalities, and auguring political tensions. Trusting in magic and painless solutions is obviously tempting, especially if there is now a consensus growing around them. The debt solution is dangerous enough in an advanced economy, but a fatal mistake for emerging economies.

The region must not forget that its problems predate the pandemic and are rooted in misconduct in terms of productivity, human resources, institutional development and numerous structural reforms yet to be enacted. These will not be solved with monetary expansion, more spending and more debt. Believing otherwise is not just naive, but as reckless as jumping off a cliff without a parachute.


*Fernando Fernández is a lecturer at the IE Business School in Madrid.

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New Delhi, India: Fumigation Against Dengue Fever In New Delhi

Anne-Sophie Goninet, Jane Herbelin and Bertrand Hauger

👋 வணக்கம்*

Welcome to Thursday, where America's top general reacts to China's test of a hypersonic weapon system, Russia is forced to reimpose lockdown measures and Venice's historic gondola race is hit by a doping scandal. French daily Les Echos also offers a cautionary tale of fraud in the crypto economy.

[*Vaṇakkam, Tamil - India, Sri Lanka, Singapore]

🌎  7 THINGS TO KNOW RIGHT NOW

Top U.S. general says Chinese weapon nearly a "Sputnik moment": China recently conducted a "very concerning" test of a hypersonic weapon system as part of its push to expand space and military technologies, Gen. Mark Milley, the U.S. Chairman of the Joint Chiefs of Staff, told Bloomberg News. America's top military officer said that this was akin to the Soviet Union's stunning launch of the world's first satellite, Sputnik, 1957, which sparked the Cold War space race. Milley also called the test of the weapon "a very significant technological event" that is just one element of China's military capabilities.

Brexit: France seizes British trawler: A British trawler has been seized by France while fishing in French waters without a license, amid escalating conflict over post-Brexit fishing rights. France's Minister for Europe said it will adopt a zero-tolerance attitude towards Britain and block access to virtually all of its boats until it awards licenses to French fishermen.

COVID update: Russia confirmed a new record of coronavirus deaths, forcing officials to reimpose some lockdown measures, including a nationwide workplace shutdown in the first week of November. Germany also saw its numbers spike, with more than 28,000 new infections yesterday, adding to worries about restrictions this winter there and elsewhere in Europe. Singapore, meanwhile, reported the biggest surge in the city-state since the coronavirus pandemic began. Positive news on the vaccine front, as U.S. pharmaceutical giant Merck granted royalty-free license for a COVID-19 antiviral pill to help protect people in the developing world.

Iran nuclear talks to resume: Iran's top nuclear negotiator said multilateral talks in Vienna with world powers about its nuclear development program will resume before the end of November. The announcement comes after the U.S. warned efforts to revive the deal were in "critical phase."

First U.S. passport with "X" gender marker: The U.S. State Department has issued its first American passport with an "X" gender marker. It is designed to give nonbinary, intersex and gender-nonconforming people a marker other than male or female on their travel document. Several other countries, including Canada, Argentina and Nepal, already offer the same option.

China limits construction of super skyscrapers: China has restricted smaller cities in the country from building extremely tall skyscrapers, as part of a larger bid to crack down on wasteful vanity projects by local governments. Earlier this year the country issued a ban on "ugly architecture."

Doping scandal hits Venice's gondola race: For the first time in the history of the Venice Historical Regatta, a participant has tested positive to marijuana in a doping test: Gondolier Renato Busetto, who finished the race in second place, will be suspended for 13 months.

🗞️  FRONT PAGE

"End of the ice age," titles German-language Luxembourgish daily Luxemburger Wort, writing about how the ice melting in the Arctic opens up new economic opportunities with a new passage for countries like Russia and China but with potentially devastating effects for the environment. The issue of the Arctic is one of the topics that will be discussed at the COP26 Climate Change Conference which kicks off in Glasgow on Sunday.


#️⃣  BY THE NUMBERS

$87 billion

A new United Nations report found that extreme weather events such as tropical cyclones, floods and droughts have caused India an average annual loss of about $87 billion in 2020. India is among the countries which suffered the most from weather hazards this year along with China and Japan.

📰  STORY OF THE DAY

Air Next: How a crypto scam collapsed on a single spelling mistake

It is today a proven fraud, nailed by the French stock market watchdog: Air Next resorted to a full range of dubious practices to raise money for a blockchain-powered e-commerce app. But the simplest of errors exposed the scam and limited the damage to investors. A cautionary tale for the crypto economy from Laurence Boisseau in Paris-based daily Les Echos.

📲 The story began last February, when Air Next registered with the Paris Commercial Court. The new company stated it was developing an application that would allow the purchase of airline tickets by using cryptocurrency, at unbeatable prices and with an automatic guarantee in case of cancellation or delay, via a "smart contract" system. Last summer, Air Next started recruiting. The company also wanted to raise money to have the assets on hand to allow passenger compensation.

📝 On Sept. 30, the AMF issued an alert, by way of a press release, on the risks of fraud associated with the ICO, as it suspected some documents to be forgeries. For employees of the new company, it was a brutal wake-up call. They quickly understood that they had been duped, that they'd bet on the proverbial house of cards. Challenged by one of his employees on Telegram, the CEO admitted that "many documents provided were false", that "an error cost the life of this project."

⚠️ What was the "error" he was referring to? A typo in the name of the would-be bank backing the startup. A very small one, at the bottom of the page of the false bank certificate, where the name "Edmond de Rothschild" is misspelled "Edemond". Before the AMF's public alert, websites specializing in crypto-assets had already noted certain inconsistencies. The company had declared a share capital of 1 billion euros, which is an enormous amount. Air Next's CEO also boasted about having discovered bitcoin at a time when only a few geeks knew about cryptocurrency.


➡️ Read more on Worldcrunch.com


📣 VERBATIM

"A weapon was handed to Mr. Baldwin. The weapon is functional, and fired a live round."

— Following the Oct. 21 on-set shooting death of cinematographer Halyna Hutchins, Sante Fe County Sheriff Adan Mendoza told a press conference that the "facts are clear" about the final moments before Hutchins was shot. The investigation continues to determine what led up to that moment, and any possible criminal responsibility related to how the "prop" gun that actor Alec Baldwin fired was loaded.

✍️ Newsletter by Anne-Sophie Goninet, Jane Herbelin and Bertrand Hauger

Share with us your favorite gondola memories or worst crypto scams — and let us know what the news looks like from your corner of the world! info@worldcrunch.com

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