The great post-Covid macro themes

The coronavirus pandemic is not over and there will be more pain to come, not least in the developing world. But the shape of the post-Covid global economy is now coming into focus. It offers both risks and opportunities, writes Victor Hill.

Out of the bunker?

This week the UK re-emerged from lockdown, though life is still not entirely back to normal. We can go to pubs, but we still can’t prop up against the bar and rub shoulders with our mates. There is anxiety about the spread of the Indian variant of SARS-CoV-2, with hospitalisations having spiked in hotspots such as Bolton and Blackburn. But very few experts think that there will be a third wave in a country where well over half the population has had one jab and about one third of the population has been fully vaccinated with two. It is a different story in countries where vaccination levels are still low. India may be over the worst of the recent surge with new cases plummeting, but the country reported over 4,500 deaths on Wednesday (19 May).

And advanced Asian countries which have endured much lower levels of mortality than the UK or the USA are once again in full or partial lockdown. Tokyo, where supposedly the Olympic Games will take place in July (though that is now in doubt) is currently under a state of emergency. South Korea, where there have been fewer than two thousand deaths since the start of the pandemic, has been hampered by a shortage of vaccines at a moment when the rate of daily new cases is ticking up. In Vietnam, 70,000 people have been confined as a wave of new cases has been detected. Singapore has just banned indoor dining. Even Taiwan, which has seen just 12 deaths, has banned large gatherings and closed schools for two weeks in response to a cluster of new cases linked to airline crews.

Countries which have relied on a policy of elimination – seal the borders to keep Covid out, isolate carriers securely and make mask-wearing compulsory etc. – are now facing the prospect of continued restrictions as they placed their orders for vaccine late and will now have to wait until supplies arrive. The Australian Medical Association (AMA) warned this week that the country would have to remain closed for decades if it wishes to remain 100 percent Covid-free. There is thus a debate in Australia about whether it wishes to become a hermit nation. Moreover, vaccine hesitancy (and complacency) seems to grow in states where vaccination programmes have been delayed.

That means that international travel, both leisure and business, is unlikely to return to pre-pandemic levels for some time – if ever. That is bad news for countries such as Thailand which had a tourism industry in 2019 worth £46 billion and where just three percent of the population has been vaccinated. But Britain, America and to a lesser extent Europe can look forward to a vibrant H2 2021 in which economic growth resurges. The UK may be heading for growth of over 5 percent for Q2 2021. Capital Economics thinks that the UK may regain its pre-pandemic levels of output by the late summer. Goods exports to the EU in March regained last summer’s level. Despite Brexit!

This is therefore a good moment to consider what will be the main macro themes of the global economy, post-Covid. Thirteen months ago, when the vaccination programme was still far off, I co-authored a special report with my colleague, James Faulkner. The gist was that the pandemic had accelerated several global economic and social trends that were underway before anyone had heard the word coronavirus. Some of these are reasonably well understood: the move away from bricks-and-mortar retailing to online shopping; the rise of home-working and the changing role of the office; the decline of cash and the centrality of digital payment platforms; the symbiosis of big government with big pharma; the increased reliance of monetary policy to finance fiscal deficits.

What is becoming apparent now is that the post-Covid world economy will be one of technological opportunities on the upside and severe financial risks – of which inflation is paramount – on the downside. The march of decarbonisation will also further exacerbate these downside risks because the costs involved have been underestimated. Major power users such as steel makers transitioning to carbon neutrality will either require government subsidies or will be obliged to hike prices. While fortunes will be made in the post-Covid recovery, it is not at all clear that global living standards will rise as rapidly in the 2020s as they did in the 1960s, the 1980s and the 20-noughties.

Demand-pull

In early March I wrote here that the wolf of inflation could be heard howling from afar. More recently, I considered the consequences of a shortage of microprocessors and essential commodities. It’s evident that the prices of essential inputs like iron ore and copper are rising – and lead times are getting longer. Freight shipping costs, as measured by the Baltic Dry Index, are soaring. A recent Bloomberg article proclaimed that the world economy is suddenly running low on everything. It is also now clear that there are shortages in global labour markets too. That will drive up wages and further impel the forces of inflation. This week we learnt that the consumer prices index (CPI) in the UK had doubled from 0.7 percent in March to 1.5 percent in April. Inflation is also rising in Germany. In the US, the headline inflation rate is already at 2.6 percent.

Job vacancies across Britain leapt by 88,000 last month to reach 747,000. With hotels and restaurants re-opening across the UK (Northern Ireland next week) recruitment demand is greatest in the hospitality sector. Pubs and bars are desperate for staff. As many as 1.3 million foreign nationals may have left the UK during the pandemic, reducing the size of the workforce accordingly. The ONS recorded the biggest fall in UK unemployment in six years in Q1 2021: the number of claimants fell from 5.1 percent to 4.8 percent. Employers added another 97,000 to payrolls in April alone. Rational optimists expect that unemployment will be back to near where it was pre-pandemic by the time the furlough scheme is wrapped up in September this year. The Bank of England Governor, Andrew Bailey, thinks that most furloughed workers will have returned to work by then.

Sectors which have historically been highly reliant on foreign seasonal workers such as farming, food processing, and care for the elderly will be hard hit by the labour shortage. The waters of employment statistics may be muddied, however, by the number of gig economy freelancers who are becoming employees with holiday pay and pensions, due to judicial pressure. This week Australia became the latest liberal democracy to require that gigsters be given employment status. The Fair Work Commission (FWC) ruled that a Deliveroo driver was akin to an employee and not a contractor.

There is a similar pattern in America. A survey by the National Federation of Independent Business found that 44 percent of small businesses in the US had vacancies they cannot fill. That is a record high.

Money-push

The economist Milton Friedman (1912-2006) wrote that inflation is always and everywhere a monetary phenomenon. Inflation arises because the money supply or stock of money is growing faster than monetary value of underlying stock of goods and services available to purchase in a given economy. The problem is that the new breed of central bankers – what I have called in these pages the priestly caste – see it as their sacred mission to sustain demand and therefore employment in any downturn by expanding the money supply by means of quantitative easing (QE). Since the financial crisis of 2009-10 they have been able to print money while keeping interest rates at near-zero levels without unleashing inflation. That may be about to change.

The balance sheet of the US Federal Reserve has almost doubled from $4 trillion to nearly $8 trillion in the last year alone. This at a time when the Federal government is embarking on the greatest spending spree since the New Deal in the 1930s (though the numbers were tiny by comparison then). According to the Centre for Financial Stability the money supply in the US (M4) grew by 24 percent in the twelve months to March. In the UK, M4 is growing this year at a clip of 16 percent. The Bank of England now owns nearly half the national debt. Much of that debt has been used to finance transfer payments – of which the furlough scheme, meritorious as it has been – which do nothing to grow the economy. For a year or more we have been sustained by helicopter money.

Even if there is not an immediate upturn in inflation, rational actors suspect that there is a high probability that it will manifest itself soon. That means that corporations will try to put up prices in anticipation of future rises in input costs. That’s called inflationary expectations.

Add to these the expectation – indeed knowledge – that corporate taxes will rise. That entails that many companies will rein in investment plans – though in the UK that might be mitigated in the short-term by Mr Sunak’s regime of super-deductions. Jefferies Group thinks that the super-deduction policy could mobilise much of the £100 billion or so cash balances held by UK companies. Overall, American banks are most bullish on the outlook for the UK economy, perhaps because Americans (just) still believe in market economics.

But beware of statistics. The way in which UK GDP was calculated exaggerated the severity of the downturn in the UK by ignoring the value of health and education output – unlike our European neighbours. The mantra often repeated by those such as Angela Rayner MP that the UK had the worst mortality outcome, and the biggest economic contraction, is highly misleading.

Big government – Daddy knows best

Gigantic state expenditure programmes are about to be unleashed. The Biden administration in the US has pledged eye-watering amounts to get America back on its feet and to fix its crumbling infrastructure (as I explored a month ago). The EU is now unlocking its €750 billion Recovery Fund. Individual EU states are pursuing their own stimulus packages. The Johnson government in the UK pledges new spending initiatives almost every week. This at a moment when $500 billion of pent-up savings could be released in America and another £130 billion in the UK.

Governments generally have a poor record in the game of picking winners and dropping losers. That game is more proficiently played by the market. 

Joining the queue

One of the big questions in Britain elsewhere post-Covid will be how to modernise and improve healthcare provision. The UK National Health Service across the four nations now has a waiting list for non-urgent treatment of five million. More than half a million people have been waiting more than a year for elective surgery such as hip and knee replacements. Millions of Britons are frustrated by the time and effort required to get a doctor’s appointment – if they can get one at all. (There has been a lively correspondence on this topic in the Daily Telegraph). That has triggered a boom in online doctors’ consultations, such as those offered by Babylon Health. The issue of how to pay for the long-term care of the elderly, and especially those suffering from dementia, is still far from being resolved.

Clearly, the UK and other countries with socialised medical systems will have to spend more money on healthcare in the aftermath of Covid-19. This comes on top of all the other demands for government spending – policing, border security, defence, education, transport and so on. But where is the money going to come from? It’s all very well raising corporation tax, Mr Sunak (from 19 to 25 percent), but that is unlikely to be enough. At some point the UK Tory government will most likely break its pledge not to raise national insurance and VAT. But that will be regarded as unfair on the least well off. Eventually, even the Tories will succumb to the idea that new wealth stroke property taxes are inevitable as the only way to address increasing levels of social and economic inequality.

Technology advances

All this will unfold at a time when the pace of technological innovation is accelerating.

Blockchain technology which powers digital currencies will become standard. All the central banks of advanced countries will roll out fiat digital currencies. Artificial intelligence (AI) will entail that algorithms determine outcomes from medical treatments to the criminal justice system. 5G networks combined with new constellations of mini satellites (which I discussed last week) will increase the speed of internet connectivity dramatically. We shall all have daily interactions with robots. We’ll talk over our investment decisions with personal financial advisors living inside our smartphones; and we’ll have android valets to organise our wardrobes. The Internet of Things will ensure that you never again burn the toast or forget to feed the cat. Sensors implanted in our bodies will monitor critical medical parameters such as blood pressure and forewarn us of impending heart attacks so that we can be whisked to hospital in good time by a driverless ambulance…

These are all themes I have explored in these pages. So how come tech stocks in the pandemic endgame have retreated? Last year the most crowded space was technology growth stocks. But as we emerge from the pandemic the smart money is pouring into value stocks such as LMVH (EPA:MC). (Its CEO, Bernard Arnault, overtook Mr Musk to become the world’s second richest honcho this week.) Heritage brands still have mileage. Quite what is going on here is something I’d like to consider soon.

Macro themes in black and white

So, putting all this together, the main themes of the post-Covid decade will be as follows. Rising inflation, rising interest rates (with huge consequences for government finances), rising government expenditure, increased taxation (including new wealth taxes), increased state monitoring and interference in our personal lives; and, of course, accelerating decarbonisation. And rising protectionism stroke national resilience; plus, more state ownership of social assets. (The UK government is effectively re-nationalising the railway network in England just as the SNP government is taking control of train operators in Scotland.)

Decarbonisation will have to be paid for largely by the consumer via higher transport, domestic heating and food prices. This will put downward pressure on average living standards which will be only partially offset by gains in productivity arising from robotisation. And let’s not forget that the poor fare worst under rampant inflation.

Wealth taxes will entail that the state needs to garner as much information as it can about our personal assets. State-sponsored crypto-currencies will further mean that the state will be able to monitor all transactions. Combined with the spread of facial recognition technology, it is very probable that the USA, the UK and Europe will become surveillance states, just as China is already. These surveillance systems will be justified as helping to prevent a future pandemic:track and trace-style GPS location monitoring will become normalised. Just as state control of social media databases will be justified as fighting hate crime. The distinction between liberal democracy and Chinese-style authoritarianism will blur.

For people of my demographic, all this sounds uncomfortable. But the young don’t seem to mind.

***

Thailand. It is shortly before eight o’clock on the radiant morning of 26 December 2004. Two young women – sisters – are having breakfast on the terrace outside a backpackers’ hostel near the crescent beach on Phi Phi Island. Palm trees; a glistening seascape; golden sand. A cool hairy dude is strumming a guitar…Strangely, the tide seems to be going out rapidly…

A waitress drops a tray…There is screaming. And suddenly everyone starts running. The young women’s autonomic nervous systems kick in and they run too. We thought it was a terrorist attack one of them later told me. Following the stampede, they find themselves on higher ground. Some minutes later they survey the devastation the tsunami has wrought…Then they see bodies bobbing in the water.

The point of my story is that when people start running, they don’t always know what they are running away from – and they can never be sure they will reach a place of safety. Though, happily, these young women did.

Investors should take note.