Zhang Yuyan:

The COVID-19 Pandemic and the World Economic Situation

Zhang Yuyan:

Professor at the School of International Relations, University of Chinese Academy of Social Sciences, and an Academia of the Chinese Academy of Social Sciences (CASS)

The global pandemic outbreak of COVID-19 had a huge impact on the world economy in 2020, and there were significant regional differences depending on intensity of the impact. In the face of the pandemic outbreak, governments or economies had taken unprecedented response measures and produced varying degrees of effect. The fragile and uneven recovery in the global economy was compounded by the worsening problems of low growth, low interest rates, low inflation and high debt, high asset prices and high income inequality that emerged after the financial crisis. The uncertainties inherent in the evolving COVID-19 outbreak, the resilience and policy trends of major economies and their spillover effects, global and regional economic governance, as well as the competitive and cooperative development of major countries, to a large extent, will determine the fundamentals of the world economy in 2021.

The global economy under the influence of the Covid-19 pandemic

The huge impact of the pandemic outbreak on the world economy is mainly manifested in the following aspects.

First, the economic growth rates of various economies dropped sharply. The International Monetary Fund (IMF) points out in its World Economic Outlook reported in October 2020 that the global economic growth rate in 2020 is expected to be -4.4%, the lowest growth rate since the Second World War, which is a big fall from the forecast figure of 3.0% of the economic growth in 2020 a year ago. Meantime, the impact of COVID-19 pandemic on economies was not uniform. Developed economies as a whole grew at -5.8%, with -4.3% in the United States and -8.3% in the Eurozone, emerging market and developing economies grew by -3.3%, with Russia at -4.1% and Brazil at -5.8%, and presently, the Asia-Pacific economies have begun to recover, but the speed of recovery varies among countries. The IMF cut its forecast for Asia-Pacific growth by 0.6 percentage point to -2.2%for 2020 because of sharper than expected contractions in the region's major emerging markets,1such as India, which contracted by more than 10% this year. For the world, economic growth in the second quarter of 2020 was hardest hit by the outbreak. But China has recovered strongly since the end of the second quarter and is the only major economy showing positive growth, at an estimated 1.9%.2In the third quarter, economies of many countries began to recover as the spread of the pandemic was somewhat controlled and governments quickly adopted huge rescue policies, but the IMF remained pessimistic about economic performance for the full year. The European Central Bank predicted in mid-December that the Euro zone would return to negative growth in the fourth quarter following a new wave of the rampant pandemic outbreak accelerated in many of its member countries and the pace of global economic recovery, especially in developed economies, slowed down in the fourth quarter.

Second, prices fell and unemployment rose. The U.S. consumer price index (CPI) was 2.5% in January 2020, fell to 0.1% year-on-year in May, and then rose to 1.2% in November. The situation is similar in Europe and Japan. The Euro zone harmonized Index of Consumer Price (HICP) grew by 0.8% year-on-year in October 2019 and fell to -0.2% in August 2020. It was -0.3% in both September and October, indicating that deflation emerged in the Euro zone. Japan is teetering on the brink of deflation. Inflation in major emerging economies has followed a similar trajectory, with China's CPI falling by 0.5 percentage point from November 2019 to November 2020, even in Argentina where inflation is high for many years, the CPI fell from 50.5% in September 2019 to 36.6% in September 2020.3Unemployment in the world's major economies fluctuates more than price levels. The U.S. unemployment rate was just 3.5% in February 2020, jumped to 14.7% in April, and then fell to 6.9% in November. Unemployment in the Euro zone and Japan fluctuates similar to that of America. Among major emerging economies, Russia's unemployment rate rose by 1.9 percentage points to 6.4% between September 2019 and September 2020. China's unemployment rate rose from 5.2% in December 2019 to 6.2% in February 2020,4and then fell to 5.2% in November as the epidemic outbreak was brought under control and the economy recovered. The pandemic impact on different industries and social groups varies greatly among various countries, with low-income people, young people and women the hardest hit, and the plight of the poor further worsened. The number of people living in extreme poverty in Latin America will increase by 16 million to 83 million by 2020, according to estimates by the Economic Commission for Latin America and the Caribbean.5

Third, trade and cross-border investment and volatility in staple commodity prices reduced. According to the Trade and Development Report 2020 released by the United Nations Conference on Trade and Development (UNCTAD) in September 2020, global merchandise trade drops by one fifth and global foreign direct investment drops by 40% compared with the previous year. In terms of utilization of foreign investment, China's actual utilization of foreign investment from January to November 2020 grew by 6.3% year-on-year (4.1% in U.S. dollar terms) in the unfavorable conditions, showing off China the only major economy in the world.6In addition to the pandemic impact, the unilateralist and protectionist policies pursued by some countries have a continuing negative impact on trade and investment. In 2020, the average tariff rate of Chinese exports to the United State was as high as 19.3%. In December alone, the U.S. Department of Commerce added 77 entity companies, including Chinese enterprises, to the so-called "Entity List" for alleged "actions contrary to U.S. national security or foreign policy interests". Similar to the rebound in economic growth, staple commodity prices went on a roller-coaster ride in 2020. Brent prices were $63 / BBL in November 2019, fell to $19 / BBL in April 2020, and then rose to $49 / BBL in mid-December. The price of iron ore among the minerals surged in the second half of the year, with the main contract hitting a record high since iron-ore futures were launched in 2013.7Although the food grain price of the bulk commodity did not experienced the same ups and downs as during the financial crisis, it also show a trend of falling first and then rising. The Food and Agriculture Organization's (FAO) Food Price Index (FFPI) for 2020 was 102.5 in January, fell to 91.0 the yearly lowest in May, and then climbed all the way to 105.0 in November. Among them, grain prices were relatively stable, reaching 100.5 in January, 97.5 in May and 114.4 in November, respectively, the latter being the highest since 2014.8

Fourth, the asset prices of developed economies have recovered, the dollar declined and debts of various countries expanded rapidly. In March 2020, the US stock market suffered four melt-downs, and the financial panic spread rapidly. Then central banks of major economies such as the United States immediately launched super-intense conventional, especially unconventional easing monetary policies to rescue the market. With a surging flood of liquidity, American share prices have rocketed to record high, with a gap of about two-thirds in a year. Although having not returned to the start of the year, the major European indexes have also seen a relatively large recovery in the same period, and the U.S. stock market entered a period of high volatility, and asset prices recovered in sharp contrast to the reverse movement of the dollar index. In the early days of the pandemic outbreak, the dollar index rose briefly and then fell all the way down. On December 17, it dropped below 90, the lowest since April 2018. The dollar index fell along with the sharp rise in gold prices and broke through the $2,000 / ounce mark, and later fell back but still hovering at historic height. In addition, various emergency responses to the pandemic outbreaks have increased global government debt from 83.3% of gross domestic product in 2019 to 96.4% in 2020. The ratio of government debt to GDP in advanced economies rose from 105% in 2019 to 126% in 2020. The U.S. budget deficit for fiscal year 2020 rose to $3.13 trillion, or 15.3% of GDP, the highest since the end of the Second World War. By the beginning of December, outstanding U.S. debt stood at $27.4 trillion, or about 130% of GDP.9Global corporate and individuals debts are also rising, according to the Institute of International Finance, combined with government debts, global debts would reach $277 trillion by the end of 2020, or 365% of GDP, again setting record.10

In March 2020, the U.S. stock market saw 4 times of melt-down, and the financial panic spread rapidly. Then central banks of major economies such as the United States immediately launched super-intense conventional, especially unconventional easing monetary policies to rescue the market. Traders work at the New York Stock Exchange in New York, the United States, March 18, 2020. On that day the New York stock market suffered its fourth melt-down during the month. (Photo credit: Xinhua News)

Major economies adopted different policies to respond to the impact of the pandemic outbreak

Governments have responded to the impact of the COVID-19 pandemic with various forms of temporary fiscal and monetary policies. In terms of fiscal policy, in the United States for example, the Congress passed the US$2 trillion CARES Act in March 2020.11As the second wave of the pandemic wantonly hit places such as North America and Europe in the fourth quarter of 2020, further bail-outs by economies are inevitable. In late December, the U.S. House of Representatives and Senate passed a $900 billion pandemic aid bill and a government appropriation bill of $1.4 trillion, mainly used for cash disbursement and assistance in unemployment, small businesses, schools and colleges, child care, transportation, family rents and others. As far as European Union is concerned, finance ministers agreed in early April on a 540-billion-euro package of measures to combat the pandemic outbreak. On December 10, European Union heads of state at an EU summit gave their final approval to a much-discussed and ever-changing 1.85 trillion Euros budget and stimulus package.12The deal not only finances a 750 billion Euros ($909 billion) pandemic aid fund in the form of common debt, but also paves the way for the implementation of the EU's 1.1 trillion Euros seven-year budget for 2021-2027. China announced in May that it would issue 1 trillion yuan RMB of special bonds to combat the pandemic. Although the international community has mixed opinions on the timing, scale, implementation intensity and long-term impact of relevant countries' rescue policies, on the whole, the financial rescue policies adopted by various economies have played a direct and prominent role in maintaining economic operation and social life.

From the perspective of monetary policy, in the first 11 months of 2020, central banks of world economies cut interest rates 205 times in total, and central banks of major developed economies continued to maintain ultra-low interest rate policies, such as the Federal Funds Rate of the United States at 0% to 0.25% range.13In addition to cutting interest rates and keeping them low, conventional monetary policy includes things like pegging to an inflation target. At the end of August 2020, at the annual meeting of global central banks held in Kansas City, the U.S. Federal Reserve announced an update to the statement of its long-term objectives and monetary policy strategy, and changed the statement that it was committed to achieving an inflation rate near the "symmetric 2% target" to achieve a long-term goal of "2% average inflation rate".14The adoption of average inflation targeting means that the Fed can use the "balance" of future inflation to make up for the "deficit" of the past, and provide additional room for monetary policy by increasing the tolerance of inflation in the controlled way to cut interest rates to deal with the increasing risk of deflation. However, it is doubtful whether such a new framework for monetary policy will have the desired effect and may even have some side effects.

First, in contrast to the previous old framework, the adjustment neither introduces new monetary policy tools nor directly adjusts interest rates, but instead, seeks to achieve policy objectives by guiding inflation expectations. Inflation has been below the Fed's 2% target for most of the last economic expansion since it began. This also reduces the market's confidence in the Fed's overshoot expectation for future inflation and its ability to control inflation to some extent. Secondly, while the Fed explicitly introduced an average inflation target in its statement, it did not disclose more details about how the target would be calculated. This means that the Fed can subjectively select a specific period for its evaluation and "technically" adjust the average inflation level in line with the Fed's expectations, thus replacing the original explicit Taylor rule with a new rule that can be adjusted subjectively. This approach increases the unpredictability of Fed policy, reduces the transparency of monetary policy operations under the new framework, and ultimately undermines the Fed's credibility. Thirdly, in order to release abundant liquidity to the market, the Fed's asset purchase targets will further expand to corporate bonds, commercial paper, etc. in the post-pandemic, and its behavior is bound to go beyond the scope of "lender of last resort" function. At the same time, in order to guarantee the funds needed for the financial rescue, the Federal Reserve needs to buy government bonds on a large scale on the one hand and reduce the cost of debt by keeping interest rates low on the other hand. In this way, monetary policy is deeply tied to fiscal policy, which weakens the independence of monetary policy and the ability to control the market, and ultimately it is difficult for the Federal Reserve to achieve its goal of restoring the internal growth of the American economy.

Since 2008 international financial crisis, the conventional monetary policy performance space of major developed economies such as the United States, Japan and Europe is very narrow, they during the period responding to the pandemic outbreak rely mainly on unconventional monetary policy including quantitative easing (qe), the control of the yield curve, negative and zero interest rates, bank targeted lending and the so-called "helicopter money drop" and others.15In the face of the most exogenous shock since the end of World War II, the Federal Reserve announced unlimited and indefinite quantitative easing and continued to increase its holdings of Treasury, agency mortgage-backed securities and other junk bonds the least at the current pace. These moves rocketed the Fed's balance sheet to $7.1 trillion at the end of June from $4.2 trillion in the week of January 6, 2020. At that rate, the Fed's balance sheet would expand to $10 trillion by the end of 2021.16Meanwhile, more emerging markets, under the influence of further quantitative easing by the Europe Central Bank, the Bank of England and the Bank of Japan, have followed suit, setting bond yield targets around zero to complement quantitative easing and drive down borrowing costs as countries issue more debts. For now, with nominal interest rates at or near 0% for banks like the U.S. Federal Reserve and the Bank of England, a return to negative rates by central banks of relevant countries is not out of the question. Europe, for its part, opted for targeted lending to big banks. The ECB's Targeted Long-term Refinancing Operation has already lent about 1.5 trillion Euros to banks at -1% interest rate, and countries that do not accept negative interest rates are likely to take this route in the future. In addition, there are some unconventional policy in the making, such as using the theory middle area of blending monetary policy with fiscal policy, some related inside-circle professionals put forward, as long as the low inflation rate and low interest rate to assure the central bank to keep borrowing costs low, government can go all out in health care, education and infrastructure spending without worrying about debt levels, the proposal may promote more stimulus measures.

The impact of unconventional policies of major economies on the future world economy

While the various unconventional policies adopted by the world's major economies have had positive effects, but have also created uncertainty for the long-term growth of the global economy. Globally, while a real economic recovery and loose monetary policy will provide some support to asset prices, the disconnect phenomenon between risky asset prices and the economic outlook and deteriorating credit quality remains. According to the Bloomberg Barclays Global Indices, on December 10, 2020, the total amount of global negative yield bonds reached $18.04 trillion, another record high, which accounted for 27% of the global investment-grade bonds, approaching 30% of the previous peak in August 2018.17According to a survey of institutional investors by French Natixis Investment Managers, more than half of those surveyed believe that the quantity of bonds with negative yields will increase in 2021.18The immediate cause is a surge in bond issuance by governments and companies around the world, and a boom in demand for the highest-rated debt. Predictably, in search of the best possible returns, many investors will recklessly take risks by buying lots of risky assets. The exuberance of the U.S. stock market has been fully reflected in the sharp rise in price-to-earnings ratios. The price-to-earnings ratios for the Dow Jones Industrial Average, the S&P 500 and the Nasdaq rose from 22, 24 and 33 at the beginning of the year to 29, 35 and 69 on November 16.19During the same period, the price-to-earnings ratios of other major countries also rose to varying degrees. Meantime, the combination of the pandemic outbreak and ultra-loose monetary policy together has pushed up U.S. housing prices sharply. In the United States, the Case-Shiller 20-city composite index of home prices rose to 233 in October from 219 in February 2020, the highest level of home sales since 2006.20The parallel of economic contraction and rapid asset price rise means that large volatility in global capital markets over the next year or so is not a small probability. Huge capital market fluctuations in major economies are bound to have negative spillover effects on other countries and regions and thus provoke negative feedback.

Under the impact of the pandemic outbreak, the accelerated adjustment of the global supply chain has become an important issue for the world real economy. According to theMcKinseyGlobal Institute Report in August 2020, it is estimated that global enterprises may shift a quarter of their global product manufacturing to new countries in the coming five years, including more than half of pharmaceutical and apparel production. The total price of goods affected is between US$2.9 trillion to US$4.6 trillion, which is about 16%-26% of global commodity exports in 2018.21Global supply chain became a hot topic in 2020. From enterprise perspective, under the dual pressures of main factors such as the technical progress and diffusion, digitalized production, labor arbitrage space smaller, and environmental factors such as trade tension with major economies, nearly paralyzed multilateral trading system, frequent climate and natural disasters and cyber attacks frequently, high concentration of key trade goods enable companies to invest in more resilient supply chain so as to obtain greater profits through reevaluations. At the national level, some countries plan or have introduced a series of policies aimed at increasing self-sufficiency or localization, encouraging the home-returning of manufacturing or diversifying supply chains. Although China is the center of discussions of the supply chain and the main target for "decoupling", China's exports and foreign investment in 2020 are at historic height thanks to the country's successful efforts to contain the pandemic outbreak and take the lead in resuming production.

Moreover, the "unusual" movements in the dollar's exchange rate in the global economy in 2020 are of particular concern. In past recessions or financial crises, people's natural instinct was to increase their holdings of safe assets in an attempt to protect themselves. On most occasions, dollar assets have acted as a global safe haven. The 2008 international financial crisis perfectly demonstrated the dollar's role as a reserve currency. Since the crisis, foreign investors and U.S. funds have poured big sum of money into U.S. bonds, benefiting from a stronger dollar and rising bond prices. From late 2007 to early 2009, foreign purchases of U.S. assets amounted to 13% of U.S. GDP, one effect of which was to allow the United States to be financed cheaply from global markets. The global recession triggered by pandemic outbreak, however, revealed a different picture in front of the world: from March to September 2020, the total amount of debts foreign central banks were holding was reduced by $155.2 billion, the federal reserve rather than international investors and the American funds became the main buyer of U.S. treasuries, so that the bond prices plunged in March 2020 followed by continuously weakening, the dollar index dropped significantly too. The reason for this "anomaly" is not only the unprecedented liquidity injected into the economy by the United States indefinitely, but also the declining position of the United States in the world economic structure. Since the beginning of the 21st century, the proportion of U.S. national debt to global GDP is rising, while the proportion of U.S. economic output to global GDP declining. The situation is similar to the "Triffin's dilemma" faced by the Bretton Woods system of the 1960s: the dollar has a fixed ratio to the dollar has a fixed ratio to gold and is freely convertible, but there is a flood of dollars floating around outside America. The collapse of the Bretton Woods system in the early 1970s is perhaps a premonition of what was to come for the dollar. In addition, the EU takes the most solid and decisive step on the road to fiscal union in the year 2020. On July 21st leaders of the European Union's member states reached a historic agreement on a 750 billion Euros recovery fund (known as the "next generation" EU project), bringing together at last the three pillars of EMU: a single currency, a central bank and a credible commitment to a single fiscal policy. The "next generation" EU project, which would receive crucial support from large-scale pan-European sovereign bond issuance, would finally make Europe the champion of new risk-free assets outside the United State, making the Euro a strong competitor to the dollar in the international monetary system.

The Regional Comprehensive Economic Partnership (RCEP) leads to the formal establishment of the world's largest free trade zone in November 2020, and will significantly enhance the volume of regional trade, investment liberalization and facilitation, and prominently upgrade the attractiveness and competitiveness of the region. Photo taken on August 17, 2020 shows the container terminal of Pasir Banjang in Singapore. (Photo credit: Xinhua News)

Outlook of the world economy for the year 2021

Whether the Covid-19 pandemic will be brought under successful control will have a direct impact on the global economy in 2021. The positive news is that vaccines developed by the United States, Europe and China should be available for mass vaccination in the first quarter of 2021, and there should be more than a 70% chance that the pandemic will be effectively contained or evolve into a common flu in the second half of the year. Historically, most outbreaks of major infectious diseases last about two years, and somehow become invisible and. That may be seen as a reason for keeping optimistic. Meanwhile, policymakers in the major economies will continue fiscal bail-outs and the ultra-loose monetary policy that is closely tied to them, and are well prepared in theory to do so. The negative news is that in December 2020, a new and more contagious variant of the COVID-19 virus appeared in the United Kingdom, causing London to be "closed down". As a result, the ECB has cut its forecast figure for Euro-zone GDP growth in 2021 by 1.1 percentage points to 3.9%.22In 2021 the world economy will recover largely in rough, major developed economies may reproduce contraction in the first quarter, then speed up the pace of recovery in the second and the third quarter, the global recovery to go from V shape to irregular W shape, factors such as employment, prices, trade, capital and foreign exchange market, staple commodity prices and others also can follow the developments and changes accordingly. Relatively speaking, the extent of the world economic recovery and the constraints to recovery from non-pandemic disturbances are difficult to determine. Notably, the Regional Comprehensive Economic Partnership (RCEP) was agreed to lead to the formal establishment of the world's largest free trade zone in November 2020. Meanwhile, according to the IMF External Sector Report, which assessed the currency and imbalances of the world's 30 largest economies, the proportion of the global net current account balance in GDP dropped to 2.9% consecutively in 2019, highlighting the increasing balance of the world economy. China's current account surplus in 2020 is about 1.3%,23which is in line with its economic fundamentals. Taking together, global economic growth in 2021 is expected to reach 4.5% in purchasing power parity terms.

Even if the pandemic outbreak is effectively controlled or the current virus evolves into a common virus, the world economic recovery in 2021 will still face various non-pandemic factors. A financial analysis report issued by world authoritative agency Standard & Poor's in the middle of November 2020 points out that compared with 2009, despite more healthy overall situation of the global banking industry, it still has "negative" outlook on about a third of global banks, and the year 2021 is likely to be the most difficult year for the global banking industry since the international financial crisis in 2008. According to the report, the global banking industry will face the following risks in short to medium terms: First, the credit ratings of banks under continuous pressure may fall before the COVID-19 pandemic is fully contained; Secondly, governments will gradually end their assistance to the affected sectors, which may increase the debt of businesses and households and make it difficult for them to finance in normal times. Thirdly, the continuous growth of corporate debt and more defaults will impose great pressure on the asset quality and profitability of banks. Fourthly, the underlying problems in the housing market increase and its severity is underestimated, such as longer periods for rent payments and mortgages, the renegotiation of bank mortgage agreements, ultra-low interest rates and the financial distress caused by the worsening pandemic, which mask the asset quality problems.

Rising policy risks are likely to be another factor that will derail the global recovery in 2021. Market, academic and policy-makers views on the future direction of prices are at odds and fiercely debated. One view holds that the post-pandemic world will enter a period of inflation, with main reasons as follows: firstly, the astronomical amount of liquidity injected into the economy led to a sharp increase in the money supply. Secondly, major central banks are pursuing ultra-loose monetary policies. Thirdly, the massive bail-outs have boosted household wealth, which will eventually translate into household consumption. Fourthly, the impact of the pandemic outbreak on the supply chain may lead to supply shortages. Fifthly, the huge increase in the supply of labor that led to deflation over the past 30 years is reversed into faster ageing and higher wages. If inflation rises above 5% or even hits 10% in the major advanced economies in 2021, central banks will have to step in. A shift in the intensity or timing of central banks' policy moves, whether they raise rates or exit quantitative easing, could disrupt a slow, uncertain and uneven recovery course. The other view is that prices will fall in the post-pandemic era. The main reasons include: firstly, although the amount of money in circulation has increased dramatically, the velocity of money circulation has slowed considerably; secondly, residents' fear of the future increased due to the impact of the pandemic, leading to a conservative trend in household consumption; Thirdly, the loose labor market and the decline of equipment utilization caused by the rising unemployment rate create conditions for the expansion of supply; Fourthly, quantitative easing policy, implemented after the 2008 global financial crisis, did not generate the inflation that had been widely expected. An argument against this is that it is the asset prices that were pushed up by quantitative easing after the 2008 global financial crisis, and it is the wages that have risen in the wake of the current pandemic. The world economy in 2021 is full of uncertainties. In view of the fact that the practice of fiscal policy, especially monetary policy, is far beyond the past for more than a decade, and the development of macro-economics in the future will also go beyond the scope of current textbooks, thus, it is a major challenge for monetary policy makers of all countries whether or not they can make an accurate judgment on inflation or deflation.

In addition to the micro-level risks, the risks hidden in global capital market and foreign exchange market should not be underestimated either. While the probability of huge fluctuations of more than 20% in the stock and property markets is more than 1/3, the impact of capital market movements needs to be discounted because the correlation between asset prices and the real economy is not what it was. More worrying is the moving direction of the dollar. Although variables affecting the dollar exchange rate fluctuations are too many and too difficult to ake accurate judgment, yet in the coming two years it seems no suspense for the United States to continue the existing monetary policy, the Fed liquidity big drain in a sense already has no choice, so the possibility for the dollar to drop is very large, in addition to some individual countries except the United States that also may see serious currency crisis. Meantime, the possibility of a chain of sovereign debt crises due to defaults in individual emerging and developing economies cannot be ruled out. In terms of global and regional economic governance, the relationship between cooperation and competition among major economies will continue to strengthen around the reform of the World Trade Organization, and the prospect of reform is uncertain. On December 30, leaders of China and the EU jointly announced the completion of negotiations on the China-EU Investment Agreement as scheduled, plus the gradual implementation of the RCEP, so the dawn of world economic recovery will be brighter at least from the perspective of trade and investment,.

(Edited excerpts of the article in Contemporary World, No. 1, 2021.)

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