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Looking beyond the pandemic – reasons for economic optimism?

As Boris Johnson returns to work George Trefgarne draws some lessons from history.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

With the Prime Minister Boris Johnson back at work, the focus for some is shifting to easing the lockdown in the next few weeks. For some, the worry will not end there. But for the UK economy as a whole, I am leaning towards optimism.

There isn’t going to be a recession

Assuming the lockdown is lifted progressively in coming weeks from 11 May (a big assumption, admittedly), I don’t think there is going to be a recession in the ordinary sense of the word.

There is going to be a massive drop in output, but that is not quite the same thing. A typical recession occurs at the end of a business cycle, when a long period of expansion comes to an end, usually because businesses, consumers and Governments have grown too rapidly, inflation takes off and central banks put up interest rates.

What we are experiencing is not a conventional recession, but a shutdown. Assuming we can avoid a vast increase in bankruptcies, I think most economic growth is going to be deferred, not lost altogether although of course there are no guarantees.

The General Strike

I have been trying to find an economic precedent for what we are experiencing and the best I can come up with is the 1926 General Strike. This was precipitated by the return to the Gold Standard at too high a price.

Gold Standard – a monetary system where money is tied to a fixed unit of gold.

The strike – in which 1.7m workers took part, bringing the country to a halt - lasted only nine days in May 1926 and, according to a new paper by the National Institute of Economics and Social Research, contributed to a circa 7% fall in GDP. But the economy bounced back rapidly when companies restored production and people went back to work. The comparison is not exact, for many reasons, but in 1926-7 there was undoubtedly a V-shaped recovery.

A sinking fund

The impact on the public finances – £218 billion of additional borrowing and a deficit of some 14% GDP according to the OBR – is scary, but it is going to be historically trivial if we both think of the numbers and account for them in the right way. One of the roles of the state is to act as the insurer of last resort in a crisis, such as a flood, and that is what is happening now. The costs should be thought of as being a “sinking fund” (as first used by William Pitt the Younger in 1786), parked in a separate corner, funded by ultra-low interest rates and paid off by economic growth over 50 or 100 years.

This isn’t a banking crisis, it is a public sector crisis

This event is not, thus far, like the financial crisis, where the public sector had to effectively bail out the private sector for mistakes made by bankers and others. But managing this pandemic is primarily the responsibility of the public sector.

This could be the first economic crisis in history from which the major banks emerge in reasonable health. They have plenty of capital and liquidity with which to absorb sour loans. If there is not a banking crisis, money should continue to flow into the economy.

Cheaper energy

Much of the commentary and reporting about the collapse in the oil price gets it wrong by presenting it as bad news. Cheap energy is one of the great elixirs of life. It fuelled the Industrial Revolution.

Not only has the oil price collapsed to record lows, but so, unreported, have other energy prices, such as natural gas and wholesale electricity. This is not just owing to the shock to demand or the oil production war between the regimes in Saudi Arabia and Russia, but also because of structural changes in supply, including from renewables.

When life does start to return to normal, we should all receive an additional boost from cheap petrol and lower fuel bills for businesses and households. The chancellor could even have room to put up taxes on energy, perhaps raising fuel duty, to help try and restore the public finances.

Stimulus packages

The Office for Budget Responsibility has suggested that GDP could fall by 35% and unemployment rise by 2 million. But it was careful to say this is not a forecast, but a scenario. That is because it cannot, at this point, say how firms and Governments will respond.

There are already signs that companies are in fact adopting expansionary strategies to take advantage of the rebound, when it comes.

However, the critical move will come from Governments. My judgement is that we should expect a plethora of stimulus packages announced over the summer, led by Washington. There could be potential tax cuts or tax holidays and additional spending in certain areas, such as social care, and investment in infrastructure.

I do not wish to be irrationally optimistic. This virus has been horrific. But we must all try and keep positive and reflect that we are still lucky to live in a prosperous era in a prosperous country, full of inventiveness, goodwill and social capital, where things can and do work, after a fashion.

George Trefgarne is CEO of Boscobel & Partners, a political consultancy. Hargreaves Lansdown may not share the views of the author.

This article is not personal advice. If you are unsure whether an investment is right for you seek advice. All investments can fall as well as rise in value so you could make a loss. Past performance is not a guide to the future.

Mark Dampier, HL, Head of Research

How many times have you heard “brace brace” in the safety drill on an aircraft?

You’ve probably become immune to it. Rather like financial experts telling you to make sure you have emergency money for those events you can’t forecast. But suddenly we have a global pandemic.

Market reactions aren’t surprising

Economic figures from around the world already look awful, and are breaking records for their awfulness. As you might expect these all capture the media headlines, and I can tell you they are not going to get better anytime soon.

If you pause most of the world economy the figures are sure to look awful. But do they tell you anything that you don’t know, either personally through your own job or what you see through your own eyes?

Not surprisingly the global markets have taken fright at the near shutting down of the world economy. We’ve seen the fastest falls in stock markets in history, and that includes October 1987, which is forever etched in my brain.

Have we reached the bottom?

Yet markets have displayed a remarkable turnaround since the lows in March.

How can this be when the news is so bad, not only economically but health wise too? Companies’ earnings are being decimated, and this is surely a keystone of support for the markets.

What I’m about to say might seem like madness given this background, but I believe the lows have been etched out, at least for a while. As George Trefgarne says above, the nature of this crisis is nothing we’ve really experienced before. The analogy with the General Strike wasn’t perfect, but it was a one off event.

My point is we all know the bad news, we know exactly what’s caused it. We know it will be with us (the virus that is) for quite some time, and we are going to have to adapt. Business is remarkably good at adapting, at least the good ones – you have to deal with change all the time.

Effective stimulus lifts sentiment

However, my reason for believing that markets (at least those led by the US) are unlikely to retest their lows anytime soon is based on central banks and government action. The latter has taken fiscal action injecting money into both business’s and people to make sure there’ll be an economy to come back to. It’s not perfect, but it’s a good work in progress.

But what really stopped the markets falling was the unprecedented action taken by central banks around the world to make sure the financial system remained intact. In just a few weeks central banks did more than they did over the whole 2008 crisis.

The most important central bank, the US Federal Reserve, has injected huge amounts of liquidity in the system. It’s doing whatever it takes. For the first time ever it’s even bought both ‘investment grade’ and ‘junk’ corporate bonds to help the system not to freeze up. Would it be a surprise if it even bought equites like the Bank of Japan? Probably not.

I think we’ll see an extension of recent market themes. Continuing to rise will be the stocks that have been leading up in the last few years, namely technology growth stocks in the US. Central bank actions, including lowering interest rates, have reinforced the case for some of these companies.

I think it’s quite possible we could see new highs. While company earnings are the long term support for the market, sentiment and liquidity can trample over this in the shorter term. Remember there are no guarantees and it could fall further.

The long-term picture

Now before you get carried away with this bullish forecast, I’m considerably less sanguine in the longer term.

Total world debt stands at around $250tr. The world has never been so indebted. The problem has been brewing for years. Since 2008, which itself was a problem about debt, the situation has become worse. I think the virus has been the catalyst to bring this to the fore.

At some stage the Fed will probably try and rein in on how much money it’s printing – it could eventually look to remove money from circulation. This is likely to cause a big adverse market reaction.

The debt is deflationary, so to reduce it will cause a reduction in demand, already hit by the virus, demographics and technology. Deflation makes debt more expensive and makes assets cheaper, the same assets that much of the debt is based upon.

Needless to say this is not a good scenario for assets, which during my working lifetime have been good to own. The central banks will do their best when they see this to stop it, by throwing even more money at the problem. In the end they may well win, but the cost could be inflation in double digits.

As always with macroeconomic forecasts this could be wrong, and the timing is always very tricky. What I firmly believe though is that this decade will be nothing like the ones I have seen over my working career.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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