The economic outlook for 2021

Every January economists like to give their assessment of the state of the world and predict what the future holds for us all in the coming year.  And this year has been no exception – and with video conferencing and the ease of attending seminars via the internet, I have listened to more sessions of talking heads offering their thoughts on what lies ahead than usual.  And what emerges is that the economics profession is largely all at sea, with as wide a range of forecasts as I can ever remember.

Not that agreement among the experts is an indicator that they have any better chance of being right in their predictions.  The various forecasts made this time last year were all surprisingly consistent – and all totally totally wrong!

Not a single crystal ball-gazer in January 2020 predicted the pandemic and the devastating affect it would have on our lives, the dramatic 40% fall in stock markets around the world last Easter, or the sharp recovery that has followed.

More surprisingly, no‑one foresaw the transformation of China into an arrogant international bully, ignoring diplomatic niceties and its WHO obligations in dealing with both the pandemic and its consequences, riding roughshod over Hong Kong in breach of its obligations under the Sino‑British Joint Declaration and rough-handling anyone who dared oppose its worldview.  In retrospect one can perhaps see that it is in keeping with what we knew of President Xi a year ago, but “hindsight is 20‑20 vision”, and nobody predicted it at the time.

Nor did anyone predict the rapprochement between Israel and so many of its Arab neighbours that has been one of the rare pieces of good news to emerge from 2020, or, on another level, Donald Trump’s completion of his metamorphosis from incompetent president to lawless rabble-rousing thug, inciting his supporters to attack the nation’s parliament rather than accept his electoral defeat.

In the world of economics, no-one foresaw the ease with which we would all accept remote working and video conferencing, or the dramatic effect on pollution levels when the early lockdowns so reduced travel.  And in their look at the world of politics, no-one even hinted at how quickly governments, of all persuasions, could impose restrictions on personal liberties and open the spending taps.  Just one figure from the UK illustrates the scale of the spending:  the current Chancellor of the Exchequer, Rishi Sunak, has not even been in office for 12 months yet, but in that short time he has borrowed more than any other peace‑time chancellor, even more than Gordon Brown, who held the post of Chancellor for more than 10 years.  And the UK’s experience is shared by many other countries.

But in their presentations over the last few weeks, few economists dwelt long on the failures of last year’s set of predictions.  It is true that admitting past errors, let alone apologising for them, is not the profession’s strongest suit even at the best of times, but in this case the pandemic was so far outside anyone’s expectations or previous experience that even the harshest critic has been prepared to accept that the way 2020 unfolded was unforeseeable.

Nevertheless, the experience of being quite so wrong has clearly affected at least some in the profession.  This time round I detected rather more humility than usual in their forecasts for the coming year; indeed some were even prepared when presenting their thoughts or answering questions to utter those usually forbidden words “we don’t know”.

And this is not entirely surprising, because the world is in a strange limbo position, where the certainties and rules of the past no longer apply and the new rules for the future are not yet fully apparent.  Both politics and economics are showing signs of great stress, and even to look a short way into the future is to see huge uncertainties.

We are, as one commentator put it, “at a point of singularity, a break in the continuum of the economic universe, not connected to either our pre‑pandemic past or our post-pandemic future”.  Just as in cosmology the rules of space-time break down and do not hold at the centre of a black hole, so the economic rules that we are familiar with and which applied until March last year seem to be suspended in the eye of the pandemic storm.

Consider the following.  Firstly, we have a Crisis of Supply in the world economy, and at the same time a Crisis of Demand.  The Crisis of Supply is that many of the standard ways our economies function have been disrupted – workers cannot get to their factories or offices, supply chains are disrupted and under stress, movements of goods and people are impeded.  The Crisis of Demand is that many people face unemployment and reduced incomes, and even those who still have an income may not want to (or may not be able to) spend it, as travel, entertainment, shopping are all more difficult or outright impossible.  And even where expenditure is possible, uncertainty over the future leads to more caution – in many countries, savings ratios have moved sharply higher over the last 9 months.

This poses a considerable challenge to governments.  Textbooks have standard remedies for a shortfall of supply, and others for a shortfall of demand, but there are few guides to what to do when faced with both at the same time.  As we have already noted, most Western governments have in practice responded by greatly increasing their support for the economy – “if in doubt, spend money” seems to be the motto – with the aim of keeping companies, factories and infrastructure functioning (thus addressing the supply-side challenges), and supplementing incomes through social support (thus addressing the lack of demand).  But it is not clear for how long this strategy is affordable, or what the long-term consequences for government fiscal management will be.  In the words economists never like using, “we don’t know”.

It is probably just as well therefore that there is a second anomaly, which is that the usual rules for government borrowing seem to have been suspended.  As we have noted, governments are borrowing unprecedented sums, but at the same time, debt service costs are very low – indeed in many countries this avalanche of debt is being issued at negative interest rates.  This leads to many governments having relatively modest and affordable interest and debt service costs despite their high debt levels.  Many economists argue that this debt service cost is a better measure of debt sustainability, being a “Flow vs Flow” measure, whereas Debt to GDP is a mismatch, being “Stock vs Flow”.

So should we be worried, as debt-to-GDP levels approach or exceed 100%?  One remembers Rogoff and Reinhardt’s paper of 2010 that warned that 90% debt to GDP was the “point of no return”, at which economies started to deteriorate and risk a debt implosion.  Or should we take comfort from the fact that this debt is affordable and that governments have no problems funding themselves?

Much depends on the answer to this question, not least how quickly governments start to consider raising taxes to “close the borrowing gap” – and as our regular readers will know, we have argued on many occasions that it is more damaging to do this too soon than to stay one’s hand.  But once again, economists can only say “we don’t know”.

One of the reasons that governments have been able to fund this borrowing is that central banks are monetising the debt at a very active rate.  And this leads to our third anomaly: the printing presses are rolling but there is as yet no inflation.  Money supplies are growing faster than for many years: in the first 11 months of 2020, ie to end November, US M1 was +54% and M2 +25%, and other countries show similar figures (eg in the UK, broad money – M4, much broader than US M2 – is up 13% on a year earlier).

But at the same time, there is no sign of inflation.  Across the OECD as a whole, inflation in December was +1.2% year-on-year; in Japan, France, Germany, Italy and several other countries it was actually negative.

So again, should we be worried?  Surging money supply growth has always in the past implied future inflation. Or should we take comfort from the fact that central banks have failed for 10 years to generate inflation, even when they have been mandated to and have tried to?  Is it possible that the structures of economies have changed sufficiently that the relationship between money and inflation has also changed?  Yet again, “we don’t know”.

And finally, there is the puzzle of the markets.  Given the challenges we have discussed, one might expect markets to be in sombre mood.  But the reverse is the case!  The S&P 500 is currently 70% above its spring 2020 lows, and for the year overall was up over 15% – and this is the whole index, which includes many badly hit stocks such as companies in the aviation, travel and entertainment sectors.  US Tech stocks have done many times better, with some showing quite extraordinary valuations (Tesla’s stock price currently values the company at more than $1 million for every car they have ever sold!).

Other markets outside the US are not as extreme but most show a similar pattern.  Even the UK FT-SE 100 index, in many ways a laggard among major market indices, is up 35% from its mid‑2020 lows.

The general public can be excused for simply not understanding this.  At a time when economies are under great strain, and the very fabric of normal life is threatened, the valuations of markets are for many people beyond incomprehensible and bordering on obscene – and this adds to the alienation between, as the Americans say, “Wall Street and Main Street”, Them and Us.  But even many in the markets do not fully understand price levels and fear a bubble is growing.

After every major crisis, every world-changing event, the question is asked “when will we return to normal”.  But it is in fact much more likely after a crisis that the world does not return to the status quo ante.  The leisured world of Edwardian England vanished for ever in the trenches of the First World War and was not recreated after the war ended.  The world of European empires and colonies similarly vanished after World War II – it took slightly longer, but the demise of empires was no less inevitable and no less in doubt.

In finance, more than 10 years after the Global Financial Crisis and even before the pandemic made such questions moot, there was no sign of central bank balance sheets shrinking or interest rates returning to more traditional levels.  And on another level completely, 20 years after the 9/11 attacks in the US, air travel has still not returned to the carefree, security-light norm of the late 20th century, and however it recovers after the pandemic we will still have all the checks and scanners and restrictions that 9/11 made necessary.

We do not know how the world will look when the pandemic is finally behind is.  Will city centres thrum with life again, or will many people still work from home?  Will travel restart and countries re-open their borders as before or will caution rule?  Will governments ever rid themselves of the dominant place they currently have in so many economies, or are we going to live in highly centralised tax-and-spend states for many years to come?

The past is another country.  The future is unknown and unclear.  We are stuck in the discontinuity between the two, where normal rules seem not to apply and even economists are prepared to admit that when it comes to what might happen in the coming 12 months, “we do not know”.