Even Covid-19 cannot damp partisanship

As the human and economic damage mounts, old political divides are likely to re-emerge

Gideon Rachman

Coronavirus skulls
© James Ferguson

The slate is wiped clean. It does not matter what political spectrum any of us are on. So said Lee Cain, director of communications at 10 Downing Street, as the British government began to marshal the country to deal with coronavirus.

The urge to unite in the face of a national emergency is a noble one. The British like to talk about the “Blitz spirit”, invoking the memory of the country’s finest hour in the second world war. Similar calls for the abandonment of political partisanship can be heard all over the western world as governments from Warsaw to Washington struggle to respond.

There are already some powerful examples of bitter political adversaries coming together. The US Congress — a byword for paralysis and partisanship — was able to bury differences and pass a $2tn stimulus package. In the UK, a recent poll gave Boris Johnson a 78 per cent approval rating for his handling of the crisis — numbers which may get a further sympathy bump now the prime minister himself has the virus. Other national leaders, including Italy’s Giuseppe Conte and Emmanuel Macron in France, have also seen their poll ratings rise.

But look a bit harder, and the familiar partisan divisions are usually just beneath the surface. This virus will not kill off those political disputes. On the contrary, as the human and economic damage caused by Covid-19 mounts, so old political divides are likely to re-emerge, widen and become more bitter.

The wartime analogies that are currently so commonplace are imprecise. In a war, domestic enemies are displaced by foreign enemies — and those enemies have faces and names. It may be harder to unite a country for a long struggle against a disease — which is an invisible, inhuman foe.

In the US, one tell-tale sign of the persistence of partisan division is the stark difference in attitudes to coronavirus between Republican and Democratic voters. Polls taken on a state-by-state basis show that Democrats are more likely to say they are extremely concerned by the Covid-19 outbreak.

Attitudes to Donald Trump’s performance reflect the same divide much more directly. For his most ardent critics, the US president’s daily appearances provide incontrovertible proof of what they have thought all along — that Mr Trump is fundamentally unsuited for high office. The president’s critics are incredulous that his approval ratings have actually gone up since the beginning of the crisis.

As the health and economic situation worsens in the US and the presidential election heats up — this Trump-induced polarisation will probably become even more rancorous. Any suggestion that his administration may seek to delay November’s vote because of coronavirus would make the situation explosive.

In the UK, the health emergency has made normal politics, and even the Brexit debate, irrelevant — but the bitter political antagonism between Remainers and Leavers has not disappeared. Many Remainers still firmly believe that Mr Johnson is an incompetent liar. Any evidence that he has mishandled this emergency, or been less than frank, will be taken as confirmation of this long-held belief.

Meanwhile, Brexiters are alert for any sign of a Remainer conspiracy to thwart Britain’s exit from the EU. The suggestion that Britain’s trade negotiations with the EU should be extended, to allow the government to concentrate on the pandemic, is treated with the utmost suspicion.

The notion of forming a national unity government as happened during the second world war is also dismissed by many Brexiters as a great Remainer plot.

The American and British pattern, in which the outbreak simply entrenches political partisans in their most deeply held beliefs, is also holding inside the EU. Advocates of common European debt instruments have seized upon the crisis as proof of the urgent necessity of the thing they have wanted all along — eurobonds. But the Dutch and German governments are still suspicious of the idea. Attitudes have not shifted but there has been an increase in the bitterness of the language used.

António Costa, the Portuguese prime minister, has dismissed statements by the Dutch finance minister that southern countries had failed to carry out necessary economic reforms, as “repugnant” and warned that “recurring pettiness” threatens the future of the EU.

Familiar divisions are also widening within some European nations. In Spain, the confrontation between the government of Catalonia and the central government in Madrid has flared up again — this time over whether the Catalan government has the right to demand and enforce stricter lockdown measures within its own region.

The clash between Catalan and Spanish nationalists is a classic form of identity politics, which was always likely to prove impervious even to a life-and-death emergency like this. Put under extreme pressure, people are even more likely to fall back on group loyalties and core beliefs. They will see the crisis through those lenses — and will be alert for any evidence that groups they already despise are at fault or conspiring against them.

It would be nice to think that this crisis will allow western nations to get beyond identity politics and political partisanship and pull together. But I would not count on it.

Trough to peak

How high will unemployment in America go?

The financial crisis looks a better reference point than the Depression

In august 2005 the unemployment rate in Louisiana was 5.4%, close to its all-time low. Then Hurricane Katrina hit. The storm destroyed some firms, while others were forced to close permanently. Within a month, Louisiana’s unemployment rate had more than doubled.

Now America as a whole faces a similar shock. From a five-decade low, early data suggest unemployment is shooting upwards, as the onrushing coronavirus pandemic forces the economy to shut down. Millions of Americans are filing for financial assistance.

The jobs report for March, published shortly after The Economist went to press, is a flavour of what is to come—though because the survey focused on early to mid-March, before the lockdowns really got going, it is likely to give a misleadingly rosy view of the true situation.

How bad could the labour market get?

GDP growth and the unemployment rate tend to move in opposite directions.

Unemployment hit an all-time high of around 25% during the Great Depression (see chart).

The coronavirus-induced shutdowns are expected to lead to a year-on-year gdp decline of about 10% in the second quarter of this year.

Such a steep fall in economic output implies an unemployment rate of about 9% in that quarter, based on past relationships, which would be roughly in line with the peak reached during the financial crisis of 2007-09.

But the coronavirus epidemic is not like past recessions. For one thing, hiring could be even lower than is typical. Delivery firms notwithstanding, surveys suggest that firms’ hiring intentions are as low or lower than they were in 2008. And applying for a job is especially difficult with cities in lockdown.

Even without a single virus-induced layoff, hiring freezes would lead to sharply rising unemployment. For instance, young people entering the labour market for the first time now would struggle to find work.

The decline in gdp associated with the lockdowns is also particularly concentrated in labour-intensive industries such as leisure and hospitality. Mark Zandi of Moody’s Analytics, a research firm, calculates that more than 30m American jobs are highly vulnerable to closures associated with covid-19.

Were they all to disappear, unemployment would probably rise above 20%. Research published by the Federal Reserve Bank of St Louis is even gloomier. It suggests that close to 50m Americans could lose their jobs in the second quarter of this year—enough to push the unemployment rate above 30%.

The numbers will probably not get that bad. In part that is a matter of statistical definitions. To be officially classified as unemployed, jobless folk need to be “actively seeking work”—which is rather difficult in the current circumstances. Some people could end up being counted as “economically inactive” rather than unemployed, which would hold down the official unemployment rate (a similar phenomenon occurred in Louisiana after Katrina).

America’s economic-stimulus bill will be a more genuine check on rising joblessness. The $350bn (1.6% of gdp) set aside for small firms’ costs is enough to cover the compensation of all at-risk workers for perhaps seven weeks, according to our calculations, making it less likely that bosses will let them go.

Other measures in the package should support consumption, and thus demand for labour. In a report published on March 31st Goldman Sachs, a bank, argued that unemployment will peak in the third quarter of this year at nearly 15%—an estimate that is roughly in line with those of other forecasters.

A big jump in unemployment is less of a problem if it quickly falls once the lockdown ends.

Louisiana offers an encouraging precedent. After a few bad months in late 2005, the state’s unemployment rate dropped almost as sharply as it had risen, falling in line with the rest of the country.

Whether the economy will prove so elastic this time is another matter. Travellers and restaurant-goers will be cautious until some sort of vaccine or treatment is widely available; social-distancing rules, even if relaxed, will continue for some time.

Goldman Sachs’s researchers reckon that it will take until 2023 for unemployment to fall back below 4%.

The lockdowns should be temporary, but the economic consequences will feel much more permanent.

The Firemen Are Also The Arsonists

James Grant, the venerable publisher of Grant’s Interest Rate Observer, just wrote an opinion piece for the Wall Street Journal that, had it appeared on a free site, would have been at the top of today’s “Best of the Web” links list. But since it exists behind the WSJ’s paywall, here’s an excerpt to illustrate why Mr. Grant has so many fans:

The High Cost of Low Interest Rates
It took a viral invasion to unmask the weakness of American finance.  
Distortion in the cost of credit is the not-so-remote cause of the raging fires at which the Federal Reserve continues to train its gushing liquidity hoses. 
But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised the U.S. economy’s financial integrity. 
‘A Very Tough Two Weeks’ 
The coronavirus pandemic would have called forth a dramatic response from the central bank in any case. Not even the most conservatively financed economy could long endure an official order to cease and desist commercial activity. But frail corporate balance sheets and overextended markets go far to explain the immensity of the interventions. 
Perhaps never before has corporate America carried more low-grade debt in relation to its earning power than it does today. And rarely have equity valuations topped the ones quoted only weeks ago. 
“John Bull can stand many things, but he can’t stand 2%,” said Walter Bagehot, the Victorian-era editor of the Economist, concerning the negative side effects of a rock-bottom cost of capital. Needing income, investors will take imprudent risks to get it. And if 2% invites trouble, zero percent almost demands it. 
Interest rates are the critical prices that measure investment risk and set the present value of estimated future cash flows. The lower the rates, other things being equal, the higher the prices of stocks, bonds and real estate—and the greater the risk of holding those richly priced assets. 
In 2010 the Federal Reserve set out to lift market prices through a rate-suppression program called quantitative easing. Chairman Ben Bernanke was forthright about his intentions. “Easier financial conditions will promote economic growth,” he wrote at the time. Lower interest rates would make housing more affordable and business investment more desirable. Higher stock prices would “boost consumer wealth and help increase confidence, which can also spur spending.” The Fed commandeered investment values into the government’s service. It seeded bull markets in the public interest. 
But investment valuations don’t exist to serve a public-policy agenda. Their purpose is to allocate capital. Distort those values and you waste not only money but also time—human heartbeats. 
Like a shark, credit must keep moving. Loans fall due and must be repaid or rolled over (or, in extremis, defaulted on). When the economy stops, as the world’s has effectively done, lenders are likely to demand the cash that not every borrower can produce. 

To resolve the devastating panic of 1825, the Bank of England rendered “every assistance in our power,” as a director of the bank testified, “and we were not upon some occasions over nice.” 
In a still more radical vein, the Fed has set about buying (or supporting the purchase of) commercial paper, residential mortgage-backed securities, Treasurys, investment-grade corporate bonds, commercial mortgage-backed securities and asset-backed securities. It has abolished bank reserve requirements. Through a new direct-lending program, the Fed has become a kind of commercial bank. 
If not for the buildup of the financial excesses of the past 10 years, fewer such monetary kitchen sinks would likely have had to be deployed. No pandemic explains the central bank’s massive infusions into the so-called repo market that followed this past September’s unscripted spike in borrowing costs. For still obscure reasons, a banking system that apparently is more than adequately capitalized was unable to meet a sudden demand for funds on behalf of the dealers who warehouse immense portfolios of government debt. 
The superabundance of Treasury securities is the spoor of America’s trillion-dollar boom-time deficits. Persistently low interest rates have facilitated that borrowing, as they have the growth of private-equity investing (ordinarily with lots of leverage), the rise of profitless startups, the raft of corporate share repurchases, and the unnatural solvency of loss-making companies that have funded themselves in the Fed’s most obliging debt markets. 
For savers in general, and the managers of public pension funds in particular, lawn-level interest rates confer no similar gains. On the contrary: To earn $50,000 in annual interest at a 5% government bond yield requires $1 million of capital; to earn the same income at a 1% yield demands $5 million of capital. To try to circumvent that forbidding arithmetic, income-famished investors buy stocks, junk bonds, real estate, what have you. It worked as long as the bubble inflated. 
In a bubble, performance is the name of the investment game. Over the past 10 years, skeptics of our debt-financed prosperity have had to fall in line. To keep up with the Joneses, fiduciaries have sought an edge in lower-quality assets. Managers of investment-grade bond portfolios dabbled in junk bonds. Junk-bond investors slummed it in lower-rated junk or in the kind of bank debt that is senior in name but structured without the once-standard protective legal fine print. 
Investing at positive nominal yields, Americans are still comparatively lucky. The holders of some $10.9 trillion of yen-, euro- and Swiss franc-denominated bonds are paying for the privilege of lending. “Investors seeking safety were prepared to face a guaranteed loss when holding the debt to maturity,” was how the Financial Times last summer tried to explain the nearly inexplicable. 
Negative nominal bond yields are a 4,000-year first, according to Sidney Homer’s “A History of Interest Rates,” republished for a fourth edition with co-author Richard Sylla in 2005. Topsy-turvy investment-grade bond markets aren’t without precedent, but the extent of the upheaval today is startling. If adversity is the test of the quality of a senior security, as old-time doctrine held, segments of today’s corporate bonds and tradable bank loans have already flunked.  
On March 20, according to S&P Global Market Intelligence, the volume of such loans quoted below 80 cents on the dollar topped the peak distress level of 2008. While the panic subsequently abated, many supposedly senior corporate claims are proving to be fair-weather investments, not so different from common equity.
Deceived by ultralow interest rates, Americans borrow and lend in the kind of false economy that candidate Donald Trump properly condemned in 2016. Covid-19 will sooner or later beat a retreat. For the sake of honest prices and true values, it would be well if the central bankers did the same.

Capitalism’s Triple Crisis

After the 2008 financial crisis, we learned the hard way what happens when governments flood the economy with unconditional liquidity, rather than laying the foundation for a sustainable and inclusive recovery. Now that an even more severe crisis is underway, we must not repeat the same mistake.

Mariana Mazzucato

mazzucato13_Erin Schaff-PoolGetty Images_trumpovalofficeangrystubborn

LONDON – Capitalism is facing at least three major crises. A pandemic-induced health crisis has rapidly ignited an economic crisis with yet unknown consequences for financial stability, and all of this is playing out against the backdrop of a climate crisis that cannot be addressed by “business as usual.” Until just two months ago, the news media were full of frightening images of overwhelmed firefighters, not overwhelmed health-care providers.

This triple crisis has revealed several problems with how we do capitalism, all of which must be solved at the same time that we address the immediate health emergency. Otherwise, we will simply be solving problems in one place while creating new ones elsewhere. That is what happened with the 2008 financial crisis. Policymakers flooded the world with liquidity without directing it toward good investment opportunities. As a result, the money ended up back in a financial sector that was (and remains) unfit for purpose.

The COVID-19 crisis is exposing still more flaws in our economic structures, not least the increasing precarity of work, owing to the rise of the gig economy and a decades-long deterioration of workers’ bargaining power. Telecommuting simply is not an option for most workers, and although governments are extending some assistance to workers with regular contracts, the self-employed may find themselves left high and dry.

Worse, governments are now extending loans to businesses at a time when private debt is already historically high. In the United States, total household debt just before the current crisis was $14.15 trillion, which is $1.5 trillion higher than it was in 2008 (in nominal terms). And lest we forget, it was high private debt that caused the global financial crisis.

Unfortunately, over the past decade, many countries have pursued austerity, as if public debt were the problem. The result has been to erode the very public-sector institutions that we need to overcome crises like the coronavirus pandemic. Since 2015, the United Kingdom has cut public-health budgets by £1 billion ($1.2 billion), increasing the burden on doctors in training (many of whom have left the National Health Service altogether), and reducing the long-term investments needed to ensure that patients are treated in safe, up-to-date, fully staffed facilities.

And in the US – which has never had a properly funded public-health system – the Trump administration has been persistently trying to cut funding and capacity for the Centers for Disease Control and Prevention, among other critical institutions.

On top of these self-inflicted wounds, an overly “financialized” business sector has been siphoning value out of the economy by rewarding shareholders through stock-buyback schemes, rather than shoring up long-run growth by investing in research and development, wages, and worker training. As a result, households have been depleted of financial cushions, making it harder to afford basic goods like housing and education.

The bad news is that the COVID-19 crisis is exacerbating all these problems. The good news is that we can use the current state of emergency to start building a more inclusive and sustainable economy.

The point is not to delay or block government support, but to structure it properly. We must avoid the mistakes of the post-2008 era, when bailouts allowed corporations to reap even higher profits once the crisis was over, but failed to lay the foundation for a robust and inclusive recovery.

This time, rescue measures absolutely must come with conditions attached. Now that the state is back to playing a leading role, it must be cast as the hero rather than as a naive patsy. That means delivering immediate solutions, but designing them in such a way as to serve the public interest over the long term.

For example, conditionalities can be put in place for government support to businesses. Firms receiving bailouts should be asked to retain workers, and ensure that once the crisis is over they will invest in worker training and improved working conditions.

Better still, as in Denmark, government should be supporting businesses to continue paying wages even when workers are not working – simultaneously helping households to retain their incomes, preventing the virus from spreading, and making it easier for businesses to resume production once the crisis is over.

Moreover, bailouts should be designed to steer larger companies to reward value creation instead of value extraction, preventing share buybacks and encouraging investment in sustainable growth and a reduced carbon footprint. Having declared last year that it will embrace a stakeholder value model, this is the Business Roundtable’s chance to back its words with action. If corporate America is still dragging its feet now, we should call its bluff.

When it comes to households, governments should look beyond loans to the possibility of debt relief, especially given current high levels of private debt. At a minimum, creditor payments should be frozen until the immediate economic crisis is resolved, and direct cash injections used for those households that are in direst need.

And the US should offer government guarantees to pay 80-100% of distressed companies’ wage bills, as the UK and many European Union and Asian countries have done.

It is also time to rethink public-private partnerships. Too often, these arrangements are less symbiotic than parasitic. The effort to develop a COVID-19 vaccine could become yet another one-way relationship in which corporations reap massive profits by selling back to the public a product that was born of taxpayer-funded research.

Indeed, despite US taxpayers’ significant public investment in vaccine development, the US Secretary of Health and Human Services, Alex Azar, recently conceded that newly developed COVID-19 treatments or vaccines might not be affordable to all Americans.

We desperately need entrepreneurial states that will invest more in innovation – from artificial intelligence to public health to renewables. But as this crisis reminds us, we also need states that know how to negotiate, so that the benefits of public investment return to the public.

A killer virus has exposed major weaknesses within Western capitalist economies. Now that governments are on a war footing, we have an opportunity to fix the system. If we don’t, we will stand no chance against the third major crisis – an increasingly uninhabitable planet – and all the smaller crises that will come with it in the years and decades ahead.

Mariana Mazzucato is Professor of Economics of Innovation and Public Value and Director of the UCL Institute for Innovation and Public Purpose (IIPP). She is the author of The Value of Everything: Making and Taking in the Global Economy, which was shortlisted for the Financial Times-McKinsey Business Book of the Year Award.