The Post-COVID Global Economy 1— Recession and Deflation
The catastrophic impacts of the COVID-19 on the global economy are surfacing. It does not only plummet the global stock exchange markets, but it is freezing the tourist industry, halting many operations of a city, and distancing people’s social engagements. Millions of jobs have been cut and the unemployment rate is skyrocketing.
Many people are wishing a V-shape rebound, but more analysts are warning about an L-shape recession and deflation. Anyway, a substantial drop in the GDP growth rates in Q1 and Q2 of 2020 seems to be a consensus, even though the estimated magnitude of the fall varies.
So far very few economies have reported the 2020Q1 GDP figures, Singapore is one of the exceptions, so let’s make it a reference on the severity of the GDP plummet. It is a good candidate for reference, as it is one of the major logistic and tourist hubs in the Asia Pacific and is also hard hit by the coronavirus.
Figure 1 shows the QoQ GDP growth rates of Singapore in the past 12Qs. The 2020Q1 GDP growth rate is -10.6%, the magnitude is commensurate to that in 2008.
Technically, we define a consecutive 2 quarters’ negative GDP growth as a recession. A warning of recession implies that people will consume less and invest less. It is a very plausible consequence when the unemployment rate increases. But then why deflation?
It can be better understood by referring to the Equation of Exchange: MV=PQ, where M is the supply of money, and V is the velocity of turnover of money, P is the average price level at which each of the goods and services is sold, and Q is the quantity of goods and services produced.
Even though many governments have already sharply increased the money supplies M in the past few weeks, the velocity of turnover can be expected to come to a halt. It does not only because people would spend less and save more in this period of risk and uncertainty, but it is also the governments’ orders to stop most of the market activities. Put it simply, no matter how much money you supply, if people do not spend, the economy does not grow! Furthermore, when the default of loans increases, it is equivalent to a reduction in money supply M.
Thus, when M and V fall, PQ would fall (i.e. GDP will fall!). However, there are two ways that can equally lead to a GDP plummet. Either it is a fall in Q (buying less quantity of goods and services) or a fall in P (price level drops, i.e. deflation), or both.
In fact, they are highly interrelated. When consumers cut their consumption in quantity, then the businesspersons would normally cut their prices to attract customers to buy more. Deflation is notorious to have a positive feedback spiral effect. Once the consumers expect lower prices in the future, they would defer their consumption and wait for a further lower price.
Unless there are some extraneous forces to alter the market expectations, otherwise the debt-deflation spiral is hard to break (Yiu, 2020). Thus, it depends very much on whether the number of defaults and/or bankruptcies would be substantially increased or not. It explains why many governments are directly subsidizing corporations and businesspersons to pay wages and salaries, as well as cutting interest rate to negative and providing loan guarantees to prevent any large scale unemployment and loan defaults.
However, such a substantial increase in the money supply would ultimately result in hyperinflation. When V goes back to normal, M would normally cause P to increase proportionately, as Q is hard to increase after passing a certain threshold.
I hope my readers have well prepared for the coming recession, as I have made numerous warnings of a coming recession in this blog for almost a year. For example on Mar 22, the first day of an inverted US Yield Curve, it is a strong signal of a coming recession which I further explained in Aug 20 (Yiu, 2019a, b). Then on Jun 21, I asked bluntly on the title of the article that “Are You Ready for the Upcoming Global Recession?” (Yiu, 2019c) On Oct 20 and Nov 1, I pointed out that Hong Kong is leading the world to dip into recession. (Yiu, 2019d, e) On Nov 16, I further reviewed the IMF’s report on a global recession. (Yiu, 2019f) And the most recent one analyzed the demand-led and supply-led deflation caused by COVID-19. (Yiu, 2020) I hope all of you can be safe and the global economy can be recovered soon. But I think there will have some fundamental changes in economic development. Let’s discuss in more detail here in the future.
Yiu, C.Y. (2019a) Yield Curve is Inverted Today, Medium, Mar 23. https://medium.com/@ecyY/yield-curve-is-inverted-today-eb5e3c207749
Yiu, C.Y. (2019b) Why an Inverted Yield Curve can Predict a Recession? You are probably one of the contributors! Medium, Aug 20. https://medium.com/@ecyY/why-does-an-inverted-yield-curve-predict-a-recession-you-are-probably-one-of-the-contributors-c1d0168b3b7a
Yiu, C.Y. (2019c) Are you ready for the upcoming global recession? Medium, Jun 21. https://medium.com/@ecyY/are-you-ready-for-the-upcoming-global-recession-565772bea427
Yiu, C.Y. (2019d) Global Recession is Imminent, HK Government Launches Unorthodox Measures, Medium, Oct 20. https://medium.com/@ecyY/global-recession-is-imminent-hk-government-launches-unorthodox-measures-328be685de51
Yiu, C.Y. (2019e) Hong Kong runs ahead of the world to jump into the global recession first, Medium, Nov 1. https://medium.com/@ecyY/hong-kong-runs-ahead-of-the-world-to-jump-into-the-global-recession-first-bf30fb1c4e23
Yiu, C.Y. (2019f) Why Global Recession 2020? A Review of IMF’s (2019) World Economic Outlook Report, Medium, Nov 6. https://medium.com/@ecyY/why-global-recession-2020-a-review-of-imfs-2019-world-economic-outlook-report-part-1-391722a34faf
Yiu, C.Y. (2020) Supply-led Deflation due to COVID-19 cannot be solved by liquidity easing, Medium, Mar 14. https://medium.com/@ecyY/supply-led-deflation-due-to-covid-19-cannot-be-solved-by-liquidity-easing-74f8aeb2728d