Uncharted waters

Governments in lockdown are desperate to restart economic activity. They know they cannot support businesses indefinitely. Plus the sums being borrowed are huge and cannot be repaid quickly. The possibility of inflation is beginning to raise its ugly head again.

Private individuals and companies have few safe places to store wealth. This allows for governments to borrow very cheaply, because lenders know they will almost certainly be repaid. But if interest rates rise, this could become much more expensive.

Governments raise money from taxation. There are powerful economic and social arguments for higher taxes on wealth, and on companies that avoid tax by transferring their profits to low-tax regimes. Mechanisms to tax companies that trade in different tax jurisdictions already exist between states in the USA; similar arrangements can be developed to tax companies such as Amazon or Google which trade across national borders.

Resources may, in theory, be found by cutting spending elsewhere. But the existing cuts to public services, including the underfunding of healthcare in the USA and UK, have been cruelly exposed by coronavirus. That kind of austerity is discredited and no government is going to continue it.

Alternatively, a government could simply write cheques or borrow from itself. The immediate danger of this is the misuse of state funds by authoritarian governments. The longer-term danger is an inflation that can be very difficult to end, as wages rise in response to rising prices, and prices rise in response to rising costs. After the first world war, between 1922 and 1924, hyper-inflation meant that the real costs of repaying the loans taken out to finance the war, and of the reparations Germany was made to pay to the victorious allies, declined in value to almost nothing. Those who had lent their money to the government, notably the middle classes, lost as prices rose astronomically, and in effect paid for the war. After the second world war inflation again led to most of the costs of reindustrialisation and rebuilding in Europe being written down.

But such policies need not be inflationary if labour and machinery is idle and put back to work. In the 1930s, only a few years after the hyperinflation, Hitler and Mussolini, used the printing press to invest in motorways and other infrastructure without allowing inflation to get out of hand.

We are in uncharted waters. There is much that we do not know about coronavirus. We can, however, make some inferences about the economic future:

1. Increased taxes on wealth and on companies are the safest way to pay for the huge costs of the lockdowns. But if that is not possible, inflation is a real possibility. A modest level of inflation, say 5%, could be sustainable in these circumstances, and a way of taxing property and wealth. More than that and there is a serious risk of hyperinflation.
2. Governments which provide support for companies should take stakes in their equity. Many of these will turn out to be worthless, but some will be extremely valuable in future years.
3. If investors begin to realise that inflation is a real possibility, interest rates will rise very fast.
4. Some governments will not be able to repay what they have borrowed, especially if interest rates rise. Those who have lent them money may have to accept rescheduling or write-offs of ‘unrepayable debt’, as they did with the debts owed by poor countries in 2005.
5. A new future will need new institutions, comparable to those created after the second world war, around the World Trade Organisation (originally GATT, the General Agreement on Tariffs and Trade), the International Monetary Fund, the Bank for International Settlements, and the World Bank. These will have to recognise that American dominance has ended, and fully involve China, the emerging Asian economies, and South American and African countries.

We are in uncharted waters. Never before has a depression affected both supply and demand so suddenly and to such an extent. A depression is inevitable and inflation very possible. The owners of property, across the globe, need to appreciate that their assets will be more secure if there are effective international institutions that can manage the huge debts accumulated during the lockdowns.