Covid-19: Effects on Debt Levels and Inflation By Les Nemethy

You may recall that at the beginning of March 2020, I wrote an opinion that many considered outlandish at the time —that Covid-19 deaths in the US alone may surpass a million. I can only wish I were wrong, but as of mid October, US fatalities have topped 735,000– and are still rising. According to the Economist, there have been over 16 million ‘excess deaths’ worldwide—probably attributable to covid-19.

Allow me to first summarize the scenarios that I see for Covid moving forward; after which I will talk about their impact on financial markets and the economy.

(a) Scenarios for covid-19 moving forward

Most experts think that Covid-19 will eventually become endemic like the flu—always present, but producing “acceptable” levels of fatalities. But there are many paths to becoming endemic.

The best scenario is that Covid-19 relatively quickly fades into endemic status. The worst scenario is that before we get there, one or more vaccine-resistant viruses emerge, that spread faster and/or are more fatal than even the Delta version. And of course there are countless intermediate scenarios.

The probability of a new, faster spreading and/or more fatal versions emerging is unfortunately — considerable. The number of people carrying the virus continues to expand globally: the more humans carry the virus, the more colonies of different covid-19 viruses exist, with increased chance of mutation. Eventually, a strain may emerge that will displace the Delta variant as the globally dominant strain.

Let’s look in a little more detail at the worse case scenario. The spread of a vaccine-resistant worse-than-Delta variant would begin with only a few cases in absolute numbers (think back to Q2 2020)—but would spread exponentially. This would provide virologists and vaccine producers some time to (a) identify and isolate the virus; (b) provide a genetic footprint of the virus; (c) implement large-scale manufacturing and distribution. (All previous vaccine stocks would be useless against the new variant).

It would be a race against time. While one might argue that the above process would be faster because vaccine technology and production capacity has advanced with lightning speed over the past two years– as of October 2021, still less than 50% of the global population has received one jab. A new, highly fatal/faster spreading resistant variant definitely has the potential to wreak global havoc.

(b) Financial and economic effects of covid-19 in the coming years

Financial markets seem to have shrugged off Covid-19, and continue to proceed from all-time-highs to all-time-highs. Certain sectors, like technology, seem to have even benefited from the virus (e.g. accelerated adoption of digitalization).

Given the high degree of uncertainty as to the course of the virus, and the hardship still wrought by the virus, governments might be forgiven for failing to enforce fiscal discipline. There have been unprecedented levels of stimulus, handouts, bank guarantees, deficits, etc. Perhaps the most pervasive financial effect of the virus will be an accelerative effect on debt accumulation. (Global debt now exceeds 350% of global GDP). Similarly, Central Banks have not raised interest rates to quash inflation.

All of the above assumes a relatively benign course of the virus. Should a vaccine-resistant strain emerge that spreads faster or is more fatal than Delta—the effects could be still more severe. Travel and tourism may once again come to a standstill, lockdowns might be imposed, as in spring of 2020, dramatically curtailing economic activity. However, unlike spring 2020, when there was no light at the end of the tunnel (e.g. a vaccine that might restore some semblance of normality), lockdowns might be relatively short-lived and in the expectation that these would serve to bridge the gap until new vaccines could be distributed in sufficient quantities. Such a worst case scenario would likely result, compared to the benign scenario, in further accelerated stimulus and debt accumulation.

The above worst-case scenario would be for the developed world. Presumably the lag of providing vaccines to the developing world would not change, making these countries bear the brunt of a vaccine-resistant outbreak. (Nor do many developing countries have the financial strength to permit massive stimulus/deficits). Assuming the new mutation spread fast in the developing world—the cycle repeats itself, and newer, more resistant variants may emerge. It goes to illustrate that the only good response to an epidemic is a global response—sorely lacking until now.

The rapid accumulation of debt and acceleration of inflation as legacies of Covid-19 cannot be underestimated. These will be the defining financial issues of the coming decade. High debt levels create financial instability and volatility (e.g. also increase the chances of a financial crash).

I am not for a moment suggesting that central banks and Governments are blame-free, and all the responsibility can be heaped on Covid-19. But the virus has played a role in facilitating such profligate behavior.

Consult with one of our senior staff.

No obligation consultation