Global financial crisis 2.0 is coming for your wallet

It is not just banks and corporations that will suffer from a financial crisis. Consumers and small borrowers will, too.

A shopper wearing protective gloves pays for a purchase with cash at a farmers market in San Francisco, California, U.S., on Wednesday, March 25, 2020. Fearful of close-quarters in packed supermarkets
A shopper wearing protective gloves pays for a purchase with cash at a farmers' market in San Francisco in the United States [File: David Paul Morris/Bloomberg]

Desperate problems can sometimes justify extreme solutions, but leading economists fear financial interventions intended to ease the coronavirus crisis could cause even more fundamental problems. The cure might create a financial catastrophe of its own.

Just a few years ago, right-wing politicians were mocking left-wing rivals and warned voters not to believe promises of governments distributing “free stuff” in the United States; nor in “the magic money tree” in the United Kingdom.

Now those self-same right-wing realists seem to have discovered a whole forest of magic money trees in their quest to prevent COVID-19 from causing another Great Depression.

Such fears are not unfounded. Last week the International Monetary Fund (IMF) forecast the deepest contraction for the global economy since the 1930s.

Kristalina Georgieva, IMF managing director, said that 170 of its 189 member countries would suffer falling output per head in 2020 and added: “The bleak outlook applies to advanced and developing economies alike. This crisis knows no boundaries. Everybody hurts.”

No wonder the US President, Donald Trump, has abruptly abandoned his previous scepticism about the seriousness of the crisis or the potential benefits of government spending and, instead, opted for an estimated $2 trillion aid package.

As Trump trumpeted: “It’s going to be big, and it’s going to be bold,” telling reporters at a White House briefing there was “enthusiasm” on Capitol Hill for the measures. 

Coming down from the clouds, shoppers are being encouraged to spend money they do not have on credit cards and homebuyers are being offered temporary relief from interest payments on their debts in the UK.

One in nine mortgage holders in the UK has taken a so-called “payment holiday” as their finances have been hit by the effects of coronavirus.

Lenders have agreed that 1.2 million homeowners can delay repayments as jobs are cut and wages reduced, said UK Finance, the organisation that represents banks and that compiled the figures.

Banks and building societies have offered up to three months of mortgage repayment deferrals for those struggling financially. This does not mean these bills are being cancelled, as they will still need to be paid at a later date.

The bills are mounting rapidly. For the typical capital-and-interest repayment mortgage, about 775 British pounds ($960) is being deferred each month. The number of deferrals in place more than tripled in the two weeks between March 25 and April 8, growing from 392,130 to 1.24 million. This is an increase of nearly 850,000, or an average of around 61,000 payment holidays being granted by lenders per day.

That is just the UK – similar measures will be taking place in other countries that have granted such payment holidays, such as the US.

In the UK alone, if all those with a mortgage were to take a three-month break, a total of about 2.6 billion pounds ($3.21bn) would have been deferred.

The total would have risen since then, and is likely to increase further. Robin Fieth, chief executive of the UK mortgage lending trade body, the Building Societies Association, says: “We know that this is a difficult time for many homeowners with a mortgage, and building society staff have been working hard to offer individuals the right solution.”

Similarly, Britain’s banks are asking regulators to relax the rules on credit card repayments to help customers cope during the coronavirus crisis. Lenders hope to allow repayment of credit card bills to be postponed for up to three months and have asked the Financial Conduct Authority, the UK’s financial watchdog, to waive the current regulatory requirement that customers make a minimum repayment each month.

But credit card issuers could still charge interest and fees during any such payment “holiday” and the total debt would ultimately still have to be repaid. This raises the awkward fact that financial gravity cannot be denied indefinitely.

You cannot borrow your way out of debt. Although many individuals and governments have attempted to do so over the years, it has never ended well.

Hard though it may be to believe now, in the midst of a global health crisis, excess government spending results in the disease of money known as inflation.

This is the insidious enemy of savers and investors because it results in them being paid for their prudence with money that has less real value – that is, purchasing power – than the cash they set aside.

There is no need to take my word for this. Tim Congdon, chairman of the Institute of International Monetary Research (IIMR) at the University of Buckingham, warns: “The policy response to the coronavirus pandemic will be followed by an inflationary boom.”

Specifically, he foresees a British inflation rate “closer to 10 percent than we have seen for many years”. The most recent figure for UK inflation is from March, when it was 1.5 percent.

On the other side of the Atlantic, the Nobel Prize-winning economist, Paul Krugman, is less gloomy. He says: “There may be a slight hangover from this borrowing but it shouldn’t pose any major problems.”

By contrast, however, Kenneth Rogoff – one of Harvard University’s few conservative professors – wrote about an “economic catastrophe, likely to rival or exceed that of any recession in the last 150 years”, with lingering effects, potentially leading to a “global depression”. The pandemic, Rogoff argued, was akin to an “alien invasion“.

Talk about two views make a market!

To end on a cautionary tale: Last month saw a reality check for anyone who believes governments cannot go bust. In a development that would have received wider coverage in quieter times, the Lebanese prime minister, Hassan Diab, admitted the country would not be able to pay a $1.2bn Eurobond when it reached redemption date.

The country is now considering using depositors’ money to salvage its crisis-hit banks as part of an overhaul of the sector following the country’s first sovereign debt default.

So, it is sad and cautionary to recall that Lebanon’s former reputation for financial security meant it was often referred to as “the Switzerland of the East” back in the 1960s.

Confidence can take decades to build but can be lost quite suddenly.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial stance.