Shutdown: How Covid Shook the World's Economy

by Adam Tooze

Over the week that followed, the Fed bought an astonishing total of $375 billion in Treasury securities and $250 billion in mortgage securities. At the high point of the program, the Fed was buying bonds at the rate of a million dollars per second. In a matter of weeks, it bought 5 percent of the $20 trillion market.

In April the International Monetary Fund estimated that the total fiscal effort worldwide in all forms already came to $8 trillion. In May it revised that to $9 trillion and in October to a staggering $12 trillion. By January 2021 the total had reached $14 trillion.2 That was vastly larger than the stimulus following the 2008 banking crisis. The scale of this spending and tax relief in 2020 was crucial in mitigating the social disaster that might otherwise have resulted from the shutdowns.

According to the International Monetary Fund, by October 2020 the average advanced economy managed a discretionary fiscal effort of almost 8.5 percent of GDP. The average for middle-income emerging market countries was just shy of 4 percent. Low-income countries generally mobilized less than 2 percent of GDP for coronavirus measures.6

Impoverished Haiti launched a stimulus program amounting to an impressive 4 percent of GDP.7 On April 21, South Africa’s government launched a substantial $29.9 billion package focused on health care spending, financial relief to municipalities, and a system of social grants for the least well off. It came to almost 10 percent of national income. On the other hand, Nigeria, battered by the collapse in oil prices, managed barely 1.5 percent of GDP in tax cuts and spending.

In 2008, China had launched what in relative terms had been a huge stimulus. In 2020, with the epidemic under control and an eye to the overinvestment and over-borrowing of the past, Beijing was more restrained. The fiscal package announced at the “two sessions” in May 2020 amounted to RMB 3.6 trillion (c. $550 billion), slightly less than the RMB 4 trillion introduced after the 2008 financial crisis in what was a much larger economy. By the end of 2020, the total fiscal effort was estimated at 5.4 percent of GDP, of which 2.6 percent was support for investment, particularly at the local level. Unlike in the West, direct transfers to households played virtually no role in China’s recovery.

The final appropriation under the so-called CARES Act would come to $2.7 trillion, nigh on three times the Obama stimulus of 2009. At its peak, in the week ending May 1, the federal government was pumping $200 billion per week into the economy. The rate of emergency spending did not fall below $50 billion per week until the third week of May.25 If the worst predictions of March and April did not come to pass, it was in part because of the scale of these interventions. The fiscal packages of 2020 were not stimulus in the conventional sense. Given the supply constraints due to the shutdown, they could not generate the multiplier effect one would normally hope for. What they did do was to provide income security and maintain demand in those areas of the economy that were still functioning.

Between January and May 2020, the OECD estimated that total debt issuance by advanced economy governments came to $11 trillion. By the end of the year, the total would reach $18 trillion. Of the huge surge in debt in the first five months of the year, some 67.5 percent was accounted for by the United States and 10 percent by Japan; the rest was divided among the Europeans.

Even as deficits exploded, the share of government spending allocated to debt service fell. Despite being exceptionally heavy borrowers, Canada, the United States, and the UK all saw their borrowing costs plunge. Over the course of the first half of 2020, the German government, which issues debt at negative rates, looked forward to being paid 12 billion euros to hold the money of anxious investors.47 Private rates fell too. The yields on investment-grade corporate bonds in the United States plunged to lows not seen since the 1950s.48

Over recent decades, even as public debt was on a secular upgrade, interest rates had been moving in the opposite direction. This was one of the phenomena that moved Larry Summers in 2013 to suggest that we were living in an age of secular stagnation.49 True to the basic supply-and-demand framework, Summers argued that if the price of funds, the interest rate, was falling, it must be due to an imbalance. There was either too much saving or too little investment. Either way, it was a good moment for government investment to take up the slack.

So the most succinct answer to the question of how epic government deficits could be financed without driving up interest rates was that one branch of government, the central bank, was buying the debt issued by another branch of government, the Treasury.

The constellation of low interest rates, large government deficits, and bond buying by the central bank had first emerged in Japan in the 1990s. It went hand in hand with a downward trend in price increases that ultimately resulted in deflation. After 2008, it had become common to the euro area and the United States as well—though in the U.S. the deflationary tendency was less pronounced. The central bank policy of government bond buying became known as quantitative easing (QE).

One obvious interpretation was that the monetization of giant stimulus spending was the belated and long overdue triumph of radical Keynesianism, a return to the logic of so-called functional finance first spelled out in World War II.55 The zealous new school of Modern Monetary Theory rode to prominence on the coattails of Bernie Sanders and his revival of the American left.

The defensive answer from the central banks was that they would off-load the bonds as soon as they could do so without disturbing the market and driving up interest rates. At that point, the market maker argument converged with the second basic justification for their actions—the original argument for QE. They were buying debt to massage the interest rate, and they were entitled to do that because their basic task was to ensure price stability, which in 2020 meant that the economy must be prevented from sliding into deflation. Avoiding deflation meant stimulating demand by all means. For the central bank, that meant holding interest rates down. Once again it came down to financial markets. As far as anyone could figure out, QE worked by driving government bond prices up and yields down.65 Lower interest rates helped to encourage borrowing for investment and consumption. Lower yields also prompted asset managers to reallocate funds from Treasury markets, where prices were driven up by central bank buying, to riskier assets, like equity and corporate bonds. This boosted corporate borrowing and the stock market. It increased financial net worth and boosted demand.

In March the central banks found themselves facing a meltdown in the safest asset markets that threatened the entire system of market-based finance. Stepping into the breach, the central banks absorbed unprecedented quantities of government debt to restore the safety of the safe asset—that is, U.S. Treasuries, UK gilts, and euro area bonds. In the process they monetized the debt. The cash that the central banks paid out to buy the debt ended up in reserve deposit accounts in the name of private banks. To ensure that they kept it there, they were paid interest. Within the consolidated balance sheet of the public sector, rather than the Treasury paying bondholders, it paid interest to the central bank, which paid interest to the banks. The financial markets were pacified. The market-based financial actors—offshore dollar borrowers, hedge funds, open-ended mutual funds, et al.—were saved from disaster. Interest rates were driven to rock bottom. Following the logic of QE, this caused a redirection of funds into equities and corporate debt. Financial markets took off from their lows in March 2020 and did not look back. The affluent 10 percent in advanced societies who hold the most financial wealth received a stimulus that dwarfed anything openly declared in the public accounts.

What the biggest banks and fund managers wanted to see was emerging market central banks and treasuries developed into solid buttresses of the dollar-based Wall Street system. One key move was to minimize sovereign borrowing in foreign currency. As far as possible, from the early 2000s, governments in emerging markets did as advanced economy governments did: they borrowed, whether from their own citizens or foreign lenders, in their own currency. Crucially, that enabled their national central banks to retain ultimate control over repayment.

A second crucial lesson was not to lessen the currency risk for foreign lenders by attempting to peg exchange rates. Fixing the exchange rate against the dollar or the euro offered a mirage of stability. In good times, it would attract excessive inflows of foreign capital. In bad times, money would run, and in that event, it was both futile and expensive to try to maintain a dollar peg. The amount of hot money that would be mobilized by both foreign and local investors was simply too great. Better to let them exit and pay the price in losses as the local currency depreciated. If investors needed to hedge their risks, there were always the derivatives markets.

A sudden devaluation, if it gathered momentum, might overshoot. Then the national authorities would have no alternative but to hike interest rates, amplifying the pain. To moderate these risks, what was warranted was not a rigid defense of a particular currency peg, but intervention to moderate the pace of exchange rate movements. For this the authorities needed ample foreign exchange reserves. From the beginning of the millennium, China’s reserves rose to a peak in 2014 of $4 trillion. No one could match that, but Thailand, Indonesia, Russia, and Brazil all accumulated large foreign exchange reserves too.

Though it continued to run national programs with tough conditionality, the IMF preferred to see itself as a cooperative and self-reflexive partner in what was dubbed the Global Financial Safety Net.20 Its principal role, at least according to its new self-understanding, was not to discipline rogue sovereigns, but to help developing countries acquire the capacities they needed to maneuver successfully in the world of market-based finance. That this helped to extend the reach of bond merchants, financial advisors, and asset managers hardly needed saying. Financial globalization was a given.

For the most stressed emerging market borrowers, on the other hand, any help came too late. As the year began, Argentina, Lebanon, and Ecuador were at the top of the list of troubled debtors. By the summer, all three had defaulted. Argentina had been struggling for years. In 2018, its record $56 billion in IMF loans had not been enough to stabilize its situation. Lebanon, torn by internal strife and caught in the force field of regional geopolitics, had long been on the endangered list. Ecuador was on the brink of crisis as 2020 began and was hit hard by the sudden drop in oil prices.

The surprising thing about the majority of the major emerging markets in 2020 proved to be their financial resilience. When faced with the sudden stop of the spring of 2020, the new toolkit for managing financial stress worked. As government borrowing surged to fund crisis spending and as the confidence of foreign investors wobbled, domestic central banks stepped in to buy the bonds they were selling.

But the Fed’s remarkable loosening of monetary policy changed the weather in the currency markets. Only a select few—Brazil, Mexico, and South Korea—could access dollars by way of the Fed’s swap lines. Rumor had it that Indonesia, as a G20 member in good standing, had applied to the Fed for a swap line, to complement those it already had in place with the People’s Bank of China and the Bank of Japan. It was denied but was offered instead a $60 billion repo facility with the New York Fed.37 This made little difference. What mattered was the huge wave of liquidity that the Fed unleashed. With American interest rates plunging toward zero, the dollar reversed, the emerging market currencies rallied, and with them also the returns on offer for foreign investors.

As had been the case in 2008–2009, Mexico had the singular distinction of both drawing on an IMF credit line and receiving support direct from the United States by way of a Federal Reserve liquidity swap. There was thus no prospect of Mexico running out of dollars. But despite the level of support it received from the outside, López Obrador’s government pursued a remarkably passive response to the coronavirus crisis.59 It provided virtually no fiscal stimulus to offset the fall in economic activity and exports. All told, emergency spending in 2020 came to a derisory 0.6 percent of GDP.60 The result was a surge in poverty. The number of Mexicans eking out a living on less than $5.50 per day increased from 33 to 44 million.

All in all, the emergency spending of the Bolsonaro government in 2020 came to an impressive $109 billion, or 8.4 percent of GDP, which put Brazil on a par with the UK and Israel.65 That helped to ensure that the overall contraction of GDP in 2020 was no more than 5 percent, compared to a slump of between 7 and 9 percent in Argentina and Mexico.66 As in the United States, the scale of the crisis response meant that Brazil actually saw a temporary reduction in poverty and inequality in 2020.

The ruling by the German constitutional court stated out loud what was undeniable: the vastly expanded role that central banks had taken on since 2008 exploded the paradigm of independent central banking that had been established in the 1990s. Its legitimacy was, indeed, in question.

At moments of crisis, as after the Fukushima Daiichi nuclear accident in 2011 or in 2015 on the refugee question, Merkel had repeatedly shown her willingness to abruptly change course. The constitutional court judgment was one possible trigger. To cut off a nationalist backlash, Merkel needed to make a show of leadership.

But if we are looking for a deeper motivation, it derives from Merkel’s appreciation that the coronavirus presented Europe with a new type of challenge, a harbinger of the new era of violent environmental shocks. It was telling that in the pivotal press conference with Macron on May 18, Merkel made the point that Covid was the kind of crisis that demonstrated the obsolescence of the nation-state. “Europe must act together, the nation-state alone has no future.”

She was thinking about the bigger strategic question of the European economies and of how such public health crises might be managed in the future, through joint surveillance, countermeasures, and vaccine development. This functionalist logic, the unfashionable common sense of the globalization era, was Merkel’s lodestar.32 It was not a matter of faith or idealistic commitment to liberal internationalism. It was simply realistic. In a world of complex new challenges, European cooperation was more urgent than ever. The centrifugal tendencies amplified by 2020 had to be stopped. Platitudes of globalese morphed into drivers for urgent action.

For the EU, it marked a moment of relaunch.39 Since the climax of the eurozone crisis in 2012, the lack of progress on deeper integration had been demoralizing. Merkel had refused to put Germany’s weight behind Macron’s initiatives. Now suddenly the EU had lurched forward. The unpopular institutional appendices bequeathed by the years of crisis had been sidelined—notably the European Stability Mechanism. Instead, with the UK out of the picture, the powerful mainly Western European members of the euro area had asserted themselves within the EU as a whole. They had established the possibility of EU debt, and on that basis they had given Brussels a meaningful countercyclical fiscal capacity. Skeptics would insist that it was no more than a provisional response to an emergency. Whether any of it would become permanent was an open question, but the precedent had been established. For once, undeniably, the EU had scored a political success.

The EU’s own newly issued debt would have a credit rating equivalent to the best sovereigns in the world.41 Potentially, Crédit Agricole gushed, the Europeans were about to create a “massive new pool of high-quality, euro-denominated bonds . . . that could be used by foreign investors to diversify away from [U.S.] Treasuries and the dollar.” This was the authentic voice of the people who managed the really big pools of global money. Far from being a dangerous and regrettable liability, good quality public debt was indispensable fuel for private finance.

Not discipline, but ensuring favorable financing conditions for both public and private borrowers, was now the focus of ECB policy.48

And the idea of a comprehensive reshoring, on account of Covid, was illusory as well.19 It was not just costs, but sophisticated networks of suppliers and systems of logistics that made China attractive for modern manufacturing. Those advantages did not evaporate overnight because of a few substandard masks or defective Covid tests.20

The global politics of the virus drove home the point that the “China shock” meant something different, depending on where you were in the world. To Europe and the United States, China appeared as an unwelcome competitor. For other parts of the world, China’s growth might be daunting, but it also opened up spectacular opportunities. Brazil in 2019 exported twice as much to China as it did to the United States.25 For the Pacific-facing economies of Peru and Chile, China was even more important.

After New York and London, Hong Kong was the third most important financial center in the world. In 2019, Hong Kong was competing with Nasdaq and New York for the launch of the biggest initial public offerings of new shares.27 It was the third-largest dollar trading center, hosting 163 banks and 2,135 asset managers.

Beijing’s vision went well beyond that. Its aim was to merge Guangdong province, Hong Kong, and Macao into a giant economic powerhouse to be known as the Greater Bay Area. When the idea was inaugurated in 2017, the area had a combined population of 71 million and a GDP of $1.6 trillion.40 That made it the twelfth largest economy in the world, on a par with South Korea. Accounting for 37 percent of China’s exports, the Greater Bay Area had spectacular future prospects. Memories of Hong Kong’s autonomy would drown in the money to be made in Asia’s Silicon Valley.

Since the 1990s, American financial interests had led the charge into China, and the repression in Hong Kong in 2020 did not put them off. Indeed, the fondest hope of Wall Street was to break out of the Hong Kong beachhead defined by “one country, two systems” to gain access to the vast market of mainland China.

2020 was a banner year in China for the biggest names of Wall Street.47 JPMorgan was looking forward to taking full control of a futures business in the Chinese markets. Goldman Sachs and Morgan Stanley had taken majorities in their Chinese securities ventures. Citigroup was granted a coveted custodian license to act as a safekeeper of securities. In August, BlackRock was awarded the ultimate prize, a stand-alone, wholly owned mutual fund license that would allow it to compete for the right to manage the c. $27 trillion in financial assets held by Chinese households.48

The huge central bank interventions in the West in the spring of 2020 were no doubt needed to stabilize the markets, but their negative side effect was that they crushed yields. Even with a Cold War in the air, the most remunerative safe haven for capital in 2020 was Chinese sovereign debt.

The year 2020 dealt a savage blow to India’s pretensions to Asian leadership. Delhi’s coronavirus response was botched. Tens of millions were hurled into destitution. India’s economic contraction was among the worst in the world. When Indian and Chinese soldiers clashed in the Himalayas in June, in the worst border violence since 1975, it did not end well for the Indians. Dozens were killed and China ended up in control of 600 square miles of extra territory in the disputed Ladakh region.74 The ensuing patriotic protests led to a boycott of Chinese cell phones and apps like TikTok. But India could not afford a Cold War. For all India’s recent growth, Beijing’s defense budget was almost four times that of India and its economy six times bigger.

America was attacking not just Huawei, a national champion, but an entire pillar of China’s industrial economy. Beijing was left with no option but to rethink its approach to globalization. The new model of economic development floated at the “two sessions” in May 2020 was “dual circulation.”84 One circuit was the economy of international trade. The other would be driven by China’s national economic development. The idea was to rebalance the relationship between them and to make the latter independent of the former. This was not a general abandonment of globalization, but a rebalancing away from overdependence both on foreign demand and on imported inputs that might be vulnerable to U.S. sanctions.

In time for the two sessions in May, Beijing announced a giant new technology program with a mandate to spend $1.4 trillion over the next five years.85 It was focused on strategic areas like data centers, ultra-high-voltage power transmission, AI, and the base stations of the new 5G network. But none of this would matter if America could turn off China’s supply of cutting-edge microchips. The year ended with a roll call of seventy-seven Chinse firms added to the sanctions list, including, apart from Huawei and SMIC, DJI, the world’s favorite maker of drones.

For the United States to be declaring China, the main driver of global growth, to be a national security threat upended one of the basic assumptions of the post–Cold War world. Contrary to the flat-world presumption of globalization, the United States was making the nationality of firms, Chinese or not, fundamental to Washington’s willingness to allow them to access American technology.

Deutsche Telekom was desperate to gain a slice of the Chinese market. Germany’s car firms were too tightly integrated with Chinese communication technology to be able to contemplate a clean break.

Tech was complicit with China’s surveillance state. “Hollywood’s actors, producers, and directors pride themselves on celebrating freedom and the human spirit,” he scoffed. “And every year at the Academy Awards, Americans are lectured about how this country falls short of Hollywood’s ideals of social justice, but Hollywood now regularly censors its own movies to appease the Chinese Communist Party, the world’s most powerful violator of human rights.”17 Barr came remarkably close to pronouncing a divorce between his ideal of America and actually existing American capitalism.

The previous year, the Fed had embarked on a basic review of its monetary policy framework. What was to be done about the repeated failure to meet the inflation target of 2 percent? After a year of deliberation, America’s central bank was no closer to an answer. The United States, like all the other advanced economies, had a low-inflation problem. What the Fed could do was to change the way it targeted its policy. Henceforth, rather than committing to keep inflation below 2 percent, it would seek to achieve an average inflation rate of 2 percent. If inflation slipped below that target, as it had done persistently in recent years, the Fed would aim to make up for it. If and when inflation finally did rise above 2 percent, the Fed would not preemptively seek to restrain it, but would allow the economy to “run hot.”

As far as taxation and redistribution were concerned, as he told a group of well-heeled donors at the Carlyle hotel in June 2019, it was time for America’s upper class to make concessions. Biden had no intention of “demonizing” wealth, but “you all know, you all know in your gut what has to be done. . . . We can disagree in the margins. But the truth of the matter is, it’s all within our wheelhouse and nobody has to be punished. No one’s standard of living would change. Nothing would fundamentally change . . . When you have income inequality as large as we have in the United States today, it brews and ferments political discord and basic revolution. It allows demagogues to step in.”

Looking back from September, a study by the Swiss bank UBS found that a quarter of the rebound in the stock market since May, when the publicly funded vaccine race began in earnest, was attributable to vaccine news.3 In November, on the news of the success of the Pfizer/BioNTech trials, oil prices and shares in airlines surged. Those in food delivery companies and tech slumped. Safe-haven assets in general sold off, led by Treasuries and tech stocks.4

If it had not been for coronavirus, the headlines in 2020 might have been made by other triumphs. In March, a man in London became the second person in history to be cured of HIV/AIDS. On August 25, after four years without a case, Africa was declared free of the wild polio strain, a disease that had once crippled 75,000 children every year. In November, the computers of a British AI company successfully predicted a protein’s 3D shape from its amino acid sequence, promising a huge acceleration in drug development.6

By the 2010s, two-thirds of the world’s children were vaccinated with jabs produced by India’s Serum Institute. The Serum Institute got its start in the early 1970s producing tetanus vaccine from horse serum to replace unaffordable imports.15 In the 1980s the company positioned itself as one of the mainstays of India’s Universal Immunisation Programme, which aims to provide complete coverage each year for the country’s giant 27-million-strong birth cohort.16 As the first developing world manufacturer to obtained prequalified status from the WHO, the Serum Institute in the 1990s became a global supplier. By the 2010s, at 1.3 billion shots per annum, it had the largest manufacturing capacity in the world.

One of the most powerful activist coalitions, CEPI, the Coalition for Epidemic Preparedness Innovations, was unveiled in January 2017 at Davos. It focused on developing a vaccination for the highly dangerous MERS-CoV and on building a “rapid response platform” that would enable a quick reaction to the emergence of a hypothetical new pathogen, dubbed “Disease X.”17 Public-private partnerships like CEPI did not end the wrestling match over pricing, IP, and the transparency of contracts, but they did push more money—$706 million—into nineteen vaccine candidates.18 Ahead of time, 2020 was earmarked as the final year of the first decade-long Global Vaccine Action Plan backed by donors like the Gates Foundation, the Wellcome Trust, the GSK foundation, and CEPI. A number of new vaccines, including those for malaria and HIV, were within sight of the finish line. And then in January 2020 “Disease X” actually arrived.

The drama of the coronavirus vaccine was that for the first time, all three processes—development, testing, ramping up production—were accomplished simultaneously, on a scale intended in due course to cover the entire population of the world, even as the pandemic was still progressing. The researchers got to a solution so fast in part because much of the basic research and preclinical testing on animal models had been done in 2003 in response to the SARS pandemic.21 The SARS crisis had ebbed before the vaccine development was completed. This time round, the global vaccine race developed a gigantic momentum.