Crisis and Currency Risk: Macroeconomic Perspectives on COVID-19

The Current Economic Landscape: Crisis and Currency Risk

Macroeconomic outlooks are shifting in light of the coronavirus pandemic, which will influence our ways of doing business for years to come. This article aims to provide a macroeconomic overview related to COVID-19, helping businesses frame their strategic decisions in a context shaped by crisis and currency risk As the pandemic spreads globally, supply chains are breaking down, and lockdowns are occurring across continents. India, among others, has announced a total shutdown. Governments and central banks have responded with unprecedented aid programs.

COVID-19 is causing simultaneous disruptions in supply and demand, and worse — its duration and full impact remain unknown. While banks are functioning normally despite businesses rushing to secure short-term credit, that stability could change if a wave of defaults begins. A global recession is underway — could it lead to a depression?

Macroeconomic Outlook: Impacts on Businesses and Supply Chains

Supply chains are under stress — some even halted — due to quarantines, factory closures, and transport restrictions. Goods are not being produced or shipped, revenues are not being generated, and invoices are going unpaid. Most organizations are in crisis mode. For how long? That’s the question.

It is likely that post-COVID market shares will look very different. Buyers unable to receive deliveries will turn to alternative suppliers. Force majeure clauses, price or quantity adjustments, or refusal to accept delivery may protect one party in the supply chain — and hurt another. It's better to be the one holding those clauses.

Companies must forecast the impact of COVID-19 on customer demand and future delivery capabilities. Maintaining communication with partners is now essential. The focus is shifting to resilience, risk exposure, and business continuity planning.

Investors and the Preference for Liquidity in Times of Crisis and Currency Risk

Facing uncertainty, investors and businesses are clearly prioritizing liquidity. Investors are selling off stocks and bonds, favoring cash — particularly in US dollars. Companies are in liquidity preservation mode. The resulting surge in the US dollar's value is painful for countries and businesses holding USD-denominated debt. They now face a stronger dollar — and a severe recession.

Emerging-market corporations and sovereign entities, especially in vulnerable sectors like energy, tourism, and commodities, face falling demand, declining prices, and more expensive debt repayments. Credit rating agencies are downgrading firms, restricting their access to capital. With 2020–2021 being peak years for corporate refinancing, a wave of defaults may significantly reduce risk appetite.

Effectiveness of the Monetarist Approach and Fiscal Policies

Many governments are seeing tax revenues fall and expenses surge due to COVID-19. As the economic damage deepens, monetary policy becomes less effective.

Since 2008, we've operated in an ultra-loose monetary environment — endless quantitative easing, negative interest rates. These tools helped avoid disaster during the last crisis, but they’ve also fueled asset bubbles and underestimated inherent risk.

The use of these tools over the past decade has generated an abundance of cheap money (read: debt) and ever-rising asset prices—whether in real estate, stocks, or bonds—along with an underestimation of the inherent risks tied to these assets.

We're now in an era of over-financialization, and collapsing demand caused by COVID-19 might not respond to central bank tools. Government fiscal measures will be essential to restarting economies.

Central Banks and the Risks of Over-Financialization

In any case, aggressive monetary easing—of uncertain effectiveness in stimulating demand—risks exacerbating systemic issues related to over-financialization (excess debt and underpriced asset risk). In other words, the pandemic is causing a demand shock that won’t be resolved with “a flood of money.”

In this environment, fiscal policy tools will be necessary to attempt to lift global economies.

Keynes is back (1).

The pandemic's economic impact is still unfolding, but it will be massive. Lockdowns and social distancing could last months, not weeks.

Governments must support affected populations at unprecedented levels. Most people, and even many governments, lack the savings to handle this crisis.

The priority for everyone is to save lives. The budgetary positions of many countries suggest serious challenges in meeting these needs, even though it is clear that disposable income must be preserved to prevent collapse.

Regional Macroeconomic Challenges

Governments from the Eurozone have attempted a coordinated response to the virus—but with limited success. Differences in member states’ budgetary positions are a major barrier. Germany and the Netherlands are the only countries with strong fiscal margins (debt-to-GDP ratios under 70%), whereas several major European countries already exceed 100% (France and Spain ~100%, Portugal ~120%, Italy ~130%).

The ability of many eurozone governments to respond to the COVID-19 shock is limited. GDP (the denominator) is falling while debt (the numerator) is exploding. When the time comes to rebuild devastated economies, countries with weak fiscal positions will lack one major recovery tool: they won’t be able to devalue their currency to boost competitiveness. For the eurozone, weak responsiveness to monetary stimulus is a serious concern

Another risk: a massive sell-off of Italian and/or Greek bonds could make it impossible for these countries to finance their needs based on their own credit ratings. They will still need to spend heavily on direct aid to people and businesses—and will need to find the resources (via taxation or borrowing) to do so.

In short, this economic shock—on top of Brexit and rising nationalism—could signal the eventual collapse of the euro.

Let’s recall Greece ten years ago: bankrupt, but unable to default. Trading, but unable to devalue its currency.

Remember the debate of the time—should the fiscal discipline of some members be extended to support others in trouble? Should the taxes of one member finance the stabilization of another’s economy? In other words, how far does the union go?

What if multiple Greece-style crises erupted at once? COVID-19 could very well take us to that breaking point. The response of fiscally strong countries will be decisive for the euro’s survival.

We could imagine, for instance, Italy realizing that vague promises of support are not enough. Then comes the dilemma: is it better to default and leave the euro—or accept years of debt servitude, like Greece? Hopefully, Europe will offer a better, more unified answer.

The Importance of Risk Management in Times of Uncertainty

Canada

Canada entered this crisis with a solid fiscal position. The federal debt-to-GDP ratio was under 35% (pre-COVID-19), and even when adding provincial debt, the overall ratio remains well below 70%. Most provinces had stable fiscal positions—except for Newfoundland and Labrador—and should be able to absorb the shock.

Of course, Alberta and Saskatchewan are struggling due to the oil price crash, but their pre-COVID debt levels were reasonable.

Provincial debt-to-GDP ratios before the crisis ranged from under 20% (BC, Alberta, Saskatchewan) to 30–40% (Manitoba, New Brunswick, Nova Scotia, PEI) and remained below 45% for Ontario, Québec, and Newfoundland. Tax burdens vary across provinces, but most still have some fiscal room.

The federal government has implemented unprecedented support programs for individuals and businesses, with some measures topped up by provincial programs.

The Bank of Canada intervened three times in March (rate cuts) to ease market tensions and improve liquidity. As the economy slows to focus on fighting COVID-19, business bankruptcies are on the rise.

In early April, the Bank of Canada launched a program to support liquidity and ensure the provinces can secure financing. Implicitly, the federal government is guaranteeing that all provinces will find the funding they need to get through the crisis.

United States

The U.S. debt-to-GDP ratio exceeds 105%. The budget deficit stood at around 4% of GDP (pre-COVID-19). While high, tax burdens in the U.S. are not yet as heavy as in Europe (or Canada), so there remains some fiscal capacity—through increased taxation.

The need for support in the U.S. is also enormous. The financial impact on short- and medium-term fiscal health (shrinking GDP and rapidly rising debt) will be significant. After the emergency stimulus programs, the U.S. debt-to-GDP ratio could easily reach 120%—a level that has often been flagged as a serious warning signal and a sustainability concern.

The U.S. Federal Reserve responded swiftly and forcefully to ensure dollar liquidity worldwide and reinstated its unlimited quantitative easing (QE) program.

Regardless of country, governments must implement these aid measures. The priority remains saving lives. But the consequences will last. These programs will place growing pressure on U.S. public finances, increasing already high interest payments—and we won’t always be in a low-rate environment.

Like any government, the U.S. must issue debt on the open market. True, the U.S. benefits from its economic scale and the dollar’s reserve-currency status—but a steep increase in debt alongside a deep GDP contraction (a prolonged recession) could still trigger a sharp market reaction.

In conclusion, financial risk management becomes crucial in this context of uncertain macroeconomic outlook. Finance leaders must closely monitor economic developments and adjust their hedging strategies to protect their businesses from the potential impacts of this prolonged crisis.

China

While the U.S. has hesitated in its COVID-19 response, China is positioning itself as the global leader in pandemic management. However, even though plane loads of medical supplies are real, many doubt that the virus disappeared from China as quickly as claimed.

We can’t compare the Chinese economy or banking system of 2003 (SARS) to what it is today. In 2003, China experienced a sharp downturn followed quickly by a strong recovery.

At that time, China’s growth rates exceeded 10%. Today they’re under 6%, and the banking system is burdened with bad debt.

In fact, Chinese regulators had to bail out a few banks for the first time in decades in spring 2019. By early summer 2019, the Chinese government convened an emergency meeting with the banking sector. It’s no surprise that the solvency of the Chinese banking system is declining—and now COVID-19 is about to hit already weakened balance sheets.

Even a year ago, outside of the U.S.-China trade conflict, the Chinese economy was already weakening. Credit had dried up for the private sector—an important engine of growth—and consumers had begun pulling back sharply on spending. COVID-19 will only intensify this trend.

It’s clear that China’s recovery won’t be as fast as hoped. It won’t happen unless demand rises in other countries—which are now grappling with the virus. A strong rebound in domestic demand is possible, but Chinese consumers alone cannot drive global growth

Global Outlook

The longer it takes to contain the pandemic—and the longer the economic recovery is delayed—the more unsustainable debt will become, for countries, banks, businesses, and individuals alike.

The big economic question after the health crisis: will we see a V-shaped recovery or a prolonged recession?

Governments clearly want to preserve household income with aggressive stimulus. The speed at which funds reach people and businesses will be a key success factor. Bills need to be paid… so others can earn income and pay theirs… and so on.

Some sectors may recover quickly, once workers can return and supply chains resume. But no one knows if SMEs can survive an extended shutdown.

For a rapid recovery to work, aid programs must protect businesses from insolvency due to lost revenues—and there must be some level of international coordination. There’s no point restarting a supplier if the buyer is still sick…

The economy as a whole must accept slightly lower productivity in exchange for greater supply chain resilience.

More grimly, it’s reasonable to expect a second wave of infections in 2021. If that occurs, the recovery could stall—or worse, we could see a “double-dip” recession. However, by then, scientists may have had time to develop an effective treatment to slow the disease’s spread.

Let’s hope our governments, business leaders, and we ourselves are not caught off guard by that second wave.

Notes:

1. The Keynesian approach suggests that a country’s economic health (and recessions) can be managed—or avoided—by using government policies to influence aggregate demand.

2. For reference, Canada’s federal debt-to-GDP ratio before COVID-19 was just under 35%.

3. SARS: Severe Acute Respiratory Syndrome.

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