From load of debts to dividends off peace: a new new deal for the West and China

A bird eye view on the global economy options for facing the Covid-19 shock.

The Coronavirus pandemic crisis is forcing the world economies to deal with a new, complex situation. For the first time, the world’s leadership is required to act from an inferior position, without any control over the course of events. This situation somewhat resembles a dystopian type of fiction. In this real-life disaster film, we are trapped in, humanity is fighting an invisible and elusive “alien” who acts as a murderous enemy, moving freely between us. The intruder dictates the pace, charges a death toll, and unpredictably alters our economic, social, and political world. No administration is immune to these extensive changes.

The global economy is a 100-years bond of interdependent relationships between countries. Despite the concerns, further globalization of the economy is a favorable option for overcoming the crisis, both in theory and in practice. As in any open and complex system, the economy is also subject to inevitable change, as we have experienced several times before.

The global economy as a holistic, open, and complex system that faces the challenge of the Coronavirus pandemic. Like any challenge, this pandemic requires creative thinking, forcing humanity to reconsider its entrenched perceptions. The necessary adjustments in this new situation will dictate our future reality.

Using the Open complex system diagrams as a base for driving rational decisions 

The Coronavirus crisis is forcing the global system to cope with unexpected rhythmic perturbations. The dynamics of the complex crisis can be represented in a chart depicting plausible growth trajectories for an open and complex system, which is jolted by the Covid-19 shock and send the system to find a new dynamic equilibrium.

As in any other evolutionary process in the universe, this process also results from an unexpected break in symmetry. The blow to the system causes a shock that rattles the old and familiar order. The system is forced to respond to this aberration, in order to achieve a new equilibrium, at a new level of complexity. The nature of the response dictates whether the system faces growth or declination.

The horizontal line symbolizes the axis of symmetry and is suitable for describing a shock that does not change the baseline conditions and does not require change or reorganisation on the collaboration level. The restoration of the economy is done in a fast and symmetrical business cycle, similar to the English letters V or U, which describe a return to symmetry over a longer period of time.

The curvilinear trajectories describe fluctuations in symmetry breaking business cycles, forcing the system to change the level of complexity and collaboration, so that it can be stepped beyond the familiar growth boundaries.

This restoration process is depicted in the following diagram, where an increase in the level of collaboration and complexity will lead to an acceleration of growth, to a new and unfamiliar scale. Alternatively, the system collaboration can be limited, thereby reducing the level of complexity and collaboration. This situation can be represented in the diagram as the waning standard of living, as the system does not utilize the force of its relative advantage, which is accelerating growth.

Similar to natural environments, rigidity won’t win, but rather flexibility and adaptability. The flexible response allows the system to operate in a more “complex” way, in the sense of added collaboration between all its components. Collaboration leads to the exertion of synergism at all levels and fields, including the exchange of knowledge as well as economic, medical, and social partnerships.

The inherent danger in global non-cooperation is immense. A government response lacking a united global cooperation with other governments will lead the leaders to operate in different ways at a “zero-sum game strategy”, under great uncertainty and resource scarcity. The symptoms of this shock appear in the daily death toll, the collapse of healthcare, in the severe economic declination and the rise in unemployment as well as in social stress.

Amidst the great chaos we are experiencing and the diverse response which characterizes the countries’ strategy at this time, several weapons can be found in the arsenal. These coping tools depend on the future projections that each administration adopts – when will a vaccine be found? When will it be possible to return to normal? And will the routine be similar to the one we knew on the verge of this crisis?

Each forecast scenario sprouts a different response strategy:

Rapid economic rehabilitation, similar to V shape

This strategy uses the “as if there was no crisis” concept in order to preserve the economy and employment for a short period of time. It includes the governments’ guarantees that no business will be harmed and that the standard of living will be relatively maintained.

The purpose of the strategy is to return to the consumption and functionality as before the crisis emerged. Underpinning is the argument that this symmetry should be preserved, and “what has been will be again”, so there’s no requirement for a deep adjustment or even a change in the complexity. The aim is to stabilize the prices mechanism in the capital market, perceiving it is the best response in order to stabilize the liquidity and trading system.

The V Strategy believes in quick money dispersion using “the Helicopter Ben” method. This method is named after Ben Bernanke, the Chair of the Federal Reserve, in the central bank of the United States during the financial crisis in 2008, who dispersed US dollars in unprecedented amounts for the sake of stabilizing the system.

These actions included massive capital inflows into the United States financial system, including temporary or effective nationalization of banks, financial institutions, and giant corporations such as the automotive industry, which was eventually rescued by President Barack Obama.

These price mechanism stabilization actions also included the purchase of massive amounts of “toxic” assets, such as mortgages and homes, and even the prevention of real estate transactions at a loss. This policy was implemented to freeze the defective price mechanism and to prevent a vortex resulting from a contraction in prices and an uncontrolled value, which could lead to an overall financial collapse.

Back in 2008, the solution was to fight the financial crisis deriving from poor pricing of financial and real assets by “acquiring and nationalizing the temporary loss”, with the justification that the price problem will be resolved when the routine returns – which in fact it did.

The current crisis is not financial (yet), but it is proceeding there in huge strides. In essence, a demand crisis deriving from movement restrictions and fear of human lives, much like a total war whose end is unknown.

Since the future nature of the economy is also unknown, the use of a fiscal and monetary strategy for fast money diversification may be dangerous. Immense resource allocation to stabilize the price mechanism and standard of living, immediately depends on the rate of return to routine, and if it is slower than expected, the economy may find itself unresponsive and may face a deeper crisis.

Economic rehabilitation in the shape of Nike’s logo.

This strategy is describing a gradual return to a new economic routine. Its purpose is to survive the crisis and to streamline the allocation of resources for a longer period of time, due to the uncertainty regarding the date of return to normality and full demand. This strategy puts the priorities ahead of the survival of the real economy and employment fabric, with the goal of allowing to return to full employment with greater certainty, over a longer period of uptake and recovery.

A differential assistance strategy is similar to an emergency, and involves a very careful allocation of resources similar to respiratory intensive care to those who need it. Fiscal and monetary assistance is managed sparingly, serving only survival needs for companies, as last-minute funding.

The goal of this strategy is to extend the timeframe of economic infrastructure preservation. The increase in absorption capacity will come from the utilization of private capital found in corporate profits. It will come at the expense of eroding the surplus contained in corporate equity, rather than sweeping fiscal assistance.

This strategy replaces huge cash flows in the tedious work of the banking system to restructure debt, to a very large number of companies, whose purpose is to smooth the cash flow anomaly during the crisis period over the long-term yield curve. It harms the value of the companies’ “asset value”, and is likely to erode equity prices in the immediate term, as is already the case today. But if investors believe the government is managing the process in a tough but effective way, and with a long-term view, the certainty component is likely to rise in the seemingly chaotic environment, too, and with it the companies’ value will rise.

It is important to remember that the current crisis is not systematic, and that the presence of a vaccine may similarly bring the situation back to normal.

The emergency survival strategy uses all tools, including regulatory ones. For example, a change in trade laws which lead to cancellation of contractual rights, such as the right to a full rent for retail assets in a time of quarantine. Another tool is reductions in fees and taxation, in order to ease the burden of fixed spending in a world where demand has suddenly ceased. Moreover, the administration can instruct the private banking system to take high credit risk and massively reorganize debts.

The purpose of emergency changes will be to distribute the burden on the value chain, and fiscal support will only reach those who have lost their fortune and need assistance due to the stagnation implications.

The likely results in each of the western countries’ strategies, led by the US, is a significant challenge against the prospects of rapid growth. Already before the crisis, America broke records of debt-to-GDP ratios and now has to cross new boundaries. Huge public debt, significant GDP loss, and the uncertainty of the effects of this crisis on financial security, consumer habits, the nature of employment, practices, trade in the physical space, medical needs and more – will lead to immense difficulty in preserving what was in the past, and returning to symmetrical balance.

I will try to draw some predictions regarding the new organization of the global economic system:

  1. Countries’ retreat to an “anti-globalization” strategy, while striving for as much as possible existential independence, in the “Autarky economy” style for essential products. This outlook is likely to lead to entrenchment and dismantling of old alliances and a substantial retreat in economic growth.
  2. Forming opportunistic alliances of democracies with centralized administrations, while breaking existing frameworks and maintaining security and civil compromises. For example, a major country like Italy could have strategically joined China if it did not receive generous assistance from other democratic countries or the EU.
  3. Democratic alliances will be renewed and intensified, forming a discriminatory trade block against centralized economies. This forecast is based on the continued trade battles led by the US.
  4. Empowering global cooperation between democratic states and centralized policies. Waving moral judgment and replacing it with the concept of “a state will live by its faith” will lead to higher economic cooperation at the global level.

The preferred rational solution

The fourth option, which is described as exponential growth in the above open system model, requires a change in existing perceptions, and an increase in complexity and economic cooperation. Let’s take, for example, dealing with the multibillion-dollar debt that the West owes to China. This debt existed well before the crisis and will probably grow even more in its wake.

And here again, a huge explosive potential is developing in the international system, fuelled by an extreme uncertainty, fed by unprecedented debt burdens, unimaginable death toll, economic and civilian despair, and many other elements.

This explosive potential is just awaiting arson, so the narrative of trade wars that the US has been leading in recent years are very dangerous these days. Already now, opinions are being voiced by government officials, who claim that China’s debt should be dropped for its responsibility in the Coronavirus crisis.

Offensive unilateral financial strategies, which could jeopardize the Chinese administration, could lead to a military confrontation which could accelerate the international vortex.

Facing the high risk of taking these offensive strategies, the described model offers another and a preferred option, which is extending the cooperation and complexity even further. This option appears in the fourth forecast.

The Corona crisis presents an opportunity to change the governments’ aspiration to shape the world in their own image. The principle of “a country will live by its own faith ” may pave the way for economies to be salvaged quickly and even accelerate their own growth.

The current aggregate economy is similar to a large and diverse business system facing “bankruptcy”. Since the greatest debt burden is governmental, and the interdependence is very high, the following rational solution can be applied: Converting the Chinese debt into passive financial investments in Western economies. Instead of debts, the Chinese will hold rights to profits from Western economies. These will be dividends of peace, which means that the Chinese will benefit from the growth of Western economies. After all, it is the best and the inevitable investment in the whole world.

Chinese investments in the West can be channeled into several key avenues:

  1. Directing resources to invest in national infrastructure in the West while obtaining passive rights to investment dividends. The investment will generate variable profits which will be translated into dividends (rather than interest rates) for very long periods so that by effective weighting, this investment will be more preferable to holding a passive debt (moreover as the existing alternative is a debatable debt from a collapsing economy and a contradicting situation). It  is possible to put limits to the dividends yield in the form of a “band” with minimum floor and maximum ceiling so that the investment is financially preferable
  2. Converting the debts to passive investment, both in debt and equity, so the entire portfolio will reflect the growth of the US economy. Even with such a conversion, a yield range can be given to a minimum and maximum range, so that the budgetary exposure is minimal and directed to ensure only a protective safety net.
  3. Increasing the scale of Chinese direct investment in Western economies without taking over, in any other combination.

The benefits of implementing the fourth possible option for a new organization of the global economic system global are clear and immediate because the proposal is based on restructuring of numbers and value metrics on a timeline. The following are examples of quantitative benefits for all parties involved.

Benefits to the West:

  1. Immediate upturn in debt / GDP ratio
  2. Immediate investments in growth
  3. Increase in employment
  4. Increase in consumption
  5. Quick return to growth
  6. Strengthening the economy and currency
  7. Strengthening the long-term partnership between China and the West, while increasing partnership over creditor relations
  8. Transition into a responsible and equitable global economy
  9. Reducing spend on defense

Benefits to China:

  1. Converting risky debt into safe capital investment in leading economies in the West
  2. Preventing economic decline as a result of a contradictory response from the West
  3. Accelerating growth from export to the West due to the eradication of trade wars
  4. Avoidance of debt omission
  5. Strengthening the economy and currency
  6. Strengthening the regime
  7. An upgrade in the involvement of global management
  8. Avoiding short-term war risks towards the West, which is more powerful today
  9. Reducing spend on defense

Facing the challenges ahead.

Looking ahead, there are quite a few other challenges: global warming, new viruses etc. But it is quite clear that the option of collaboration and rapid change of perspectives is the required point of view at the moment, just as the US has done in the past in with the Burton Woods deal and the New Deal.

A global collaboration will enable the global economy to embark on a rapid growth path while increasing the complexity and collaborating in resources and knowledge, as well as focusing on the governance of human health. This is also the conclusion to be drawn from the Coronavirus crisis. This crisis makes us realize that the differences in military and economic power relations are eliminated when an external threat to the human race emerges. The threat requires us to work together for the sake of overall survival.

 

 

About the Author
Boaz Benrush is an entrepreneur and a partner in a credit fund based in NYC that specializes in funding companies in special situations.
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