The global economy is heading for a major financial crisis. If the worst comes to the worst, it could be like the Wall Street crash of 1929. Perhaps with equally devastating political and economic consequences opening the door to populism. The debate on economic policies to get through the coronavirus is therefore much more than the simple trajectory of economic growth.

In the United States, Paul Krugman and Lawrence Summers disagree on whether or not President Joe Biden’s $ 1.9 trillion stimulus will lead to an output gap opening the door to inflation in the goods and services market. In Europe, economists disagree on whether servicing the mountain of debt is a sword of Damocles forcing economies to kneel down.

Calamity can enter through another door, however. Lax monetary policy combined with fiscal stimulus inundated the economy with liquidity. The intention is purely Keynesian in saying that if private demand weakens, the public should step in to keep total demand unchanged. So far, so good.

Unfortunately, this correct policy, in theory, fell through because those who got their hands on the money were those who already had enough and not those who lost in the first round of the coronavirus pandemic. These people do not see the need to buy more goods and services. Instead, they inject money into the market for assets such as stocks, property, bitcoin, and similar investment goals that are not part of the productive economy.

Asset prices have skyrocketed. Anyone who doubts that this is an anomaly should try to explain why the stock and real estate markets can be at an all time high at the same time as the gross domestic product (GDP) worldwide drops with around 3, 5% and 4.9% at an advanced level. savings. Disregarding sophisticated economic theory and turning to common sense is not sustainable.

As economics teaches, the ultimate goal of all economic activity is consumption. Therefore, the accumulation of wealth constitutes a claim on GDP to be converted into goods and / or services when the owner of the asset wishes. In a stable economy–in a kind of balance–the relationship between wealth and GDP allows economic transactions to shift from the market for assets to the market for good advertising services without disrupting the effects on the economy as a whole. The amount of wealth that asset owners wish to dispose of can be converted into goods and services at unchanged prices.

What happened after the coronavirus was that the total amount of goods and services declined, leaving countries poorer now than before the start of the pandemic. During this time, the total wealth increased. Individual wealth owners do not understand this, but assume that their greater wealth equals increased demand for goods and services to be bought back at a later stage. But it is in fact impossible for all the owners of wealth to do so at the same time as the wealth has increased and the quantity of goods and services has fallen. There are simply not enough goods and services.

Sooner or later, this mismatch will manifest itself among wealth owners. They will then react as they did to Tulip Mania in 1637 and the Wall Street crash in 1929 with a massive sale, which will suppress prices, steal a good chunk of a considerable part of their wealth, and make repayment impossible. loans taken out when interest rates were close to zero. The spillover effects on the real economy will follow a similar pattern with falling demand for goods and services pushing the world into recession, if not depression.

The question is, when will this happen? This will depend on the combination of continued asset inflation and the recovery of the real economy. If the world quickly returns to a growth trajectory, like the one before the coronavirus, then it may be able to buy time. If, on the other hand, global growth stays below the pre-coronavirus era, widening the gap between the amount of goods and services and rising asset prices, it can happen quite quickly. A wild card in the game is the US-China relationship. The political dispute has marred relations between the two largest economies and if it is having an impact on the economic and business climate, investors may wonder if the time is right to cut back on some of their investments. A third concern relates to bankruptcies in emerging markets and heavily indebted developing economies (public and corporate), which can bring down financial institutions in rich countries. A fourth concern is the uncertainty of the banking sector forced to accept deposits without any prospect of normal lending activity. He must surely be in a vulnerable position if things start to turn bad.

Joergen Oerstroem Moeller is a former State Secretary of the Royal Danish Foreign Ministry and the author of Asia’s Transformation: From Economic Globalization to Regionalization, ISEAS, Singapore 2019 and The Veil of Circumstance: Technology, Values, Dehumanization and the Future of Economics and Politics, ISEAS, Singapore, 2016.

Image: Reuters