This Week in COVID-19 and Economic Diplomacy: ‘An Economic Sinkhole, not Pothole’

Our weekly COVID-19 and Economic Diplomacy tracker looks at policies that impact the coordination of international governments and central banks, ongoing commentary and analysis, and asks what these turbulent times mean for economic diplomacy. 

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The Highlights

• U.S. GDP fell 9.5% in the second quarter. Fed presidents call for Congressional action as the administration and Democratic congressional leaders continue to negotiate a second stimulus plan before August recess begins next week.
   
• Europe continues to show signs of economic recovery with Spain and Italy manufacturing sectors improving. The EU continues to fine-tune the terms of the recovery fund including a rule-of-law mechanism which would impose financial sanctions on countries undermining fundamental freedoms. 
   
• Argentina negotiated a $65B debt deal with its biggest creditors. China, South Korea, and Japan’s manufacturing sectors grew signaling Asia’s gradual economic recovery from the pandemic. 

U.S. Developments

As the U.S. surpasses 155,000 deaths, Congress continues to negotiate a new stimulus bill to stem the economic fallout of the pandemic. 

• GDP fell 9.5% in the second quarter. The equivalent of a 32.9% annual rate of decline, the drop would have been even more severe without government aid to businesses and households. More than 1.4 million Americans filed new claims for unemployment with an additional 830,000 people filing for benefits under the federal Pandemic Unemployment Assistance program. In total some 30 million people are receiving unemployment benefits. The steep decline would have been a “necessary blip while [the U.S.] addressed the virus,” stated Heather Boushey, president of the Washington Center for Equitable Growth. Germany experienced an even steeper drop in the second quarter but shows signs of an economic rebound in recent weeks as coronavirus cases remain low. 
   
• Negotiations between Trump administration officials and Democratic congressional leaders resume. Treasury Secretary Steven Mnuchin and White House Chief of Staff Mark Meadows will meet with Speaker Nancy Pelosi and minority leader Senator Chuck Schumer. It is unclear whether a deal will be made before August recess begins next week. Already, tens of millions of Americans have lost unemployment benefits and a federal moratorium on evictions. Democrats propose a $3T plan that would restore $600/week unemployment benefits through January and provides $900B to states and cities whose budgets have been decimated by the pandemic. Republicans are pushing a $1T “skinny package.” While Democrats are seemingly united behind their $3T plan, that is not the case for Republicans. Some Republicans are worried about the stimulus bill’s effect on national debt. Moreover, President Trump complicated negotiations with Republican lawmakers and aides acknowledging “they lost a week of valuable negotiating time just trying to get on the same page as the administration.”
   
• On a call with reporters, president of the Federal Reserve Bank of Chicago Charles Evans stated that the central bank had limited room to do more and that “the ball is in Congress’s court.” The Fed has cut the interest rate to near zero and has no plans or desire to pursue negative interest rates. Evans mentioned that the Fed could cap certain interest rates using yield curve control but that this did not address the real economic problem. His sentiments for a stronger fiscal policy response have been echoed by other Fed Bank presidents. Richmond Fed president Thomas Barkin warned that the pandemic may be creating an economic “sinkhole, not pothole;” Minneapolis Fed president Neel Kashkari that the government should spend more to support the economy.
   
• Democrats introduced legislation requiring the Federal Reserve’s mission to include reducing racial inequality in the U.S. economy. Though the bill is not expected to pass Congress, it illustrates a growing consensus among Democrats that the Fed has contributed to deepening inequality. The legislation requires the Fed chair to discuss disparities in income, wealth, and employment and how the Fed plans to address them. Critics of the bill state that the Fed’s toolkit is too limited to address systemic societal inequality and instead argue it is Congress’ job to do so.
   
• Serena Ng and Nick Timiraos write in the Wall Street Journal on how the Fed became the backup lender to the world. Its most significant yet least noticed expansion of power, the Federal Reserve bought a record $450B in Treasurys from investors and lent nearly $500B to counterparts overseas. This has left the world even more tied to a single country’s economy and central bank giving the U.S. enormous power. 
   
• The $660B Paycheck Protection Program has given $192M to $419M to more than 125 companies that Chinese entities own or invest in. In a study conducted by Horizon Advisory, at least 32 Chinese companies received loans worth more than $1M; these large loans totaled as much as $180M. Legislation allowed American subsidiaries of foreign firms to receive loans. The report acknowledges that by receiving the PPP loans, these companies likely saved a number of U.S.-based jobs. However, these businesses likely had access to other forms of capital. Businesses ranged from real estate companies to critical sectors such as pharmaceuticals, defense, and advanced manufacturing, to the financial technology sector.  

European Developments

Despite experiencing steep economic losses, Europe’s economy shows slow signs of recovery. 

• France’s minister for European affairs stated that the country will push for a tough rule-of-law mechanism as part of the €750B recovery fund given recent developments in Poland and Hungary. Countries accessing recovery funds who do not support fundamental rights such as a free media, democracy, and equality will face financial sanctions. The final agreement kept vague the precise nature of the mechanism amid resistance from Warsaw and Budapest. 
   
• Spain and Italy’s manufacturing sectors show signs of improvement as Europe slowly recovers from the pandemic. Spain exceeded expectations, hitting 53.5 in the IHS Markit purchasing managers’ index, despite being the hardest hit European economy during the March-April period of the pandemic. However, Spain’s GDP contracted by 22% in the first half of 2020, wiping out seven years of economic gains with 1M+ people losing their jobs. Italy’s manufacturing sector expanded for the first time in two years but foreign demand remains weak and factories may not be operating at full capacity. Though the numbers are signs of improvement, overall economic recovery remains to be seen. The Economist explores how Italy could potentially use its monies from the recovery funds.

Emerging Markets

• Argentina reached a deal with its biggest creditors to restructure its $65B debt in foreign bonds. The deal will prevent the country’s exclusion from capital markets as happened after its 2001 default. Some of the country’s largest creditors banded together to show a united front. The terms of the deal include making some debt payments sooner than expected and a recovery value of ~55 cents on the dollar. Though bondholders still need to vote on the deal, there is little worry that creditor groups will not approve the deal. If passed, this agreement opens up a new chapter for the country’s debt negotiations with the IMF. It also allows the government to focus on its economic problems including its high inflation rate and overvalued official exchange rate. 
   
• The IMF warned that a surge in COVID-19 cases increases the risks of external debt crisis among emerging and developing economies. Countries which rely on oil, tourism, or remittance from migrant workers face losses in their current account balances equivalent to more than 2% of GDP. The report stated that persistent and pre-existing imbalances between global spending and saving increased the economic risks of the pandemic. 
   
• China’s factory activity expanded at its fastest rate in almost a decade in July. A private sector survey, the Caixin manufacturing purchasing managers’ index hit 52.8, exceeding expectations. China’s growing activity is another sign that some of Asia’s largest economies are recovering from the pandemic. Though South Korea and Japan have yet to return to growth in its manufacturing sectors, both countries had their best performances since February. 

Odds and Ends

• Hanna Love, Tunua Thrash-Ntuk, and Jennifer Vey write in a Brookings paper that community economic recovery efforts must address the “symptoms of disinvestment that COVID-19 magnified” and tackle systemic root causes. Structural racism within communities and neighborhoods has become starkly apparent during the pandemic and its disproportionate effect on communities of color. The paper provides steps to confront these structural inequities. 
   
• Shayla Love argues in Vice News that the pandemic has exposed the inequalities deeply embedded within the U.S. The pandemic has shown how much income, education, housing, race, and social status impacts health outcomes. 
   
• The Atlantic explores the fallout from the pandemic domestically within the U.S. and globally. Ed Yong writes a long-form deep dive into how the pandemic defeated America. Sarah Zhang explains how the coronavirus will never fully go away, even with a vaccine.
   
• Jeffrey Frankel, a professor at Harvard, pens an oped in Project Syndicate on the pandemic impacting emerging market and developing economies worse than developed ones and how the G20 debt moratorium falls short.