April 20, 2020
What if we are wrong?
As the lockdown proceeds, some of our expectations are getting more entrenched. We cling to our own beliefs. Here are a few scenarios on which there seems to be an evolving consensus that might turn out to be wrong.
For starters, Germany might score a double-whammy: get the health response right and also the economics. The recovery will be V-shaped. What has gone down will go up. Italy will remain firmly on this side of debt sustainability. Coronabonds will not be needed. We are among those who have argued that this scenario is very unlikely. The lockdown could render many business models non-viable, or push those on the edge of viability into bankruptcy. But that expectation might be wrong. Maybe the story of this summer will be the great recovery after the great lockdown. People may really miss restaurants or large crowds, and head back to the cruise ships. This scenario would have a number of profound implications. If this were to happen, and if the global fiscal response turned out to have been massively exaggerated, even we could see the potential for higher inflation and thus for a sharp monetary correction later on. And in the eurozone, the eurobond debate would have ended for sure. Wopke Hoekstra would have been proven right. Eurozone crises would always have a happy ending. The moment for wider eurozone reform would be lost for good.
A second counter-intuitive scenario is a resounding success of Sweden’s mild lockdown. We keep an open mind on this point. But we noted that the lockdown has become a Brexit-like issue - an issue of identity politics. Sweden constitutes a rare counterfactual experiment. We will have data. The issue will not only be whether the measured mortality rate in Sweden will be higher than that of Denmark or Norway, but how Covid-19 compares to previous flu viruses. That comparison is impossible to make in all other countries because of the lockdown. But not in Sweden. If the Swedish mortality suggest that this was no worse than a bad flu season, governments all over the world may think more carefully about future lockdowns.
A third counter-intuitive scenario is a sharp reversal of the political incumbent effect in Europe. The crisis has pushed up the popularity ratings of most leaders, especially Angela Merkel and the CDU. CDU/CSU are now close to 40% in the polls, an unimaginable result only a few weeks ago. What this tells us is that even the German electorate is highly volatile. That 40% is probably the upper end of the scale. We are now back in a world where the two grand coalition parties could form another government. As we argued before, this situation would benefit Armin Laschet, the state premier of North-Rhine Westphalia, for the CDU leadership. He is the continuity candidate. But what if this scenario is reversed? What if the recovery is not V-shaped and people start turning against the government? People might support the lockdown now as a precautionary measure. But they may later turn against those who ordered it. The Greens, who have now fallen behind the SPD, might win the elections.
And finally, what if the biggest political winner from the virus turns out to be Donald Trump? As US politics is firmly outside our reservation, we refrain from making predictions. We noted Niall Ferguson’s strong forecast in the current edition of the Spectator that Trump will lose the election under all circumstances, so long as Joe Biden manages not to die. Could that be wrong?
Of course. For starters, it is more than six months until the elections. Trump’s scepticism of the lockdown is shared by many Americans. And as Trump takes on a much more confrontational attitudes towards China, he may create a broad anti-China sentiment in the rust belt states he will need to win. We have seen stranger political events in the last five years than those that would conspire to give Trump a second term.