DESPITE the most recent scientific literature tending to argue against the efficacy of lockdowns in preventing the spread of Covid-19, we observe a generalised political will insisting on that strategy as though it were the only one at disposal. Alternative (and most effective) solutions are even not taken into account. 

Instead, more general agreement can be found on the fact that lockdowns produced the worst economic crisis since 1929, adding on the greatest experiment in social engineering (to curb individual and social liberties) since the times of Hitler, Stalin and Mao. I will not mention here the very well-known data about the GDP, but I will just remind that last year unemployment in Malaysia reached the peak of 5.3%, while it is now between 4.5 and 5%. Malaysia’s unemployment rate reached “only” 4.5% at the peak of the 1998 financial crisis, while it was around 3.3% before the Covid-19 emergency exploded. 

At the same time, it has to be added that the crisis generated by movement restrictions is terribly regressive: the poor are paying a disproportionately high price and it seems that the world is jumping back to an era in which things like travelling were a prerogative of the rich.  

While the number of infections and deaths are on the rise, everybody is wondering when this nightmare will come to an end, and we wait with anxiety for Q1-2021 GDP figures. Unfortunately, there is no sign of a radical change in the anti-Covid strategy, and therefore I have little hope in a fast improvement. The vaccination campaign, at the same time, is rolling out slowly. 

Each one of us hopes for the end of the pandemic and a prompt economic recovery. Unfortunately, I fear that we may not have yet seen the worst from the economic perspective, and that an economic crisis may hit Malaysia and the world precisely in the moment when we will think to be at the inversion point. Such considerations arise from the uncomfortable news we have about inflation, and the emerging of stagflation as a mix of rising unemployment and rising prices. The economic system follows its laws… As mentioned, in the attempt of slowing the spread of the virus, the Malaysian government (together with most of the world ruling classes) imposed movement restrictions which have, in turn, worsen the economic conditions of the nation. In order to address the wounds created by the lockdowns, the government intervened in the economy with expansive fiscal policies (which is not here the place to debate). At the same time, Bank Negara has maintained a low interest policy in the belief that such a policy would be beneficial for the economy (although I do not believe in the automatic and magical powers of low interest rates, as I argue here.

Unfortunately for us, economic policies do have consequences, intended and unintended. The main problem generated by these expansive policies is that they created a dichotomy between the real economy and the monetary or financial situation. In fact, on one side we have a real economy in troubles: jobs are destroyed, capital investments abandoned, businesses closed for good; these phenomena create deflationary tendencies. On the other hand, instead, fiscal stimuli and low rates created an excess of financial means available in the market, in contradiction with the situation of the real economy (or, as it is more appropriate, of the production structure); this is creating inflationary pressures.  

This dichotomy is what is creating the premises for the next economic crisis. In fact, the artificial creation of financial means will impede the deflationary process which we need in this moment. First of all, the availability of financial resources will drive entrepreneurs toward investments that would had not happened otherwise. However, consumers will not necessarily save more to finance the new investment decisions (their purchasing power is still compromised and further weakened by inflation). At the same time, however, entrepreneurs regard the present supply of capital and the present rate of interest as an indication that approximately the same situation will continue to exist for some time.

As we are observing for nine or 10 months now, this situation initially brings about an increase in prices of raw materials and of the capital goods produced with them. At the same time, demand for labour increases, to attract workers towards the new investments, making relative wages to increase: this in turn encourages demand for consumer goods and their prices also increase. The inflation initially seen only for raw materials spread toward consumer prices. 

In order to be sustained, this process requires further credit expansion which would bring about a cumulative increase in prices that sooner or later would exceed every limit. At a certain point, the interest rate cannot but rise, forcing investment projects to be abandoned (capital destruction). 

We may find ourselves in the situation that, at the peak of the recovery, the economy discovers that it is unable to sustain a production oriented beyond its possibilities (because it was on artificial support). Demand for capital goods runs out. Many economic initiatives set up relying on excess liquidity cannot be completed, although the debts still have to be paid. Many companies have to be expelled from the system. Capital is scarce and banks raise interest rates. The period of readjustment that follows is called economic crisis or depression.

This will add tensions to the fragile situation of Malaysian households, whose debt already reached 93.3% of the GDP. During the recovery, furthermore, innovative debt practices and speculative excesses are encouraged and an unrecognised system fragility can emerge (look in example at the recent proposal for affordable homes advanced by the BMF).

Our economy is therefore on the verge of a perilous turn. If the inflationary tendencies are not taken seriously and instead the dichotomy between the structure of production and the financial system is further incentivised, we may experience a severe economic crisis precisely when the post-Covid recovery will seem to be walking on solid ground.

We need to allow deflation to happen in order to restore purchasing power and to rebalance the financial situation with the real economy. This will allow investments to be driven by consistent saving decisions and the recovery to move on to more stable territory. – May 9, 2021.