Supply Chains Will Shift, Digital Dollars Emerge After COVID-19

Post-pandemic, digital dollars will make their way across supply chains drastically reconfigured, and China will be out of the picture as the dominant U.S. trading partner.

Maybe only a little of that will be true. The digital dollars part, at least.

In an interview with Karen Webster, Dr. Paul Sheard, senior fellow at Harvard’s Kennedy School, said that COVID-19 has exposed some fundamental vulnerabilities in how goods travel the world.

But we may not see as drastic a shift toward reshoring, here in the U.S., as some might expect.

“The idea that supply chains could be disrupted because goods may stop flowing or borders may close – we didn’t really need to worry about that too much in the past,” noted Sheard.

The coronavirus changed all of that, of course.

Where We Are Now

At a high level, according to Sheard, the “sheer shock” to the system has been one where “if final demand is not there for those goods, that has ripples all the way down the supply chain.”

And in terms of magnitude, he noted that the pandemic spurred the biggest negative shock to aggregate, “final” demand that has ever been seen in the modern era, dwarfing even the downturn seen during the Great Recession.

We’re in a unique recession, he said, with government responses (read: stimulus) coming in waves to meet the challenges of economic activity that remains decimated as businesses of all types have had to shutter. The impact on the manufacturing sector has been less pronounced, but at the end of the day, pretty much everything is driven by consumer demand.

(If you picture the U.S. economy as traveling along a V-shaped recovery, Sheard said, then we’re roughly halfway up the “second leg” of the V.)

Don’t Count China Out

The V-shaped recovery shows that in all things, nothing lasts forever – including negative economic shocks. Activity has been bouncing back, even if we are nowhere near the levels seen pre-COVID. But as we re-emerge, governments, policymakers and businesses are rethinking their supply chains.

New issues – those surrounding national security, the dependence on PPE that is made elsewhere and where medicines are sourced and produced – now increasingly factor into how we get what we need from suppliers, and where those suppliers are located.

Reshoring may be a reflex, not surprisingly. But it may not last, according to Sheard.

“Some of the rhetoric here about supply chains being repatriated back on shore – probably that rhetoric is going to run ahead of the reality, because there’s a lot of glue in the system. There’s a lot of mutual benefits to countries and companies trading with one another,” he told Webster.

Those gains will not be given up lightly, he said. It’s not realistic to think that trade with China will disappear. Simply put, China is a massive economy that rivals the U.S. and has the potential to get much bigger.

As a measure of simple GDP, and adjusting for exchange rates, the U.S. is one-quarter of the global GDP and China is about 16 percent. After adjusting for purchasing power parity, and China actually surpassed the U.S. as the largest economy in the world a few years ago. But China is still a developing economy and is growing more quickly than the U.S. – so all signs point to China becoming a bigger and more formidable economic power.

“The U.S. and China have to coexist and will coexist. The question is how friendly or antagonistic is that relationship, and to what extent does the global economy and U.S.-China start to decouple,” said Sheard, adding that the challenge is moving to this period in history where there are two potentially hegemonic, very powerful economies and policies that don’t mix very well in terms of ideology and politics.

Intellectual property remains an area of contention (as demonstrated in pre-COVID trade negotiations), noted Sheard – where even if the U.S. demands some concessions, Beijing may not be able to grant them.

What Remains – With An Eye On Payments

Beyond the give and take of geopolitics, some changes to the economic, consumer and business landscape will remain. The shift to working from home is, and will, spur businesses to examine their real estate footprint or the need for business travel (with a positive impact, perhaps, on the environment).

And increasingly, of course, payments — which connect the links in all supply chains, after all – will continue to pivot to the digital realm.

With a nod toward digital currencies, Sheard noted that central banks “are looking at this out of the corner of their eye” – which they need to do, as they manage the very foundational pieces of the payments system. Libra might have been a wake-up call and a game-changer, narrowing the Fed’s and other central banks’ focus on what digital currency might mean.

“The Fed and other central banks can get obsessed in the financial markets about monetary policy, but yeah, the nuts and bolts of central banking is around payments and settlements. Everything ultimately is settled in central bank money – at least that’s the way the system works,” he said.

As the BIS and various countries have announced efforts to examine digital fiat, Sheard predicted there will be more innovation taking place at the central bank surrounding digital currencies, in tandem with private-sector players. (He cautioned that some efforts, at least near-term, will be the provenance of central banks alone, as they won’t want to “let the genie out of the bottle … it may leap beyond their control.”)

Privacy will be a near-term issue to grapple with surrounding digital currencies, Sheard said – but will be no show-stopper, as central banks will likely have the appropriate safeguards in place to counter money laundering and terrorism financing.

Halfway through the century, the way in which a lot of the things that we take for granted – including how the banking system operates and the way we pay taxes and use cash – will be quite different.

“The monetary system is always a story of innovation and evolution,” Sheard told Webster. “And I think we’re still on that trip.”