The legacy of various coronavirus (COVID-19) support spending is ringing alarm bells among analysts and some market participants, with some fearing that the combination of government funding shortfalls and the winding down of support measures in the coming months could cause a cliff edge that may tip the world economy into a crisis even worse than that experienced at the start of the pandemic.

On Tuesday, the Office for Budget Responsibility (OBR) warned in its latest Financial Risks report that UK government departments will face £10bn of “unfunded spending pressures” on average over the next three years due to the pandemic, adding that rising interest rates or a loss of investor confidence in the markets could be “catastrophic”.

“It’s still too early to say whether we’ll have more short-term upsets as new variants emerge, but even if the worst is over, the largest peacetime fiscal risk is going to leave a horrible legacy for public finances. The UK spend on relief measures during the pandemic was third only to the US and New Zealand as a percentage of GDP – at 16.2%. It was also huge on a historic UK scale. It was almost ten times the level of support given during the financial crisis”, said Sarah Coles at Hargreaves Lansdown.

“There’s also a risk surrounding the growth of public debt. We’ve been sheltered so far from much of the impact by low interest rates, but public debt is around three times higher than in 2008, so any changes in rates would have serious implications. Not only that but QE has shortened the length of maturity of government debts, which means interest rate changes feed into government costs faster, so it is particularly sensitive to rising interest rates”, she added.

Reddit trader fears 1929-style collapse

The US is also facing its own set of fragile economic circumstances as a result of the pandemic’s legacy, with even retail traders positing that the market could collapse as soon as October in a fashion akin to the declines seen during the 1929 Wall Street Crash.

In a highly voted post on the r/wallstreetbets forum on Reddit overnight, user u/catbulliesdog predicted that signs that a crash was coming were “everywhere”, highlighting Federal Reserve support for the banks as well as what they said was a bubble in the housing market that was “about to pop” when a moratorium on evictions ends later this month, which in turn will be made worse by a downturn in commercial property markets as businesses close down.

The user also flagged the surge in initial public offerings (IPOs) this year as another sign that the market was reaching a peak, adding that the resumption of US student loan repayments at the end of September will see the spending ability of young, mid to low level disposable income Americans “completely wiped out all at once”.

“We’re about to go down, way downtown, like 1929 down”, the user said.

The comments mirror previous statements made by ‘Big Short’ investor and fund manager Michael Burry, who said last month that the stock market is heading for “the mother of all crashes” once a bubble inflated by speculation in cryptocurrency and ‘meme stocks’ bursts.

In a series of now-deleted tweets, Burry said that hype and speculation in the market was drawing in inexperienced retail traders, meaning that when the bubble bust losses among ‘Main Street’ investors “will approach the size of countries”.

Climate change looms large

Elsewhere in its fiscal risks report, the OBR also flagged that climate change and efforts to reach net-zero emissions also posed a risk to the economy.

It said that early action to reduce emissions will add the equivalent of 21% of UK gross domestic product (GDP) to public debt over the next three decades, slightly less than the pandemic added in two years, however, the OBR warned that leaving action later and having to take more drastic steps to mitigate the effects of climate change would likely cost even more.

Exposure to risk increasing

Meanwhile, the report also warned that having already suffered two “once in a century” economic shocks in quick succession, the UK and other advanced economies were becoming “increasingly exposed to large, and potentially catastrophic, risks”.

“The past twenty years have seen an increase in the frequency, severity, and cost of other major risk events, from extreme weather events to infectious disease outbreaks to cyberattacks”, the OBR said.

The report added that the frequency of major crises, aside from impacting government revenue streams and public finances, could also “overwhelm private risk management and insurance mechanisms” and leave the government on the hook as an insurer of last resort.