A market
crash was coming, even before coronavirus
Cheap
credit saved the global economy in 2008. It just went on for too long.
By
Steven
Pearlstein
Columnist
March 9,
2020 at 10:02 p.m. GMT+1
This is
what panic selling looks like. When everyone wants to sell and almost nobody
wants to buy, prices suddenly stop having much to do with the underlying value
of whatever it is that is being traded. As the expression goes on Wall Street,
nobody wants to try to catch a falling knife.
But it’s
even worse than that when most of these stocks, bonds and derivatives have been
purchased with borrowed money. The wiseguys who now dominate the daily trading
on Wall Street — the hedge funds and private equity funds — typically put down
$1 or $2 of their own and their investors’ money for every $10 worth of the
securities they purchase.
What that
means is that when prices for these securities fall 10 percent or 20 percent,
the bank or hedge fund or private equity firm that lent the money for the
original trade, or took the other side of the derivative contract, has the
right to demand additional cash. The only way to get that cash is to sell
something. And in that way, selling begets more selling.
Ultimately,
all of these pieces of paper that are furiously being traded on financial
markets are tied to some company or some household in the real economy. And
that is where you run into the second problem. For it turns out that those
companies and households also hold record amounts of debt, which makes them
sensitive to any reduction in their sales or profits or normal income flows. So
even the prospect of an economic slowdown causes them to save more and spend
and invest less. While that is perfectly rational behavior on the part of any
business or household, when everyone does it at the same time, it becomes
something of a self-fulfilling prophecy, turning what might have been a modest
slowdown in the economy into a full-blown recession.
And who is
responsible for this record level of debt in financial markets, and record
level of debt in the real economy? That’s simple: the Federal Reserve and other
central banks around the world that pumped trillions of dollars in freshly
printed money into the financial system in the years following the 2008
financial crash to pull the global economy out of a deep recession. They did
that by buying up government bonds, mortgage-backed securities and, in some
places, common stock, in the process artificially propping up the prices of
those assets even as they drove down interest rates. While this unprecedented
“quantitative easing” probably saved the world from another Great Depression,
the central banks never quite got around to sopping up all that money when the
crisis had passed, as they originally promised. For to do so would have run the
risk of angering investors and politicians by disrupting what became the
longest bull market in recent memory.
The markets
are sending a message about the economy: The recession risks are real.
Instead,
they took the easy political course and allowed all that excess liquidity to be
used by banks, hedge funds, private equity funds, companies and households to
inflate a new round of financial and economic bubbles. And now that a
real-world shock to the economy and the financial system has hit in the form of
the novel coronavirus, what might have become a short but significant market
downturn looks to be turning into a full-blown financial rout.
At this
point, governments will once again have no choice but to step in to rescue the
global economy. As unfair as it may seem, the greater unfairness would be to
let billions of innocent people lose their jobs and their savings.
As a first
step, the Fed and other central banks will have to prevent the financial system
from freezing up by opening its credit windows to any bank or financial
institution in need of short-term cash. The New York Fed already took such a
step Monday morning by increasing the amount of money it will make available to
an already-strained “repo” market. And you can bet that in the coming days, the
Fed will follow up by making even more credit available to financial market
participants — lowering short-term interest rates, widening the circle of
institutions that are able to borrow from its “discount” window, and accepting
as collateral those loans stocks and bonds and other securities that nobody is
willing to buy.
In times
like this, the Fed and other central bankers would normally be buying bonds,
not selling them, to lower interest rates and increase the amount of liquidity
in the financial system. But these are not normal times. Global investors are
desperate to sell their risky assets while buying safe ones — bonds issued by
economically stable countries. Yet trillions of dollars of those safe assets
are now sitting in the vaults of central banks like the Fed. So even as the Fed
opens the spigots on short-term lending, it should begin selling its huge pile
of longer-term Treasury bonds and mortgage securities. At this point, there is
nothing economically “stimulative” about a 10-year Treasury yield of half a
percentage point, or even worse, a negative interest rate. And in a market
characterized by panic selling, lower bond rates will do nothing to encourage
investors to hold on to their riskier assets — if anything, they will only add
to the sense of panic. The right strategy for the Fed is to try to stabilize
markets by buying short and selling long.
Governments
can also help to stabilize markets by announcing their intention to borrow and
spend whatever it takes to tide over households and nonfinancial businesses
dealing with short-term cash flow problems as a result of the spreading
coronavirus outbreak. If governments can now borrow at rates of less than 1
percent, there is no reason they cannot share the benefits with households and
companies that can be expected to quickly recover when the outbreak has eased.
White House
advisers to give President Trump policy options for coronavirus response,
including paid sick leave
Expanding
unemployment insurance and no-interest loans to otherwise solvent small
businesses are obvious examples. Late Monday, U.S. regulators also issued a
statement encouraging banks to make accommodation to businesses and households
whose sales and incomes have been interrupted because of the virus spread and
may be having trouble keeping up with their loans payments
At the same
time, governments should take advantage of the steep drop in oil prices to add
to their oil and gas reserves, and lock in today’s low prices by buying
long-term supply contracts. The mere announcement of such initiatives will
immediately slow the decline in commodity prices and the share prices of companies
in the energy business.
The Federal
Reserve could also help to stabilize currency values around the world by
expanding its “swap lines” with other central banks — in effect, allowing
foreign countries to temporarily exchange their unwanted currencies for freshly
printed dollars.
What’s
important to keep in mind is that there are three things going on right now,
each of which requires slightly different strategies and treatments.
First,
there is the sharp but presumably brief global recession that will result from
the novel coronavirus, requiring short-term stimulus in the form of government
spending.
Second,
there is the usual financial panic that accompanies any dramatic change in the
economic outlook, which is as much a psychological phenomenon as an economic
one. It requires central banks to make available large amounts of short-term
liquidity even as they sell off their inventories of safe long-term bonds.
And third,
there is the huge and long-overdue correction in asset prices — stocks, bonds,
real estate primarily — after a decade of cheap and easy credit. In providing
short-term liquidity to financial markets, central banks have to take care not
to try to reflate these bubbles and allow prices to fall, debts to default,
risk to be re-priced and unsustainable companies to be shuttered.
The aim is
not to prevent this painful process from unfolding, but to ensure that it
unfolds in as orderly a fashion as possible.
Steven
Pearlstein
Steven
Pearlstein, a Washington Post economics columnist and the Robinson professor of
public affairs at George Mason University, is the author of “Can American
Capitalism Survive?”Follow
Global
economy
There will
be no easy cure for a recession triggered by the coronavirus
Simon
Jenkins
An economic collapse may have already begun and
globalisation will make recovery more difficult
Mon 9 Mar
2020 13.12 GMTLast modified on Mon 9 Mar 2020 17.21 GMT
The world
appears to be on the brink of a sudden recession. The economic disruption
caused by the coronavirus might put an end to what has been a heady decade on
the world stock market since, after the 2008 global financial crisis, low
interest rates and quantitative easing became the new normal. Today’s markets
are registering massive falls of up to 10%, unprecedented since 2008. Billions
of dollars and pounds are vanishing. It is Black Monday all over again.
The coronavirus
has shown a world vulnerable to fear of illness. We have yet to experience its
vulnerability to the economic consequences of that fear
Markets
were heading for a fall after a reckless few years, but what starts as a
classic “bear” plunge can drive a fall in global demand, stalled investment and
unemployment. At this point, the world faces something new. Most recessions
have confined themselves to one continent or two. But globalisation –
particularly the rise of China – has seen trade, migration and tourism dissolve
national, even continental, borders. As airlines and factories close down round
the world, the oil price plummets to half its peak.
When whole
economies quarantine themselves, everyone suffers. Modern capitalism depends on
the maintenance of demand and the dynamics of production. It depends on
confidence, that of millions of individual decisions, interacting with those of
governments. But the decisions of governments are motivated by politics and
ideology, viruses that no one can control.
During
medieval plagues, people turned to priests for advice, comfort and prediction.
Today we turn to scientists and doctors. Where their decisions have external
consequences, as today, we turn to economists. The easiest answer to a
pandemic-induced recession is to eliminate its proximate consequences. Do not
overly suppress people’s economic activity. Sustain demand and production, even
at some risk to those who may fall ill. People also die when economies go into
recession. There is a balance of risks to be assessed.
The
globalisation of this possible recession must make it peculiarly hard to
counter. The tools of economic recovery available to governments are national
not international. There is no global treasury to stimulate demand, pump cash
into circulation, subsidise employment and maintain investment. The instinct of
a nation’s government is now to self-isolate, build walls, impede congregation
and stifle trade. The body politic, when threatened, retreats by instinct
towards recession.
The
coronavirus has shown a world vulnerable to fear of illness. We have yet to
experience its vulnerability to the economic consequences of that fear. The World
Health Organization may be on the alert. So, too, should be the World Bank, the
IMF, the OECD, the G8 leaders and the world’s central bankers. Vast sums of
money may be needed to help the poorest victim nations. Sick economies are just
as morbid as sick people, perhaps more so. When the scientists are stood down,
the economists must have their day.
• Simon
Jenkins is a Guardian columnist
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