The long
read
How coronavirus almost brought down the global
financial system
Illustration: Peter Reynolds
The crisis has brought the economy to a near
halt, and left millions of people out of work. But thanks to intervention on an
unprecedented scale, a full-scale meltdown has been averted – for now. By Adam
Tooze
Tue 14 Apr 2020
06.00 BSTLast modified on Tue 14 Apr 2020 11.40 BST
In the
third week of March, while most of our minds were fixed on surging coronavirus
death rates and the apocalyptic scenes in hospital wards, global financial
markets came as close to a collapse as they have since September 2008. The
price of shares in the world’s major corporations plunged. The value of the
dollar surged against every currency in the world, squeezing debtors everywhere
from Indonesia to Mexico. Trillion-dollar markets for government debt, the
basic foundation of the financial system, lurched up and down in
terror-stricken cycles.
On the
terminal screens, interest rates danced. Traders hunched over improvised home
workstations – known in the new slang of March 2020 as “Rona rigs” – screaming
with frustration as sluggish home wifi systems dragged behind the movement of
the markets. At the low point on 23 March, $26tn had been wiped off the value
of global equity markets, inflicting huge losses both on the fortunate few who
own shares, and on the collective pools of savings held by pension and
insurance funds.
What the
markets were reacting to was an unthinkable turn of events. After a fatal
period of hesitation, governments around the world were ordering comprehensive
lockdowns to contain a lethal pandemic. Built for growth, the global economic
machine was being brought to a screeching halt. In 2020, for the first time
since the second world war, production around the world will contract. It is
not only Europe and the US that have been shut down, but once-booming emerging
market economies in Asia. Commodity exporters from Latin America and
sub-Saharan Africa face collapsing markets.
It is now
clear that we can, if circumstances demand, turn the economy off. But the
consequences are catastrophic. Across the world, hundreds of millions of people
have been thrown out of work. From the street hawkers of Delhi to the personal
trainers of LA, the service sector – by far the most important employer in the
modern economy – has been poleaxed. Never before has the global economy
suffered a shock of this scale all at once. In the US alone, at least 17
million people have lost their jobs in the last three weeks. A severe global
recession is now inevitable.
The crucial
question is how much of the world economy will survive the lockdown, and this
depends on the availability of credit. Business runs on credit. The bits of the
economy that do continue to function – the warehouses, the mobile phone
providers and internet firms – all need credit. Wage bills for those still
working are financed through credit. Even greater is the need of those who are
not working. If they can’t get loans, bills will go unpaid, which spreads the
pain. To survive the lockdown, millions of families and firms around the world
are relying on grants and loans from the state. But tax revenues have
collapsed, so states need credit, too. Across the world we are witnessing the
largest surge in deficits and government debt since the second world war.
But who do
we borrow from? Banks, financial markets and money markets provide the
financial fuel of the world economy. Normally, credit is sustained by the
optimistic promise of growth. When that dissolves, you face a self-reinforcing
cycle of collapsing confidence, contracting credit, unemployment and
bankruptcy, which spreads a poison cloud of pessimism. Like an epidemic, if
left uncontrolled, it will sweep all before it, destroying first the financially
fragile and then much else besides. It is not for nothing that we speak of
financial contagion.
What began
with the lockdown in Wuhan in January is more intense and more fast-moving than
any recession we have seen before. In a matter of weeks we have been confronted
with an economic outlook that is as grim as at any moment since the 1930s. But
it could have been even worse. Imagine a situation in which, on top of the pain
of the lockdown and the hellish scenes in hospital wards, we also face calls
for austerity because the government cannot safely finance extra spending.
Imagine that interest rates were surging, and the terms for credit cards, car
loans and mortgages were suddenly getting stiffer. All of this may still
happen. It is already happening to the weaker economies around the world. But
for now at least, it has not happened in Europe and the US – even after the
turbulence of March 2020, when the pandemic hit with full force.
What Europe
and the US have succeeded in doing is to flatten the curve of financial panic.
They have maintained the all-important flow of credit. Without that, large
parts of their economies would not be on life support – they would be stone
dead. And our governments would be struggling with a financial crunch to boot.
Maintaining the flow of credit has been the precondition for sustaining the
lockdown. It is the precondition for a concerted public health response to the
pandemic.
During
major crises, we are reminded of the fact that at the heart of the
profit-driven, private financial economy is a public institution, the central
bank. When financial markets are functioning normally, it remains in the
background. But when they threaten to break down, it has the option of stepping
forward to act as a lender of last resort. It can make loans, or it can buy
assets from banks, funds or other businesses that are desperate for cash.
Because it is the ultimate backer of the currency, its budget is unlimited.
That means it can decide who sinks and who swims. We learned this in 2008. But
2020 has driven home the point as never before.
The last
six weeks have seen a bout of intervention without precedent. The results have
been momentous. A giant public safety net has been stretched out across the
financial system. We may never know what went on behind the closed doors of the
US Federal Reserve, the European Central Bank and the Bank of England during
those critical moments in March. So far, only muffled sounds of argument have
reached the outside. But as the virus struck, the men and women in those three
central banks held the economic survival of hundreds of millions of people and
the fate of nations in their hands. This is the story of how global financial
meltdown was averted by central banks taking decisions that, just a month
earlier, they would have dismissed as utterly impossible.
The
financial markets scan the world for risk. Even the slightest disruption in the
vast networks of finance, production and trade offers the opportunity for
profit or the threat of loss. So the news on 23 January, that the outbreak of
an unknown virus was serious enough for the Chinese authorities to impose a
gigantic quarantine, hit the traders on their Bloomberg terminals hard. Bank
economists struggled to get a grip on the dimensions of the problem. Would this
be a minor disruption like Sars in 2003? Or were we facing the nightmare
scenario of the Hollywood film Contagion?
In late
January, investors began to move more and more money out of things like
commodities and shares in companies, and into the relative safety of government
bonds. What comforted them was the idea that the virus was a problem contained
in China. The day that illusion burst – the day that investors realised that
Covid-19 was becoming a global pandemic – was Monday 24 February. Over the
weekend the Italian government had announced that it was imposing a quarantine
in parts of northern Italy. It was the first place in the west to do so.
Ever since
the financial crisis of 2008, Italy’s economy had been stagnating. Both its
banks and its public finances were in a precarious state. Italy’s debt levels
were high enough to cause bond markets to periodically panic. Now the country
would become the frontline in the virus fight. The coronavirus would test the
solidarity of the eurozone at its weakest link.
At this
point, not everyone was taking the threat seriously. The caseload in the US
still looked tiny. Donald Trump dismissed the virus as a “scare”. But investors
were now seriously worried. Over the week that began on 24 February, America’s
main stock market index, the S&P 500, lost 10% of its value. The chair of
the US Federal Reserve, Jerome Powell, was concerned enough to signal that he
would soon be bringing forward a cut in interest rates, in order to stimulate
consumption and investment. It was a conventional reaction, but Covid-19 was no
longer looking like a conventional threat.
By early
March, whatever complacency had prevailed was long gone. The death toll in
northern Italy was rising into the hundreds and it was only a matter of time
before the government in Rome would be forced to declare a nationwide lockdown.
Investors
around the world started to panic. In times of uncertainty, they want
safe-haven assets. What makes a government bond a safe investment is not only
the financial standing of the borrower, but the depth of the market in which
lenders can sell them if they want to get their money back sooner. There is no
deeper market than that for US Treasuries, as US government bonds are known.
The greater the demand for safety, the lower the interest rate the US
government generally has to pay to borrow. In the first week of March, those
rates were at record lows.
For the rest
of the world economy, this run to safety was an alarming signal. One sector
that knew it was heading for trouble was oil. When the global economy slows, so
does the demand for energy. The oil industry of the 21st century consists, on
the one hand, of large, state-controlled producers – above all the Opec group
dominated by Saudi Arabia and Russia – and, on the other hand, of the US’s
upstart fracking industry. To match falling demand for oil, the Saudis wanted
to cut overall production and thus prop up the price. For this they needed the
agreement of the other big producers, but Russia refused to go along with them.
As Moscow saw it, cutting production with a view to propping up prices was an
invitation to American shale producers to fill the gap. If the politics of
climate change meant that the future really would bring a transition away from
fossil fuel, winning the end game involved seizing as much of the market as
possible for as long as oil was being pumped. So Russia decided not to cut
production, but to launch a price war. Not wanting to be outdone, over the
weekend of 7-8 March, Saudi Arabia took up the challenge. It announced that it
would be maximising production and discounting its prices.
On Monday 9
March, as markets opened, oil prices plummeted. The benchmark Brent crude fell
24% by the end of trading. By the end of the month its value had halved. From
the point of view of the financial markets, the ferocity of the competition in
the oil industry was a harbinger of things to come. Falling demand would force
industry after industry to either slash prices or contract production. Either
way, it was bad news for profits.
When
trading opened on Wall Street that morning, the situation was so dire that the
circuit-breakers – automatic stops to trading that are triggered when prices
fall by a certain amount – were soon activated. This was supposed to slow a
wild selloff. But it sent a message of panic. As soon as trading resumed,
everything sold.
A rout like
the one that began on 9 March has a perverse logic. When fund managers face
withdrawals from the people whose money they manage, they need cash and have to
choose which assets to sell first. They might prefer to sell the riskiest
investments, but those can be disposed of only for a large loss. So instead,
they attempt to sell their most liquid and safe assets – government bonds. That
means the prices of those bonds fall, dragging them into the maelstrom. This
has the knock-on effect of unravelling a basic relationship on which many
investors rely: typically, when shares go down, bonds go up, and vice versa. So
to protect yourself against risk, you buy a portfolio made up of both. If
everything works as it’s supposed to, the swings should balance each other out.
But in the panic that began on 9 March, this was no longer happening: rather
than balancing out, the price of shares and bonds were collapsing together. The
only thing that anyone wanted to hold was cash, and what they wanted most of
all were dollars. The surging US dollar in turn spread the pressure worldwide
to everyone who owed money in that currency.
The Fed had
desperately tried to halt the run. To signal its willingness to support the
economy and ease the pressure on the world economy from the strong dollar, it
had brought forward an interest rate cut that had been expected for the middle
of the month. But with the darkening horizon, lower interest rates did little
to help. Who would borrow or invest under such circumstances? Confidence was
broken. Just how badly would become clear over the following two weeks.
It was a
cruel twist of fate that Italy was the first European country struck by the
virus. Italy has a sophisticated medical system; Lombardy, the region worst
affected by the virus, is among the richest places in the world. The weakness
lies in the country’s public finances. To fight the crisis, Italy needed to be
spending money on public health and to support the economy during the lockdown.
But would the corset of the euro give it the leeway?
The problem
was that spending to meet the coronavirus crisis would raise Italy’s public
debts. The more indebted you are, the higher the price you pay to borrow. For a
European government, that premium is measured by the difference, or “spread”,
between your interest rate and that paid by Germany, the highest-ranked
borrower in Europe. With its pre-crisis debt at just under 135% of GDP, Italy
was perilously close to the point at which rising spreads would drive up its
deficit and thus, in a vicious circle, make its debts less and less
sustainable.
To ensure
that investors stay calm, it is the job of central banks to act as the buyer of
last resort. But because Italy is a member of the eurozone, it no longer has an
independent national central bank that can buy its debt. Its monetary policy is
set by the European Central Bank, which is prohibited from directly buying a
member country’s newly issued debt. That left the Italians exposed. As the
coronavirus crisis intensified in late February and investors became concerned
by the prospect of greater state spending, the spread to German interest rates
increased. If they rose too far, Italy would face not only a public health
disaster but a financial crisis, too. What could Europe do to help?
Italy
already had reason to feel abandoned by its European partners: they had done
little to help it tackle its chronic unemployment problem, or to take in the
refugees arriving from north Africa. The coronavirus was a new test. The signs
were not good: other member states were grudging in their reaction to Italy’s
appeals for help. But what really mattered, for the country’s financial
survival, was the stance taken by the ECB.
Under its
former president, Mario Draghi, the ECB had emerged in the course of the last
financial crisis as the pivot of the European economy. Draghi’s promise to do
whatever it takes to hold the eurozone together, uttered at the height of the
crisis in July 2012, has become a mantra of modern economic policy. Faced with
a financial panic, restoring confidence is key – and because a central bank is
in charge of issuing currency, it is the only crisis-fighter with truly
unlimited firepower.
Northern
European fiscal and monetary conservatives had always been suspicious of Draghi’s
interventions, which they saw as a way to transfer Italy’s liabilities on to
Europe’s balance sheet. And his final round of bond-buying, in 2019, proved
particularly controversial. By the time he ended his stint at the ECB that
autumn, it was all Angela Merkel’s government in Berlin could do to ensure that
there were no unseemly scenes at his retirement party.
Christine
Lagarde, the former finance minister of France and IMF boss, took over as head
of the ECB in October 2019, and inherited Draghi’s extraordinarily difficult
position. Now she would have to demonstrate that she could handle a major
financial crisis. The ECB press conference on 12 March was the crucial test.
The ECB had
good news for Europe’s banks: they would receive a huge amount of low-cost
funding. It was also going to buy an additional €120bn in assets – although if
that was spread across the members of the Eurozone, as the rules demanded, it
would hardly give Italy the support it needed. But the critical moment came
when Lagarde was asked a question about the ECB’s attitude to sovereign debt.
Her response was remarkable. “We are not here to close spreads,” she said.
“This is not the function or the mission of the ECB. There are other tools for
that, and there are other actors to actually deal with those issues.”
“Spreads”
meant Italy. And what Lagarde seemed to be saying was that it was somebody
else’s problem. But if the ECB wasn’t going to help Italy, who would? Did it
really expect the other member states of the eurozone to string together a
fiscal safety net for Italy? Obviously, given the bad blood between Italy and
the northern Europeans, Lagarde had to walk a fine line. But with hundreds of
people dying every day, with global financial markets in a state of repressed
panic, was the ECB seriously suggesting that it would wait for Berlin, Paris
and Rome to settle their differences before putting out the fire? It was
breathtaking.
For
investors, Lagarde’s comment came like a bolt of lightning. And within minutes,
she started to backtrack. She went in front of the cameras to promise that the
ECB would use the flexibility of its €120bn programme to prevent the
fragmentation of the euro area – code for helping Italy. But the damage was
done. The markets slumped, and the price that Italy had to pay to borrow
leaped: averaged out, the spread moved by 0.65%. That may not sound like a big
difference, but when applied to a mountain of debt the size of Italy’s, it
raises the interest bill by as much as €14bn for just one year. It was the last
thing Italy needed. In a rare public rebuke, both Paris and Rome distanced
themselves from the ECB. The crisis was pulling Europe further apart.
After five
terrifying days of market turmoil, the weekend of 14-15 March was a moment for
central banks around the world to coordinate their response. What everyone
wanted was dollars, so it was above all the Federal Reserve that needed to take
the lead. And as its chair, Powell did. He called an unscheduled press
conference for the afternoon of 15 March. What he announced was remarkable.
With
immediate effect, the Fed was cutting interest rates to zero – something it had
done just once before, at the height of the crisis in 2008. To stabilise the US
Treasury bonds market, it would be buying $700bn in a new round of so-called
quantitative easing. And it would start big, buying $80bn by 17 March. In the
space of just 48 hours, it would spend more on treasuries than the Fed spent in
most months in the aftermath of 2008.
These were
measures for the US economy. But the coronavirus was a global problem. The
flight to safety and the ensuing rise in the dollar had put pressure on
everyone who had borrowed in the US currency. So, to ensure that dollars could
be piped to every financial institution in every major financial centre in the
world, the Fed announced that it was improving the terms on the so-called
liquidity swap lines – deals by which the major central banks agree to exchange
dollars for sterling, euros, swiss francs and yen in unlimited amounts.
Powell was
deploying the main weapons of the 2008 crisis with far greater speed than his
predecessors ever had. But it was still not enough. When the markets opened the
next day, 16 March, the fall was vertiginous. The circuit-breakers are supposed
to come into effect if the market falls by more than 7%. That morning, the fall
was so quick that the S&P 500 dropped by 8.1% before trading could be
stopped. The so-called fear index, VIX – a measure of market volatility –
surged to levels last seen in the dark days of November 2008.
The fear in
the markets was now feeding on itself. If the Fed’s magic of 2008 no longer
worked, then what would?
The foreign
exchange market, where currencies are traded, is the biggest market in the
world. And the place where the most transactions are booked is the City of
London. On an average day, transactions back and forth total $6.6tn. But on
Wednesday 18 March, there was only one trade: people wanted to sell everything.
The only thing they wanted to buy were dollars. Every other currency was falling.
The central
banks’ failure to calm the markets had set the stage for the worst days of the
panic. Coronavirus cases were piling up in Europe more rapidly than at the peak
of the crisis in Wuhan. Hedge funds were placing multi-billion-dollar bets that
the recession in Europe would be protracted. Blue chip companies like Apple
were facing stiff premiums to borrow for as little as three months ahead. Even
gold, a classic safe haven, was selling.
That
Wednesday, on his third day as governor of the Bank of England, Andrew Bailey
organised a press conference in an effort at reassurance. But as he was
speaking, sterling plunged by 5% to its lowest level since 1985. Meanwhile, the
market for UK government bonds, also known as gilts – the oldest major asset
market in the world – was witnessing unprecedented turmoil. It was, in Bailey’s
understated phrasing, “bordering on the disorderly”.
In
response, the Bank of England monetary policy committee met the next day in
emergency session and announced that the Bank would be buying £200bn in gilts.
Unlike in 2008, it would not be doing so on a prearranged schedule. As Bailey
explained: “We will act in the markets promptly and rapidly as we see
appropriate.” This was no time for timetables. The central bank was, by its own
admission, flying by the seat of its pants.
On an
emergency conference call on the evening of 18 March, the ECB executive board
decided that it, too, needed to act. Under a pandemic emergency purchase
programme, it announced that it would begin by buying €750bn of government and
corporate debt. But the ECB was willing to go even further than that. It said that,
if necessary, it would revise some of its “self-imposed limits”.
For an
institution as hidebound as the ECB, this amounted to a revolution.
Self-imposed limits – inflation targets, rules on which European government’s
debt it could buy and in what quantities – are what the ECB lives by. It is
clear that conservative members of the bank’s governing council continued to
resist such a move. But in the end it was the turmoil in the markets that
decided the issue. The ECB needed to send a signal of determination. If Lagarde
had fluffed her “whatever it takes” moment, the ECB was now at least promising
to do whatever was necessary.
By the end
of the third week of March, 39 central banks around the world, from Mongolia to
Trinidad, had lowered interest rates, eased banking regulations and set up
special lending facilities. To ease the pressure on emerging markets, the Fed
widened the network of liquidity swap lines to cover 14 major economies
including Mexico, Brazil and South Korea. This was a remarkable wave of
activism. But the pandemic itself was only beginning to bite. Central banks
could cushion the financial shock, but not address the actual economic
implosion, let alone the health crisis.
European
governments had been quick to move. Germany had thrown aside its fiscal caution
and was committed to a gigantic programme of government guarantees for business
lending. But this made all the more glaring the gap to Italy and Spain, which
were not only hardest hit by the virus, but also constrained by the financial
legacy of the eurozone crisis. They did not want to risk sliding back into a
debt crisis.
In the US,
the Fed had leaped into action. But where were the politicians? Congress was
distracted by the upcoming presidential election. What was needed was an
unprecedented rescue package for an economy in freefall. How were Republicans
and Democrats to reconcile fundamental differences over health care and
unemployment insurance, or the notorious cronyism of the president and his
clan? Since the Democrats had won control of the House of Representatives in
2018, legislation had been largely paralysed. Now, in the face of a tsunami of
job losses, the two parties had to come to an agreement.
As trading
began in Asia early on the morning of Monday 23 March, the news from Washington
made it clear that there had been no deal on Capitol Hill. The futures markets
plunged so violently that circuit breakers were activated again – by now this
had happened an unprecedented five times in two weeks. If it wanted to avoid a
meltdown when Wall Street opened, the Fed would have to make another move.
Until this
point, Jerome Powell had been moving in the shadow of his predecessor, Ben
Bernanke, who had been Fed chair in 2008. But by 23 March, Powell had activated
all the basic elements of the 2008 repertoire – slashing interest rates, using
quantitative easing, supporting money markets. But it had not worked, partly
because it could not reach the source of the crisis itself – that is, the virus
and the lockdown – and also because it was not reaching the bit of the credit
system that was most vulnerable in 2020: the borrowing by big corporations.
The Fed has
always steered clear of corporate debt, which it considered politically
sensitive. If you bought debt from individual firms, you were vulnerable to
accusations of favouritism. If you bought a cross-section of debt you ended up
holding many very poor-quality loans. But by the early hours of 23 March, it
was clear that something had to be done to stabilise the corporate debt market.
Since 2008, bonds issued by non-financial corporations have surged from $3.3tn
to more than $6.5tn. If their value fell too far, US corporations would not
only face shutdowns and a complete loss of revenue, but also a crippling credit
squeeze.
Ideally,
the Fed would have made a grand announcement in conjunction with a
Congressional stimulus package. But by the evening of 22 March, it was clear
that the package being proposed by the Republicans was unacceptable to the
Democrats. It might take days for them to square the difference. The financial
markets would not wait.
On 23
March, 90 minutes before markets opened, Powell made his move. He announced
that the Fed was setting up legal entities – off the books of the Fed, but
guaranteed by it – that would have the capacity to buy highly rated corporate
debt, or at least any debt that the ratings agencies were still willing to
declare investment-grade. In effect, the Fed was establishing itself as the
backstop to the trillion-dollar corporate bond market. The Fed ramped up its
asset-purchase programme, to an astonishing $375bn in Treasury securities and
$250bn in mortgage securities in a single week.
It was an
extraordinary move to widen the scope of central bank intervention into the
corporate economy. And it was understood as such by the markets. Since the
start of the year, the S&P 500 and the Dow Jones, as well as the FTSE 100,
had lost 30% of their value. That day, they began to recover.
Two days
later, on 25 March, backing arrived from Congress when the Senate passed its
giant package of $2tn – more than twice the size of the stimulus bill passed in
2009. It provided funds to top up unemployment insurance, to support small
businesses and the US’s privatised hospital system. Crucially, it also set
aside $454bn to cover Fed losses. Since most loans would not be expected to go
bad, this would enable the Fed to make more than $4tn in loans, if necessary.
In the US,
the public health campaign against the virus was still a shambles. But as far
as economic policy was concerned, the full power of the American state was now
being deployed behind the emergency programme. And the Fed was also acting as a
provider of dollar liquidity to the world economy. In the UK, too, the Treasury
and the Bank of England were working closely to link the huge increase in
government spending to efforts to stabilise financial markets.
But in the
eurozone, that kind of coordination was lacking. The ECB had managed to stop
the immediate panic. Yet there was still the question of whether the member
states could come up with a financial plan to support their hardest-hit
neighbours, Italy and Spain. The obvious solution was to issue debt jointly to
fight the crisis together – an idea raised repeatedly during the eurozone
crisis, when it had been bitterly resisted by a conservative northern European
coalition led by Germany. This would ensure that Italy was not constrained by
its pre-existing financial weakness.
For a
coalition of nine states led by France, Italy, Spain and Portugal, the case was
obvious. On 25 March they called for a “common debt instrument” to fund a
crisis response. The ECB threw itself energetically behind the proposal. But,
once again, the Netherlands and Germany refused to budge. The issue was shoved
off into the Eurogroup, a meeting of the eurozone’s finance ministers, where
the outline of a deal did finally emerge two weeks later. By then the immediate
panic had passed. As Lagarde and her central banking colleagues had feared from
the outset, it was on their shoulders that the stability of the eurozone
continued to rest.
Will the
massive financial firewalls built by central banks on both sides of the
Atlantic be enough to withstand the bad news that is headed our way over the
coming weeks and months? It is too early to tell. But the first test came on
Thursday 26 March, when the US Department of Labor announced that, in a single
week, 3.3 million Americans had signed on for unemployment insurance. It was
completely unprecedented. A graph stretching back half a century simply turns
upwards in a vertical surge. In the next two weeks, another 13.5 million people
would be added to the insurance rolls. And there was no end in sight. America
is on pace for national unemployment to reach 30% by the summer – greater than
during the Great Depression of the 1930s.
The
shutdown spelled disaster for millions of American families, at least half of
whom have no financial reserves to speak of, and for businesses up and down the
land. How would the markets react? Astonishingly, they ended 26 March up 5%.
The largest surge in unemployment ever recorded in history was met with a
relaxed shrug.
Why weren’t
investors more terrified? Because the scale of Congressional stimulus made
clear that, no matter how divided American politics were, that wouldn’t stand
in the way of a huge surge of spending. And the Fed, for its part, would make
sure that the huge flow of new debt was absorbed, if necessary on to its own
accounts. The private credit system, the government budget and the balance
sheet of the Fed were welded together in a closed loop.
What the
Fed, the Bank of England and the ECB managed to do in March was prevent the
damage caused by the shutdown being made even worse by an immediate collapse of
corporate credit. At the same time, by stabilising sovereign debt markets, they
have enabled a huge surge in public spending to fight the crisis and cushion
its social and economic side effects. To do this they have both widened the
safety net to parts of the financial system never before protected, and
intervened on a scale far greater even than in 2008.
In the
final days of March, the Federal Reserve was buying Treasury bonds and
mortgage-backed securities at the rate of $83bn per day, or just shy of $1m per
second. On 9 April, at the same moment as the latest horrifying unemployment
numbers were released, it announced another $2.3tn in support targeted
specifically at municipal debt and lower-grade corporate debt. That same day,
the Bank of England adopted an even more radical approach. Rather than going
through the process of having the Treasury issue debt that would then be bought
by the central bank, it announced that it would be offering direct monetary
finance to the government, to provide it with whatever funding it needed. This
would be temporary, but it was still a radical move. The government’s current
account at the Bank of England would be repurposed to allow, if necessary, tens
of billions of pounds in coronavirus spending. The last time the British
government resorted to this mechanism was at the height of the crisis in 2008.
What we
have seen in the financial system, over the past few weeks, is a victory of
sorts – but it is a defensive one. Once again, we are propping up a fragile,
profit-driven system to avoid something even worse. It is also a victory
limited in scope.
By
flattening the curve of financial panic, the central banks of advanced
economies have managed to ensure that life under the lockdown is not made even
more unbearable by the shutting off of credit to business and households. They
have also ensured that the public health response to Covid-19 can proceed at
any scale that is required. Within Europe, there are questions about the
differences between eurozone members: Germany has been able to deliver a
conspicuously larger fiscal response to the crisis than have Italy or Spain.
But those inequalities pale next to the problems facing much of the rest of the
world. There the crucial supply of credit is being cut off even before
coronavirus cases begin to mount, meaning, once again we have confirmed that
the global financial system is hierarchical. At the apex stands the US Federal
Reserve. The ECB, the Bank of Japan, the Bank of England and their
advanced-economy counterparts all enjoy the Fed’s direct support. Thanks in no
small part to that support, the advanced-economy central banks enjoy great
latitude in propping up their credit systems. They might face moderate
movements in their currency’s exchange rate, but no devastating financial
squeeze.
If
flattening the curve in Europe and the US was the battle of March, the next
challenge is to reduce the shockwaves radiating out to the rest of the world.
The last few weeks have seen a remarkable display of technocratic energy and
imagination in western financial centres. That same level of commitment now
needs to be brought to bear in supporting the rest of the world. We cannot
control the epidemic or restore the world economy without it.
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