Are We Fighting The Last War?
The policy response has been breathtaking: massive new Federal Reserve interventions, a $2.2 trillion U.S. fiscal package and bold policy departures from Germany and the European Central Bank. That doesn’t include the list of measures the IMF has alphabetized from Argentina to the United Kingdom.
The fact that markets are still looking for direction is a measure of just how severe the economic blow will be in the weeks ahead. The historic spike in jobs claims and Ford’s downgrade to junk are just harbingers of news to come, and so the nagging question is whether the policy response will make a difference. Continuing market volatility may also be a sign that investors still worry we are fighting the last war with weapons that worked against a fundamentally different challenge.
Much of the answer lies in how quickly the virus is contained, and those of us who don’t know a great deal about medicine can do more good by avoiding careless speculation. Ultimately, a better understanding of the disease, increased testing and expanded hospital facilities should allow for a return to more normal levels of activity even without a vaccine. But the new normal may be more restricted than the old.
Without much visibility on the future, we all grasp at past precedents.
Is this like the Lehman Crisis in 2008? It sure feels like the same pit in your stomach when all the charts on the screen pointed straight down. There are familiar conversations about extremely attractive prices for stocks and bonds—before they drop another 10%. The bid-ask spreads have widened sharply and liquidity has evaporated.
But today’s markets have collapsed without shaking faith in the global banking system. For all the complaints about regulations imposed by the Dodd-Frank Act and a more vigilant Federal Reserve, few worry about bank solvency. Investors and traders trust that they can park money at their bank overnight even if they don’t share enough faith to shake hands with one another.
Maybe after such a long bull market, this is more like the bursting of the “dot-com” bubble in 2000 when we were lured by magical possibilities of technology that would transform global commerce. Recent waves of cash chasing deals and steep valuations echoed the logic that supported evanescent business models like Pets.com and implied that cyclical risks had changed.
And yet, valuations aside, investors have in fact focused on recent recession risks as the latest U.S. expansion became the longest on record. Moreover, the same technologies that disappointed us in that bust have come to the rescue this time as we all learn to work, shop and invest remotely.
So perhaps this crisis is more like the September 11, 2001 attacks when the shock came neither from economic mismanagement nor market exuberance. Like a pandemic, it was a sudden blow to economic activity and business confidence that U.S. markets may have absorbed better because they were closed for a week. Talk that terrorist risk might force permanent changes to business models and global trade dissipated soon enough amid targeted support for airlines and a comparatively modest stimulus package.
Here the differences are less hopeful. This time, there is not just a blow to confidence, but a “sudden stop” to economic activity and capital flows. Emerging markets have weathered these crises when exchange rates slid, banks collapsed and foreign capital disappeared. What makes this worse is that the damage is simultaneous across the world’s major economies, leaving no locomotive that might help jump-start fresh demand.
“What will really make a difference in the response is a greater sense of international cooperation on both virus containment and economic recovery.”
The policy response so far seems to recognize this. Lower interest rates and central bank efforts to stabilize financial flows are a crucial first step. But access to cheap financing is only so helpful if you don’t have any revenues, which makes even more important the large fiscal packages that include loans, benefits and tax breaks.
But even when virus containment allows for a return to business as usual, there will surely be inevitable aftershocks from what is undeniably an economic earthquake. There will be more forced liquidations of assets to raise emergency cash. There will be losses in private markets that have yet to be revealed and realized. There will be lingering worries that make it easy to postpone that next new car or factory until buffers and savings are restored.
All of this suggests that even the enhanced response so far may need further creativity and more resources that go well beyond what has been done in past financial crises and global recessions. We will need even more money and even sharper targeting to areas of the economy that struggle to recover. The current shock may also accelerate existing trends towards more online shopping and less business travel, stiffening headwinds for some retailers and airlines.
Most challenging of all will be ensuring that the mountain of debt that emerges on the other side is mostly borne by those who can bear it. In the United States, the government’s balance sheet is still the world’s strongest as long as the country’s business model supports better than average economic growth. In Europe, fresh approaches to share the burden will have to emerge to avoid triggering another sovereign debt crisis.
What will really make a difference in the response is a greater sense of international cooperation on both virus containment and economic recovery. An attenuated G-20 video summit this week issued a statement that said all the right things but included few concrete steps to settle trade frictions, bolster financial stability or support vulnerable developing countries.
Markets may bounce back a little more from here given the size of the latest government packages around the world, but the recession ahead will be longer and more painful without creative thinking to address what is undoubtedly a very different kind of crisis.