The writer is Allianz’s chief economic adviser and president-elect of Queens’ College, University of Cambridge
Amid the market turmoil, there is a sense that the world may be revisiting the great financial upheavals of 2008 which almost tipped the global economy into depression. It is not.
Unlike the global financial crisis, this is not a crippling crunch in the banking or payments and settlements systems.
Instead, the world economy and markets are going through a rough patch that has been years in the making. The tough times are also being amplified because governments have fewer ways to respond to them, and they are responding late.
The immediate cause of the turbulence is the erosion of three anchors that had kept markets steady, or rising to ever-higher peaks, despite deteriorating fundamentals.
First, the actual and feared impact of the coronavirus is destroying supply and demand simultaneously. This has undermined the momentum of global economic growth.
Second, although willing to act, central banks are no longer viewed as being able to repress financial volatility through massive injections of liquidity and ever-lower interest rates. Policy interest rates are already negative in Europe.
Third, Saudi Arabia’s decision to launch an oil price war, which has sent the price of crude down by over 20 per cent, has thrown into the air the financial viability of small oil companies. It has also undermined large segments of the corporate bond market.
As a result, elevated asset prices have begun to fall back to where fundamentals suggest they should trade (even as fundamentals are also deteriorating). Because this correction is happening in a disorderly manner, there is a risk of collateral damage in the financial world and the real economy.
Today’s turbulent markets recall how they behaved during the global financial crisis 12 years ago. So too does the growing likelihood of recession among a lengthening list of countries that already includes Germany, Italy, Japan and Singapore.
Even so, today’s situation, as unsettling as it is, differs in an important way from 2008.
Because it did not originate among banks, it does not endanger the nerve centre of all modern market-based economies, namely their payments and settlements systems. Unlike 2008, policymakers also have somewhat more time to formulate measures to limit financial and economic damage.
Unfortunately, today is also different from 2008 in less reassuring ways.
Governments are starting their race to address the economic turmoil from a position that is way behind. They have for too long pursued a highly unbalanced economic policy mix that has relied excessively on monetary policy to support growth. Too much policy ammunition has also been fired in an inefficient manner (such as last week’s emergency 50 basis point rate cut by the US Federal Reserve, which was ill-received by markets).
To stop what could easily become a vicious cycle, where a worsening real economy drags down markets and markets in turn drag down the real economy, governments now need to do several things.
They must use laser-targeted measures that can help create a sustainable economic floor. These could include medical measures that can help contain the virus (such as free testing); policies that protect society’s most vulnerable, including bolstering unemployment support and, in the US, covering the uninsured for virus treatment; and ways that counter financial market malfunction, such as specific instances of illiquidity.
Furthermore, these measures must use a co-ordinated “whole of government” approach. Crucially, governments must also recognise the excessive recent reliance on central banks and instead pursue truly productivity-enhancing reforms.
Lastly, these actions need to be supplemented by a layer of international policy co-ordination, similar to the successful April 2009 G20 Summit in London which was spearheaded by Britain’s then prime minister Gordon Brown, which could establish the type of collective actions that can be deployed to meet this global problem.
The faster this is done, the stronger the economic turnround will be. That eventual recovery will be turbocharged by extremely low mortgage rates and energy prices, both of which would give consumers immediately more purchasing power. The quicker that markets see that this potential turnround is coming, the faster they will also snap back. And this time, unlike in 2008, that financial snap back and economic recovery will rest on more genuine and lasting underpinnings.