I’m writing this commuting in on a half-empty train to London. I don’t know what the weather’s like where you are, but it’s a beautiful day in Kent. A proper sunny spring morning. This is my equivalent of giving you a bit of soothing background music before we dive into the unadulterated pandemonium that is the markets today, and probably for the rest of the week.
Deep breaths. We all ready? Let’s start with what the Federal Reserve just did...
Here’s why the Fed can’t do this alone
Last night, the Federal Reserve cut the Federal Funds rate – the key US interest rate – to 0% (or a range from 0% to 0.25%, to be more accurate).
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The Fed has also done a number of technical things that are all about making sure that both commercial banks and central banks in other countries are able to get access to a steady supply of dollars.
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The Bank of Japan and a lot of other less major central banks either cut rates or poured more money into markets. But none of that has stopped markets from having a brutal, brutal opening this morning. The FTSE 100 is down by 11% as I type. At one point it was back below 5,000.
What’s the problem? Well it’s pretty clear. Central banks can underpin the financial system and stop it from collapsing as credit tightens up. In 2008, that stopped the rot (eventually) because the problem lay in the financial world. Credit seized up because banks had made stupid lending decisions. That resulted in “innocent” businesses having their funding yanked and we got a big recession as a result.
The problem is that the transmission mechanism is in reverse this time round. Coronavirus has prevented companies from producing (a supply shock) and people from consuming (a demand shock).
Pumping money into the financial system means that there is scope for lenders to be lenient with their debtors; having central banks to underpin everything means that governments can also take action.
But until we see what they do, companies are still having to deal with the reality of a collapse in sales, and therefore profits. That means that equities have to fall hard to account for the “new normal”. And until we know what that’s going to look like, it’s hard to see a bottom.
Welcome to the new age of unlimited government spending
So what might the “new normal” look like? Long story short, fiscal stimulus and lots of it. In English – governments across the globe will be spending a lot of money.
But how? This morning – and this is just one example – I saw Anatole Kaletsky of Gavekal arguing that “governments in every major economy must guarantee unlimited fiscal compensation for lost revenue and wages to all businesses and workers affected by quarantines and lockdowns.”
In effect, the idea is that the government steps in, stops anyone from going bust or losing their job during the downturn. That tides us all over until things go back to “normal”.
It would cost about 25% of GDP potentially. However, says Kaletsky, that’d be fine because central banks can print money to cover it and interest rates are incredibly low anyway.
What’s my reaction to this? Being honest, it sounds loopy and deeply impractical. How do you agree on how much revenue has been foregone? How do you differentiate between businesses that were better prepared for an unexpected downturn? For example, British Airways owner IAG does not appear to be keen on bailouts, whereas arch-rival Virgin has pulled the begging bowl out. In a pro-competition world, we might think the better-prepared company deserves to reap the rewards.
There are all kinds of moral hazards involved here. And yes, moral hazard isn’t something you worry about during a crisis but the problem is we then don’t spend any time worrying about it once the crisis has passed either, which is why we end up back here again and again.
At the same time though, I entirely sympathise with the view that we should have exceptionally generous unemployment insurance. If people get laid off because of this you want to minimise the overall disruption. Ideally, we’d be talking about 100% of salary being covered for a prolonged period of time.
And ideally you don’t want viable businesses closing down because of a few bad quarters. And if the government has directed your business to shut (as is happening with all the pubs in Ireland – yes, that’s how bad it is) then it's hardly fair to expect staff and owners to just take that on the chin. So I don’t know, is the short answer.
But let’s park ideology for the moment. You might be a full-on “liquidationist” or you might be a rampant “nationalise everything”-ist. Instead, we might as well look at what will probably happen.
Right now, it looks like we will get lots of money flung at the problem. And the problem is going to get worse before it gets better. At some point, the virus will ease (if it doesn’t, then I guess you won’t be getting many more emails from me, because I’ll be out wrestling in the aisles for the last toilet roll in Sainsbury’s, so we’ll park that question for now).
Once the virus eases, all the stuff we did to get over the hump will probably not go away. Our financial system and market system will be even more confused and somewhat broken than it is right now.
Will we see inflation? Possibly. Will we see a lot more inefficient capital allocation? I’m guessing so. Will we need to start looking at a refresh of the system? I suspect we might.
This is why I’m hanging on to gold. Cash is probably good too. Cheap markets keep getting cheaper so I’m not suggesting you bail out of them. But I want to see what governments have planned before I can make any call on where the bottom might be from here.
We’ll have a lot more on this in the next issue of MoneyWeek magazine. Subscribe now if you haven’t already.
