Unlike the global financial crisis of 2008, this is not a crises which originated in the Financial sector. Unlike 2008, the banking or payments and settlements systems today do not have the same problem.
Instead, the global economy and markets are going through a purple patch that has been in the making for last few years. The tough times are also accentuated because governments have fewer options to respond to them.
The immediate cause of the disturbance is the erosion of three pillars that had kept markets steady, or even rising, despite deteriorating fundamentals.
First, the actual and feared impact of the coronavirus has affected supply and demand simultaneously. This has undermined the momentum of global economic growth.
Second, central banks are no longer seen as able to suppress financial volatility through injections of liquidity and ever-lower interest rates. Policy interest rates are already negative in some geographies such as Europe.
Third, Saudi Arabia’s decision to launch an Oil price war with Russia and US, which has sent the price of crude down more than 25 per cent, has imperilled the viability of small oil companies and undermined parts of the corporate bond markets. It has also brought fears of slowdown in OPEC countries.
As a result, asset prices have begun to fall back to more normal levels. As this correction is happening in an incoherent manner, there is a risk of collateral damage to the financial world and the real economy.
Today’s turbulent markets bring back memories of the financial crisis 12 years ago. So does the fear of recession among a lengthening list of countries that already includes Germany, Italy and Japan. Even so, today’s scenario as unsettling as it is, differs in an important way. Because it did not originate from banks, it does not endanger the nerve centre of all modern market-based economies, namely their payments and settlements systems.
Unfortunately, today is also different from 2008 in terms of the response from policy makers.
Countries are starting to address today’s turmoil from a disadvantage position. For too long, they pursued an economic policy that relied on monetary policy to support growth. Too much of monetary policy ammunition has also been fired inefficiently — such as last week’s 50 basis point rate cut by the US Federal Reserve, which was ill-received by markets.
To stop a vicious cycle, where a worsening real economy drags down markets and markets then drag down the economy, governments must now do several things.
These could include medical measures that help contain the virus, such as free coronavirus testing, better screening at airports, policies to protect society’s most vulnerable and ways to ease specific financial market malfunctions, such as liquidity crunch through both fiscal and monetary policy actions.
These measures must also use a co-ordinated “whole of government” approach. There has been too much reliance on central bank action to boost growth; governments must now pursue true productivity-enhancing reforms to boost demand and supply.
Lastly, there must be international co-ordination to establish what collective actions can be deployed.
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 boost consumer purchasing power. The quicker that markets see this coming, the faster they will bounce back. And this time, unlike in 2008, that bounce back and economic recovery will rest on more genuine and lasting foundation.
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