The Covid Financial Crisis Will Require a Much Stronger Response Than the Last Crisis

by James Meadway

1 April 2020

The scale of the global Covid-19 crisis defies immediate comparison. Over 3m people were added to the US jobless figures in a single week; nearly 500,000 in the UK. Morgan Stanley expects a 30% contraction in US GDP, while the Federal Reserve Bank of St Louis has speculated about a 50% drop.

These figures are spectacularly, cataclysmically bad in economics terms: to underline the point, we are significantly beyond anything we saw in the great financial crisis. The numbers we are now seeing forecast are closer to the kind of collapse associated with the transition from the ‘planned’ economies in Eastern Europe.

Yet it is more than a matter of scale. It is a crisis of the economic mechanism itself – of the vast global machine we have built, geared towards the production of greater and greater wealth.

The circumstances of the crisis demand that this machine is – at least temporarily, but perhaps for a significant period of time – significantly halted. But doing so extracts a tremendous price on a system which has been built on the principle that the machine never stops.

The financial system, in particular, depends on the wealth-production machine never halting as a condition of its continued existence. If the machine stops – if the flow of revenues into the system dwindles – it, too, will lurch into crisis. But this is different from 2008-9. Back then, the financial system collapsed first and the breakdown pushed itself into the underlying economy, generating a spectacular global slowdown and severe recessions in individual economies. This time, the ‘real’ economy has broken down first.

We’re now seeing that monetary authorities and governments have learned lessons from 2008 to quite a significant extent: the monetary policy response to the current crisis has been very substantial, and, again, pushed rapidly beyond the sorts of measures we saw in 2008.

They have needed to. Faced with what the new Bank of England governor Andrew Bailey called an “absolutely unprecedented” situation in the market for government bonds, “bordering on disorderly”, the Bank has intervened massively.

Its new asset purchase programme is broader than the £425bn quantitative easing programme of government bond purchases, first launched in early 2009 and expanded since. Government bond sales are how the government raises money from borrowing, by issuing ‘bonds’ (promises to pay) for sale. This time, the Bank has not only promised to buy government bonds without limit, but is additionally supplying short-term credit directly to companies that are running out of cash through purchases of ‘commercial paper’ – a form of company debt, similar to government bonds, but issued by corporations and for much shorter periods of time.

The prospect of purchases of wider sets of assets has also been raised by the governor. The alternative, as the Bank seemingly briefed journalists, was “a run on sterling, a flight to the dollar and a complete breakdown of the UK financial system’s core”.

The prospect of a disastrous capital flight out of Britain, which looked briefly in train as the government’s failure to get a grip on the crisis became apparent and sterling plummeted in value whilst government borrowing costs briefly spiked, has – for now – been closed off since the government has imposed a lockdown and intervened to support both employed and self-employed workers. There are criticisms to be made of both wage support schemes, particularly in leaving some of the most vulnerable self-employed workers out in the cold, but in terms of the scale of support being offered they represent a real step-change in provision. And the Bank of England has acted swiftly, and at large scale.

Both sets of actions by the authorities have probably held off a worsening of the financial crisis in Britain, for the time being. But some of the dangers are being pushed into the near-future, as banks expand their balance sheets with loans that they may be unable to repay or roll over if a post-Covid slump ensues.

We would, at that point, be looking at something resembling a second Great Depression, with banking and financial failures reinforcing the failures of the rest of the economy, and bankruptcies and redundancies then feeding back into the financial system in a doom loop. Immediate and very large interventions by the authorities have been needed to prevent this; it may, however, still not be enough to disarm explosions in different parts of Britain’s large and complex financial system – perhaps across consumer financing, insurance, or the growth of Exchange Traded Funds over the last decade, which has created peculiar and poorly-understood new risks across the system.

But the principal focus of the financial crisis, for now, is in the Global South, where the capital flight out of less developed countries has been, again, on an unprecedented and devastating scale.

Cumulative outflows of funds from ‘emerging markets’ since January dwarf anything seen in the 2008-9 crash, in what has been described as the “worst ever” financial crisis for the less developed world. South Africa is one of the most exposed economies –  already suffering from an overstretched public health system, rising unemployment, and weakening government finances ahead of the outbreak reaching its peak.

But across the emerging market economies, and aside from the public health emergency – set to be far worse in countries where, in too many cases, years of neoliberal prescriptions have whittled health and other public services to a bare minimum – the significant build up of debt in the Global South threatens a series of national economic collapses. The IMF, World Bank and UN Conference on Trade and Development have all called for debt relief and assistance for heavily indebted countries – with 18 countries now trading their debt at “distressed” levels, compared to just four back in December.

Debt write-offs are an urgent necessity for heavily indebted emerging market economies. But the same question will start to impose itself here, too:

As the crisis extends, and government borrowing rises, the British government’s debt will rise. Already, there are calls for post-Covid austerity; but, as Paul Johnson of the impeccably mainstream Institute of Fiscal Studies has said, “more austerity on the spending side is surely implausible” given the scale of the debts and a decade of disastrous cuts.

Far more plausible, already, are debt write-downs and one-off wealth taxes of the kind proposed by economist Laurie Macfarlane. The world, post-Covid, will be a very different place.

James Meadway is an economist and Novara Media columnist.

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