“When the rest of the world is mad,” wrote the banker John Martin in 1720, skeptical of the unfolding financial boom we now call the South Sea Bubble, “we must imitate them in some measure.” In the midst of a profligate financial boom bound to collapse, Martin realized that he still had to do something. As a banker, he had to place the funds entrusted with him somewhere to generate returns for his creditors and shareholders one way or another; there was no option to do nothing.
The topic of surfing financial waves and how to rationally ride market bubbles has often interested academic economists and financial practitioners alike. Looking out over a swirling financial sea, ivory tower economists constructed models of how prices of even worthless assets can rationally go stratospheric, though the most successful of such assets in the real world – money – was usually excluded. The secret recipe for success in riding tumultuous market waves, said another historical banking character, Nathan Rothschild, was that he always sold too soon.
Fast-forwarding to the height of the madness that is our time, the only people who sold too soon were those who got out weeks ago. Everyone else got wrapped up in events altogether familiar from these astute gentlemen’s own times. Panicked markets, eye-popping declines, and inept public policy are, in some unfortunate sense, a human universal. And all public officials, it seems, imitate one another, no matter how mad, impotent, or harmful the policy.
During last week’s market mayhem, everything fell at once: stocks and bonds, risky government debt and peripheral currencies, commodities and financial contracts. Top-of-the-line hedge funds, praising themselves for never losing money, saw their trading strategies blow up. Even bitcoin, the cherished alternative to an allegedly defunct monetary system, saw its value tumbling; gold too, the most iconic of traditional safe assets that earned its place in every stock portfolio as an uncorrelated asset, saw its price fall by double digits.
In a fortnight, everything we thought we knew about financial markets came undone. Only once all this is over may we examine the wreckage and see what’s salvageable.
Long-cherished flights to safety no longer worked, new ones sourly disappointed. Hedging strategies worked poorly when usually unrelated assets all moved downward at the same time. Central banks outdid one another in launching aggressive intervention programs best described by Daft Punk (“Harder, Better, Faster, Stronger”) – historical interest rate cuts, monumental repo facilities, and the mother of all asset purchases – yet to no avail. Futures markets quickly hit their circuit breakers right after the Fed’s announcement on Sunday night; in turn, Asian, European, and American stock markets opened Monday morning with a fresh bout of chaos.
The old playbook, where central banks nodded, promised, printed, and hinted at unending support of markets, no longer worked.
Over the last decade or so, central banks have learned a lot about their own instruments, their own behavior, the market reception of their communication, and the power of their policies. Beyond endlessly fighting the previous war, they learned that they had one or two functioning tools – short-term interest rates as governed through overnight lending or deposits at the central bank, and open-market asset purchases to push down long rates. Neither of these meet today’s challenges. Compressing term premia threatens bank operations and threatens to create zombie-like economies, which Europe can attest to. Rates are already so low that additional measures have little real-world push-through. Not to mention, lower rates and cheaper credit hardly make consumers splurge while the pandemic scare remains, nor do they move forward businesses’ investment decisions.
Monetary policy transmission, this arcane wording for marking how these actions feed through to the real economy (affecting your business loan or mortgage rate), usually takes months to meaningfully meander its way through the financial system. This is why central banks incessantly talk about future guidance and predict future economic data.
During Fed Chairman Powell’s teleconference Sunday night, it was as if everyone (not) in the room had forgotten that. The composed chairman talked about the virus impacting the real economy and how the Fed’s increasingly desperate emergency actions ensured a proper transmission of monetary policy. It was evident to everybody listening that the Fed had long since passed the point of prudent crisis fighting, instead acting with more than a tinge of desperation.
We are spent, guys, they seemed to say. But we’re going to keep buying everything that moves so that perhaps the banks and the payment system may weather the storm.
Many monetary authorities around the world have found themselves in the exact same situation. Christine Lagarde at the European Central Bank all but said it as her aides rushed in and clarified that she meant that Italy’s bond spreads were very much the ECB’s responsibility – and that there was still much else that the flustered central bank could do.
Consequently, many countries have found themselves in this strange scenario of impotent central banks talking a good game and hoping that more of the same failed medicine will miraculously cure the suddenly unwell patient. The turning of the world upside-down is complete, as fiscal authorities are temporarily delaying or returning tax payments in order to provide households and small businesses with liquidity – usually, the role of banks and central banks – while monetary authorities are busy ensuring the survivability of small businesses facing demand and supply shocks, in desperation crafting schemes for countercyclical stimulus spending. Weren’t the roles supposed to be the reverse?
All these measures only marginally mitigate the hit to workers’ and households’ finances; they look much too small to achieve their stated purpose. The UK government coupled extra healthcare spending with backstopping small businesses’ cost for employees falling ill and tax forbearance; Spain, the latest country in lockdown, has delayed value-added-tax payments for its small businesses – a measure that’s likely to be minor as tourists are sent home or blocked from entering the country. Sweden took over sick-leave liability from employers to the tune of less than 1 percent of monthly public sector payroll, delayed tax payments, and will shoulder half the burden of temporarily relieved employees.
The common theme in all of this is too little, too late. Or just the wrong things at the wrong time in the wrong way. The simplest and easiest measures amount to simply putting money in people’s bank accounts so that they can meet their pre-crisis commitments while governments’ draconian restrictions work themselves out and health care workers solve their problem for them.
With few exceptions – for instance, Hong Kong and Australia – those policies have been shunned in favor of slower, more complicated, less transparent, and frequently debt-based solutions. The cash payments that have been used are limited and comparatively slow-working band-aids for intimidatingly large bullet holes.
A lot of public officials have been busy crafting things that amount to very little – but may end up hurting us a lot. Only time will tell. Many commentators and future researchers will have opinions on what took place in March 2020. This epoch is truly breathtaking.
One conclusion is inescapable: central banks have done the only thing they know how to, and it has so far not amounted to much good. Perhaps they can still acquit themselves honorably given the hopeless task they were assigned.
In a world that’s gone mad, that’s a very small comfort.