Friday 20 March 2020 ★ FINANCIAL TIMES 9

Opinion

than realised. Banks have reduced their

market-making activities due to post-

crisis regulatory reforms. Computerised

trading strategies have also exploded in

size. Together these developments

appear to be causing liquidity to dry up

in alarming ways.

Third, if market stampedes intensify,

we must become more creative.

Exchanges are using circuit breakers to

slow equity market routs, and central

banks are restarting asset purchases

schemes to pump liquidity into the sys-

tem. The SRC thinks we should now

consider an idea first floated by Paul

Tucker, then with the Bank of England,

a decade ago: using central banks as the

market maker of last resort in asset

classes beyond government bonds.

That might horrify free-marketers.

But it is no more shocking than using the

police to guard grocery stores to ensure

orderly access to toilet rolls. And it is

better than letting markets freeze up —

or shutting them down. If this crisis

intensifies, governments should act to

keep securities circulating.

[email protected]

To make matters worse, some asset

managers have engaged in massive, lev-

eraged trades using Treasuries under a

“relative value” strategy that exploits

the difference between Treasury futures

and cash prices. It is impossible to meas-

ure the scale of this directly. However,

Bank of America told clients in a note

that “the extent of growth [of such

trades] can be seen via growth of the US

Treasury repo market [which] has dou-

bled in size since 2016”. Those strategies

appear to have suffered big losses, gen-

erating fire sales, further distorting

prices. A similar dynamic may also be

affecting hedge funds using “risk par-

ity” strategies pioneered by Bridgewa-

ter, but since widely copied.

This has three implications. First, the

sheer violence of the price moves sug-

gests that asset managers have amassed

leverage and maturity mismatches that

are much bigger than hitherto appreci-

ated. Current watchdogs should hang

their heads in shame, given the lessons

of 2008, as the Systemic Risk Council,

made up of former regulators, notes.

Second, the swings suggest that the

trading ecosystem might be more fragile

eralised uncertainty. But it is also being

driven by fund redemption requests,

and leveraged traders who have to post

cash to meet margin calls.

Consider bond funds, which have

become wildly popular and now make

up a sixth of the exchange-traded fund

universe. These are often vulnerable to

what are known as maturity mis-

matches. Although they usually offer

daily redemption rights, they often hold

risky corporate bonds, which are hard

to price and sell during turbulent mar-

kets. Investors are running for the exits

amid “rising illiquidity in the underly-

ing bond markets”, as Mizuho notes in a

client memo. That forces fund manag-

ers to sell whatever they can to raise

cash to meet redemptions. Most funds

also hold Treasuries, sparking sales.

Covid-19 fears exploded this month, the

yield on 10-year Treasuries did tumble

to 0.4 per cent. So far, so logical, given

that the Fed has slashed interest rates

and the S&P 500 has fallen by more than

a quarter, amid recession fears.

But this week, prices turned funky:

the 10-year yield jumped above 1.2 per

cent, even as equities slumped. The

yield on the 30-year bond surged to 1.

per cent, even as the yield on ultra-short

term Treasury yields turned negative.

Why? One possible explanation is that

this week’s White House pledge of a $1tn

coronavirus-fighting stimulus package

is sparking fears that investors will

choke on all the US debt that will have to

be issued to pay for it. However, this

explanation is hard to square with the

US Federal Reserve’s pledge to buy vast

volumes of Treasuries itself.

A better way to understand the moves

is to think about toilet paper panics: just

as shoppers stock up on essentials,

investors grab cash however they can.

Treasuries are easier to sell than other

securities. So they are the assets being

sold, never mind their safe haven status.

The dash for cash partly reflects gen-

T

he phrases “toilet paper”

and “Treasury bonds” are

not often uttered in the

same breath. Right now,

however, they should be.

As panic about the coronavirus out-

break has spread, western households

have scrambled to buy toilet rolls, some-

times in irrational ways. Meanwhile

investors are giving in to equivalent

impulses, albeit in a less photogenic

manner. Each example raises a similar

public policy challenge: somehow, any-

how, governments must stop this stam-

pede to prevent a self-reinforcing panic.

To understand this, consider Treasur-

ies. Normally, the price of these bonds

rally during a crisis — pushing yields

down — because US government debt

is deemed a risk-free asset. And when

Toilet rolls and Treasury bonds tell the same panicked story

Bond fund investors

are running

for the exits amid

‘rising illiquidity’

present such a move as a response to the

assistance Beijing now offers to others.

For Mr Xi, the simple fact of the

quartet would offer testimony to China’s

leading role in global governance. For

Ms Merkel and Mr Macron it would pro-

vide an opportunity to re-establish the

EU’s coherence and relevance. And, yes,

Mr Trump would also have something

to gain. The rapid spread of the virus

across the US has already debunked his

claim that throwing up barricades is an

inoculation against this disease.

Even such small moves may look

impossible against the world’s present

retreat into antagonistic nationalism.

But there is still time. The fight against

the pandemic is about to get harder. The

world is facing an emergency. Self-inter-

est demands collaboration. Whether

in China, the US or Europe, political

leaders cannot ignore this simple fact.

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The obvious framework for interna-

tional co-operation is the G20 group of

nations. It played a lead role in the

financial crisis in persuading markets of

the seriousness of political intent to sta-

bilise the global economy. Prodded by

India, the present G20 chair, Saudi Ara-

bia, has called for a “virtual” summit.

There is certainly a role for the G20.

But co-operation across so disparate a

group will be possible only if the most

powerful nations first establish a foun-

dation. It is not too late to create such an

inner steering group. As a starting point

it would include Mr Trump, China’s

President Xi Jinping and, from Europe,

say, Ms Merkel and Mr Macron.

There are some things that can be

done immediately. Washington and Bei-

jing could begin by calling a halt to the

war of words. They could set aside their

present trade disputes. Mr Trump may

need some persuading, but it should not

be beyond the wit of his advisers to

treatment and, eventually, a vaccine.

Finance ministers from the G7 have

agreed to consult weekly on where best

to aim fiscal bazookas. The “plumbing”

of globalisation — the international

bureaucracies that sit below most polit-

ical sightlines — is largely intact.

A successful effort against the pan-

demic — a process lasting a year or more

—will depend above all on leaders main-

taining the trust of their citizens. Public

confidence is a vital ingredient in every

countermeasure. Borders cannot stay

closed indefinitely. It is no use suppress-

ing the outbreak in one region only to

see it reimported from another.

Economic orthodoxies have been ren-

dered obsolete by the crisis. As with eco-

nomics, so with politics. Closed borders

and go-it-alone fiscal stimulus packages

do not match the scale of the crisis.

International responses have been

fragmented. A global threat has stirred a

human instinct to turn inwards. Bor-

ders are shut. China sought to conceal

the initial outbreak in Wuhan before

locking down the region. Mr Trump

spent weeks in surreal denial, dismiss-

ing the virus as fake news or a conspir-

acy before veering back towards reality.

Europeans seem to have forgotten

what it is to be, well, European. Ger-

many’s Angela Merkel could once claim

to be the guardian of something called

European solidarity — the politician

who understood that collective action in

a crisis yields better results than unilat-

eralism. Not this time. Germany has

gone its own way. The European Com-

mission has been sidelined as 27 nations

operate 27 action plans. Italy’s decision

to implement a draconian lockdown

was for the benefit of all. It failed to elicit

offers to share the heavy economic

costs. France’s Emmanuel Macron has

struggled to conceal his frustration.

The news has not been all bad. Central

banks have closely co-ordinated inter-

est rate cuts and quantitative easing

to underpin the liquidity of financial

markets. Scientists are ignoring borders

and ideology in the frantic search for

O

nce in a generation, maybe

once in a century, political

leaders must light a bon-

fire of contemporary pre-

conceptions to confront

ashared emergency. This is such a

moment. History may ultimately define

the 21st-century by the strong geopoli-

tical rivalry between the US and China.

Yet in the immediate future the national

interests of these two great powers are

one. Those of European nations, too.

Washington and Beijing have been

moving in the opposite direction. The

blame game signposts a route to inter-

national breakdown. The vital work of

epidemiologists and economic policy-

makers will be useless if leading powers

choose to fight rather than co-operate.

The coronavirus outbreak began in

China, has its epicentre in Europe, and

is spreading rapidly across the US. It

cannot be beaten in one of these regions

unless it is defeated in all three. Contain-

ing it, and capping the human and eco-

nomic costs, demands that the centres

of global power work hand in hand.

National action

cannot fix a

global problem

Co-operation across the

G20 will be possible only if

the most powerful states

first establish a foundation

FINANCE

Gillian

Tett

ates acute strains on the cash flows of

companies and employees, putting the

survival of firms and jobs at risk. Public

policies must help them.

Health and fiscal policies must be

front and centre in this response. Mone-

tary policy has a vital role to play in tan-

dem. Monetary policy has to keep the

financial sector liquid and ensure sup-

portive financing conditions for all sec-

tors in the economy. This applies

equally to individuals, families, firms,

banks and governments.

Any tightening in financing condi-

tions would amplify the harm of the

coronavirus shock at a time when the

economy needs more support. If it

becomes harder for the public sector —

in the euro area this amounts to broadly

half of the economy — to finance itself

when private spending is heavily con-

strained, this can be a threat to price

stability.

Over the last week, we have seen con-

ditions in the euro area deteriorate con-

siderably. Our evaluation of the eco-

nomic situation has darkened. The

depth of uncertainty over the economic

fallout is now visible across all asset

classes, in the euro area and globally.

That has led to a tightening in financing

conditions, in particular for long-dated

bonds. Risk-free rates have moved up

and government bond yields — bench-

marks that are key to the pricing of all

assets — have increased everywhere and

become more dispersed. These develop-

ments impair the smooth transmission

of our monetary policy across the euro

area and put price stability at risk.

As a result, the European Central

Bank’s governing council has created a

new Pandemic Emergency Purchase

The ECB will do everything necessary

Christine

Lagarde

POLITICS

Philip

Stephens

E

conomists are often accused

of having science envy. Their

models produce imprecise

predictions and their fore-

casts are regularly poor.

During the 2008 financial crisis it

became clear that many of these criti-

cisms were valid. Economic models

failed to capture important properties

of complex financial systems in ways

evolutionary biologists and epidemiolo-

gists found staggeringly naive. The main

working tools in financial markets

relied on hyper-rationality when their

designers and regulators should instead

have been reading more sociology and

anthropology.

The lesson was learnt the hard way

with systemic failure. Now, thanks to

people such as Andy Haldane, the chief

economist of the Bank of England who

has spearheaded lesson-learning from

other disciplines over the past dec-

ade, we can hope that those in charge

are better prepared.

The same cannot be said about Brit-

ain’s response to the coronavirus. Some

scientists close to power have clearly not

been reading their economics. They

have made mistakes over handling data,

forecasts and communication. When

UK prime minister Boris Johnson and

Patrick Vallance, the chief scientific

officer, proclaim “we will do the right

thing at the right time”, decent macr-

oeconomists hold their heads in their

hands. There is no polite way of putting

it. The statement is nonsense.

As with economic data, daily corona-

virus caseload figures are out of date

when they arrive and are inaccurate

guides to the progression of the disease.

With such profound uncertainty, there

is no way anyone can be confident about

setting policy with precision, even if the

best behavioural scientists could say for

sure how the public would react. Of

course, they cannot do that either.

This is the basic insight from the mac-

roeconomic debates in the 1960s over

fiscal fine tuning. At the start of that

decade, economists believed a nudge on

taxation here or public spending there

could ensure a perfect balance between

unemployment and inflation. By the

end of the decade almost no economists

believed it, whether they were of a Key-

nesian or monetarist bent. Economics

can tell you that efforts to fine tune the

progression of coronavirus will fail.

The UK government has also failed to

heed a second lesson from basic eco-

nomics on time consistency. In daily life,

everyone knows that promising to give

up smoking tomorrow lacks credibility

because delay is preferable to action. An

economist would say the original pledge

is “not time consistent”. Examine the

government’s original mitigation strat-

egy in this light. Believing that its mod-

els and data could predict perfectly the

spread of the disease, it decided to opti-

mise the number of deaths. Having

more early on and fewer later, the gov-

ernment believed, would create herd

immunity and prevent a second wave.

Almost every other country adopted a

“suppression” strategy, so the UK policy

would inevitably have led to many more

deaths in the first wave. Killing your

population faster than France, Italy,

Germany and South Korea might be the

right strategy, but it was not politically

sustainable. The policy was not time

consistent and decent economists

could, and did, predict it would fail.

These policy choices have had conse-

quences. To the rest of the world, the UK

has looked arrogant and incompetent, a

toxic mix. Sterling is suffering a steep

fall as a result. The U-turns have shorn

ministers and their scientific advisers of

credibility. If people do not believe the

prime minister will be able to do what

he says and achieve results, public

confidence will be lost at the most

important time.

Britain’s government desperately

needs the advice of its economists.

Ministers and officials must stop claim-

ing they are in precise control of the

path of the virus and making promises

they have no chance of delivering. And

they must learn these lessons quickly.

[email protected]

Scientists

can learn vital

lessons from

economists

To proclaim ‘we will do the

right thing at the right time’

is nonsense. There is no

polite way of putting it

ECONOMICS

Chris

Giles

T

he coronavirus pandemic is

a public health emergency

unprecedented in recent

history. It is an unbearable

human tragedy played out

across the world and our thanks go to

the dedicated health workers on the

frontline of our health systems. It is also

an extreme economic shock that

requires an ambitious, co-ordinated

and urgent policy reaction on all fronts

to support people and firms at risk.

Unlike in 2008-9, the shock we are

facing is universal: it is common both

across countries and across all sections

of society. Everyone must scale back

their daily activities, and therefore their

spending, for as long as the containment

measures last. Essentially, for a tempo-

rary period, a large part of the economy

is being switched off.

As a result, economic activity across

the euro area will decline considerably.

Public policies cannot prevent this.

What they can do is ensure that the

downturn is no longer and deeper than

it needs to be. The current situation cre-

FT series

Coronavirus: the economic cure

Programme of up to €750bn until the

end of the year on top of the €120b in

extra purchases announced on March

12. Together this amounts to 7.3 per cent
    of eurozone gross domestic product.
    The programme is temporary and
    designed to address the unprecedented
    situation our monetary union is facing.
    It is available to all jurisdictions and will
    remain in place until we assess that the
    coronavirus crisis phase is over.
    The new instrument has three main

advantages. First, it fits the type of

shock we are facing: exogenous,

detached from economic fundamentals

and affecting all European countries.

Second, it allows us to intervene across

all durations of bonds, preventing finan-

cial fragmentation and distortions in

credit pricing. Third, it is tailored to

manage the staggered progression of the

virus and the uncertainty about when

and where the fallout will be worst.

This is reflected in the terms and con-

ditions of the new programme. While

the benchmark allocation across juris-

dictions will continue to be key to the

capital contributions of the national

central banks, purchases will be con-

ducted in a flexible manner. This allows

for fluctuations in the distribution of

purchase flows over time, across asset

classes and among jurisdictions.

Moreover, to the extent that some self-

imposed limits might hamper action

that the ECB is required to take in order

to fulfil its mandate, the governing coun-

cil will consider revising them to the

extent necessary to make its action pro-

portionate to the risks that we face.

We are fully prepared to increase the

size of our asset-purchase programmes

and adjust their composition, by as

much as necessary and for as long as

needed. We will explore all options and

all contingencies to support the econ-

omy through this shock. We have also

decided to purchase commercial papers

of sufficient credit quality and to

expand the eligible collateral in our

refinancing operations. The aim is to

reinforce the actions that we took last

week to protect the flow of credit to

companies and people.

We are making available up to €3tn in

liquidity through our refinancing opera-

tions, including at the lowest interest

rate we have ever offered, -0.75%. Offer-

ing funds below our deposit facility rate

allows us to amplify the stimulus from

negative rates and channel it directly to

those who can benefit most. European

banking supervisors have also freed up

an estimated €120bn of extra bank capi-

tal to support lending by euro area

banks.

All this underlines the ECB’s commit-

ment to play its role in supporting every

eurozone citizen through this extremely

challenging time. The ECB will ensure

that all sectors of the economy can ben-

efit from supportive financing condi-

tions that enable them to absorb this

shock. We will do everything necessary

within our mandate to help the euro

area through this crisis, because the ECB

is at the service of the European people.

The writer is president of the European

Central Bank

MARCH 20 2020 Section:Features Time: 19/3/2020 - 18: 45 User: alistair.hayes Page Name: COMMENT USA, Part,Page,Edition: USA, 9, 1