the times | Saturday August 1 2020 1GM 51

Business

We can’t afford to ignore red warning

lights on the economy for much longer

was in 2007 and 2008. This time was

supposedly different because QE had

brought down long-term rates,

flattening the curve and making it

easier to invert. Historically,

inversions have been caused by rate

rises at the short end to tackle

inflation, for example. This time it

was low borrowing costs at the long

end as investors anticipated rate cuts

as the economy experienced a little

turbulence. But few were worried.

The third warning sign was the

most alarming. Last September, the

US central bank stepped in with

$53 billion of emergency funding for

the repo market. The “repurchase

agreement” market is where banks,

corporates and institutions go to get

hold of cash at short notice. It works

like a pawn shop, where collateral is

swapped for cash. The shop is paid a

small sum and the borrower soon

returns to switch the cash back. As a

key part of the financial plumbing

with a daily turnover of $1 trillion,

problems in the repo market can

“quickly ripple through the financial

system”, the Bank for International

Settlements says.

That September, the market

malfunctioned so badly that the

central bank had to step in for the

first time since the financial crisis.

Again, we were told, this time was

different. In 2008, the repo market

froze because no one wanted the

mortgage collateral on offer. This

time, the collateral was US

government debt, Treasuries. There

was no risk anyone would lose

money. Instead, they simply did not

have the cash. The problem was the

plumbing, not the foundations.

Then, in March, the plane crash-

landed. No one could have foreseen

coronavirus, least of all the markets,

but the crisis has been a reminder

that we ignore the warning signs at

our peril. Individually, each

explanation was logical but no one

was explaining why, if the rules had

changed, we were still playing by the

old ones. Worse, when the pandemic

hit, the stabilisation measures

included market interventions that

made the financial crisis look easy.

Trillions of dollars of support,

amounting to more than 15 per cent

of global GDP, has been provided by

If the global

economy is an

aircraft, the pilot’s

dashboard last year

lit up red. There

wasn’t just one warning light flashing

and beeping. Not two. But three. All

screaming emergency, land the plane

at the first opportunity and get it

serviced. Anything else would be

reckless. Instead, the pilot, who in this

analogy is everyone who should have

known better — from regulators to

policymakers — tapped the first

blinking light once or twice and

dismissed it as a system glitch. Then

did the same for the second. Then the

third. The plane was handling

beautifully after all. The problem had

to be in the dashboard’s wiring, not

the flight controls.

The three warning signs were in the

markets, the communal hive mind

that — for all its flaws — is the

operating system for the best

economic model mankind has yet

designed. The first was a familiar one.

Equity and bond prices were rising in

tandem. Share prices rise when

capitalism’s animal spirits are in

“greed” mode. Bond prices rise when

fear kicks in. According to the

markets, we were both itching to take

risky punts and scared to death that

stock market oblivion was round the

next corner.

This warning was easy to dismiss.

Since the trillions of dollars of

quantitative easing that came in the

wake of the financial crisis, the extra

money had to go somewhere. Hence,

the inflation in all asset prices. The

other signs were less easy to resolve.

The second came last July, when

the yield curve inverted. The yield

curve measures the cost of

government borrowing at different

maturities and normally rises with

the length of repayment. Borrowing

money for two years should be

cheaper than borrowing for ten, the

higher cost reflecting the greater risk.

Yet, last summer, ten-year debt was

cheaper than two-year debt in the US

and the UK. In the past 40 years

every US recession has been preceded

by a curve inversion and the curve

has never inverted without being

followed by recession. Whichever way

you look at it, history said the chance

of a US recession was 100 per cent.

The correlation in the UK was less

perfect but still a strong sign of

imminent disaster.

The last time either curve inverted

Philip Aldrick

Jobless fears

as furlough

scheme is

wound down

Philip Aldrick Economics Editor

Hundreds of thousands of jobs are at

risk as the furlough scheme begins to be

wound down today, the government

has been warned.

The Resolution Foundation think

tank said that as many as one million

people in social sectors such as hospi-

tality and leisure may be facing redun-

dancy and the Federation of Small

Businesses claimed the UK “cannot

afford to pull up the business support

drawbridge any time soon”.

From today, companies will have to

contribute to the cost of furloughed

workers by paying employer national

insurance and pension contributions.

The average cost will be £70 a month,

5 per cent of the employees’ pre-fur-

lough pay.

Since March, the government has

paid 80 per cent of any furloughed

worker’s salary up to a maximum of

£2,500 a month. It has been used by

1.2 million companies to pay the wages

of 9.5 million employees at a total cost

of £31.7 billion. According to the Re-

solution Foundation, the official figures

show total use but only half — roughly

4.5 million people — are on furlough at

present. Use peaked in April at 8 mil-

lion, it said, since when companies have

brought back many staff.

The government is phasing out the

job retention scheme by the end of

October as it tries to move the economy

back onto a normal footing. Businesses

are being encouraged to bring staff

back to the workplace to rekindle the

badly damaged restaurant and pub

trade in office districts.

However, the FSB said that help was

needed for small businesses beyond the

government’s £1,000 job retention

bonus for every furloughed worker who

is rehired until January. It called for a

cut in employment taxes either

through a national insurance contribu-

tion holiday or an uprating in the

employment allowance.

“One in five small firms have been

forced to let staff go over the last three

months,” Mike Cherry, chairman of the

FSB, said. “Even with critical emer-

gency measures in place, jobs are sadly

being lost in the here and now.”

The Resolution Foundation said fur-

loughing should be phased out “more

slowly” for sectors such as hospitality.

Rishi Sunak, the chancellor, has ac-

knowledged that ending furlough “will

be a difficult moment” and expects un-

employment to rise, but said last month

it was “in no one’s long term interests

for the scheme to continue for ever”.

the five largest central banks to

ensure markets do not deepen the

recession.

Yet the market panic was nothing

like as bad as the financial crisis. The

risk of a few busted hedge funds and a

spike in market rates is not

comparable to an insolvent banking

sector, unable to intermediate credit

between borrowers and savers. The

banking crisis was structural. The

problem in the markets is the

plumbing, but the plumbing is so bad

it is threatening the foundations.

That’s what the red warning lights

were saying, that the financial system

was not resilient against a crisis,

whatever shape it might take, and

risked making the downturn worse. A

big part of that is regulation that has

reduced the number of market

intermediaries, the pipes through

which the money flows. The repo

market ran out of cash in March

because it is so reliant on a limited

number of “pawn shop” banks that

there is not the capacity to keep it

functioning. It was the same last

September.

Another reason is the increase in

public and private sector debt, which

was larger than ever, even before

Covid, at 225 per cent of GDP —

11 percentage points more than in the

financial crisis. The debt surge has

raised the market water pressure just

as the pipes were shrunk.

Central banks were not prepared.

They have tools to intervene in

disorderly markets but QE was a hose

to flood every corner with liquidity in

the March panic, in the hope it would

work as much as anything. It was easy

to reverse-engineer a justification by

arguing that disorderly markets drive

up borrowing costs, which would push

inflation below their 2 per cent

targets. QE was not even having the

desired impact until regulations on

leverage were altered in April.

Policymakers were making it up as

they went along.

But the warning signs were there.

The repo market had revealed the

pipes were gummed, the inverted

yields spoke of a lack of confidence,

and the bond and equity bubbles

revealed a

fundamental market

distortion. The

alarm can’t be

ignored any longer.

‘‘

’’

Philip Aldrick is Economics Editor of

The Times