The Economist UK - 14.03.2020

10 Leaders The EconomistMarch 14th 2020

1

W

hen facedwith a bewildering shock it is natural to turn to

your own experience. As covid-19 rages, investors and offi-

cials are scrambling to make sense of the violent moves in finan-

cial markets over the past two weeks. For many the obvious refer-

ence is the crisis of 2007-09. There are indeed some similarities.

Stockmarkets have plunged. The oil price has tumbled below

$40 a barrel. There has been a flurry of emergency interest-rate

cuts by the Federal Reserve and other central banks. Traders are

on a war footing—with a rising number working from their

kitchen tables. Still, the comparison with the last big crisis is

misplaced. It also obscures two real financial dangers that the

pandemic has inflamed.

The severity of the shock so far does not compare with

2007-09. Stockmarkets have fallen by a fifth

from their peak, compared with a 59% drop in

the mortgage crisis. The amount of toxic debt is

limited and easy to identify. Some 15% of non-fi-

nancial corporate bonds were issued by oil firms

or others hit hard by the virus, such as airlines

and hotels. The banking system, stuffed with

capital, has yet to seize up; interbank lending

rates are under control. When investors panic

about the end of civilisation they rush into the dollar, the reserve

currency. That has not yet happened (see Buttonwood).

The nature of the shock is different, too. The 2007-09 crisis

came from within the financial system, whereas the virus is pri-

marily a health emergency. Markets are usually spooked when

there is uncertainty about the outlook six or 12 months out, even

when things seem calm at the time—think of asset prices drop-

ping in early 2008, long before most subprime mortgage borrow-

ers defaulted. Today, the time horizon is inverted: it is unclear

what will happen in the next few weeks, but fairly certain that

within six months the threat will have abated.

Instead of tottering Wall Street banks or defaults on Florida

condos, two other risks loom. The first is a temporary cash

crunch at a very broad range of companies around the world as

quarantines force them to shut offices and factories. A crude

“stress test” based on listed companies suggests that 10-15% of

firms might face liquidity problems (see Finance section). Cor-

porate-bond markets, which demand precise contractual terms

and regular payments, are not good at bridging this kind of short

but precarious gap.

In 2007-09 the authorities funnelled cash to the financial sys-

tem by injecting capital into banks, guaranteeing their liabilities

and stimulating bond markets. This time the challenge is to get

cash to companies. This is easy in China, where most banks are

state-controlled and do as they are told. Credit there grew by 11%

in February compared with the previous year. In the West, where

banks are privately run, it will take enlightened

managers, rule tweaks and jawboning from reg-

ulators to encourage lenders to show clients for-

bearance. Governments need to be creative

about using tax breaks and other giveaways to

get cash to hamstrung firms. While America

dithered, Britain set a good example in this

week’s budget (see Britain section).

The second area to watch is the euro zone. It

is barely growing, if at all. Central-bank interest rates are already

below zero. Its banks are healthier than they were in 2008 but

still weak compared with their American cousins. Judged by the

cost of insuring against default, there are already jitters in Italy,

the one big economy where banks’ funding costs have jumped.

As we went to press, the European Central Bank was meeting to

discuss its virus response. The danger is that it, national govern-

ments and regulators fail to work together.

Every financial shock is different. In 1930 central banks let

banks fail. In 2007 few people had heard of the subprime mort-

gages that were about to blow up. This financial shock does not

yet belong in that company. But the virus scare of 2020 does

create financial risks that need to be treated—fast. 7

V is for vicious

US corporate-bond spread

High-yield, basis points

800

600

400

200

0

2019 2020

How to make sense of the mayhem in markets

Financial conditions

W

hat a convenientthing a tame parliament is. On March

10th, acting on a proposal from the first woman in space

(now a celebrity mp), the Russian Duma approved an amend-

ment to the country’s constitution that would reset the clock

barring anyone from serving more than two consecutive terms

as president. As it happens, that would allow Vladimir Putin, at

present ineligible to run for another term when his current one

expires in 2024, to stay on for two more six-year terms after that

date, assuming he can win two more elections on top of the four

he has won already. By then, in 2036, he would be 83, and would

have ruled Russia for 36 years, as long as Ivan the Terrible. Two of

the world’s biggest military powers, China and Russia, now have

what look like presidents-for-life. Such leaders seldom improve

with age.

A few technicalities remain (see Europe section). Russia’s

Constitutional Court still has to rule on whether Mr Putin’s

changes are indeed constitutional. It is a sign of how completely

Mr Putin has packed and bent Russian institutions to his will

that no one imagines that he will fail to get his way, just as no one

imagines that Valentina Tereshkova, who took her giant leap for

womankind back on June 16th, 1963, was acting off her own bat.

The third hurdle is an “all-people vote” of doubtful legality on

Vlad the indefinite

The Russian president reluctantly agrees to stay on for another 16 years, if that’s what his people want

Russia