The coronavirus-induced investor panic continued on Monday, sending the NYSE tumbling by over 8 per cent, the FTSE by nearly 7 per cent, and the Stoxx 600 index of leading EU shares by 7.5 per cent. Fearing the worst, investors are fleeing equities and short-term bonds for the safety of gold, long-term bonds and, in some cases, cash.
The precipitous decline in US equity prices comes on the back of the ‘longest bull run in history’ – the twelve years since the financial crisis have witnessed an almost uninterrupted period of rising US equity prices. In the UK and Europe equity prices have been impacted by Brexit and currency movements, but in most advanced economies, stock prices have remained very high relative to likely trends in corporate profitability over the next several years.
Government bond yields, meanwhile, have sunk to historic lows on the back of extraordinarily loose monetary policy. Some governments – notably Germany’s – have benefitted from negative interest rates, meaning that investors are paying the German government for the privilege of holding its debt. Germany, however, has stuck to its policy of schwarze null, or black zero, which requires the government to maintain a budget surplus.
Corporate debt, meanwhile, has ballooned. With interest rates low, corporations have been able to borrow large amounts at very low interest rates since the financial crisis. And as investors ‘reach for yield’ – search out investments that will deliver high returns – they have flocked into risky corporate bonds, meaning that even less creditworthy businesses have benefitted from relatively low borrowing costs. Some analysts argue that there is a bubble in US corporate debt – total credit to US corporations stood at 75.3% GDP in the third quarter of 2019. In this UK, the figure is 81.5%.
The real economy, meanwhile, is performing poorly. This is not a recent coronavirus-induced trend, but a longstanding stagnation evident in advanced economies since 2009. After a weak performance since 2009, US productivity dropped by 0.3 per cent between the second and third quarters of 2019. Eurozone productivity growth hasn’t risen above 1.5 per cent since 2012. The UK, meanwhile, has endured the longest period of productivity stagnation since the invention of the lightbulb.
Productivity is the single most significant driver of per-capita GDP growth over the long-term. No wonder economic growth in most major economies has been so weak. The Eurozone, constrained by tight fiscal rules and dogged by the (as-yet-unresolved) debt crisis, has performed particularly poorly in the growth stakes since the financial crisis, though growth in the UK since the vote to leave the European Union has also been disappointing. Wages, which are linked to productivity, have stagnated in the UK and the average US worker is not much better off than they were in 1979.
What explains the huge gulf between stock markets and economic fundamentals in the advanced economies? Two words: quantitative easing. The world’s four largest central banks have poured more than $10 trillion worth of new money into the global financial system since 2010, and a big chunk of this cash has found its way into equities and bonds. Some of it has entered property markets, particularly in London, contributing to the housing crisis.
Extremely loose monetary policy has propped up asset prices for the wealthy even as the real economy stagnates. This situation was never sustainable over the long term. Ultimately, asset values should be based on economic fundamentals – if everyone wants to own a particular stock, it should be because they expect that company to report high profits in the future. House prices shouldn’t diverge from incomes over the long term. Quantitative easing has inverted this logic, pushing up asset prices even as investors expect the economy to take a turn for the worse in the near future.
The panic over the coronavirus has catalysed a long-anticipated correction in asset prices. The speed with which the virus will spread is, at this point, an unknown entity and uncertainty is the number one enemy of investment. When they’re unsure about the future, businesses and investors are much more likely to keep their capital in cash or safe assets like gold than they are to invest in equities, whose returns are linked to economic growth, or short-term government bonds, whose yields are linked to interest rates.
The collapse in asset prices is unlikely to impact the ordinary worker, other than by reducing the value of their pension pot. But stock market volatility simply provides us with a taste of the likely long-term economic impact of the virus. If, as now seems likely, the virus spreads faster outside of China than it did within it, the impact on global growth will be huge. Widespread quarantining, the cancellation of large events and ongoing uncertainty – not to mention thousands of deaths – will mean a collapse in output.
Governments are out of monetary fire power – if they respond at all, it must be with fiscal policy. Co-ordinated stimulus programmes from the world’s major economies might be enough to prevent a significant downturn – and borrowing is now cheaper than ever. Given that the virus will have a greater impact on poorer countries and more vulnerable individuals, the response must be targeted at protecting the least well-off. And given that the climate crisis represents a far greater long-term threat to humanity than coronavirus, it should also promote decarbonisation.
In other words, now is the perfect time for the Green New Deal. It remains to be seen whether governments led by Donald Trump, Boris Johnson and Angela Merkel will seize the opportunity.