The Coming Crash

Stock markets across the world are rallying as lockdowns lift and central banks pump money into the economy – but it's likely to be a calm before the storm.

Stock markets around the world have been rallying over the past few weeks, driven in part by the unprecedented actions of the world’s largest central banks. In the US, the S&P500 is now back to where it was at the beginning of the year. The rally, combined with the easing of lockdown measures currently taking place around the world, is creating a great deal of optimism among market watchers. Unfortunately, the picture is not quite as rosy as it seems. 

The stock market rally has been driven primarily by the actions of central banks – and particularly those of the Federal Reserve. The Fed has promised to implement ‘QE infinity’ – in other words, it will not stop purchasing assets (using newly created central bank money) until it is satisfied that the risk to financial markets has passed. 

Then there is the alphabet soup of new asset purchasing and liquidity programmes that are supporting other markets. Through the CPFF, the PMCCF and the SMCCF Fed is now buying the debt of private corporations – paying little attention to their creditworthiness, and absolutely no attention to their environmental impact or record on workers’ rights. Meanwhile, the government is backstopping the market for auto loans, student loans and municipal bonds through programmes like TALF (first used after the 2008 financial crisis), the PDCF and the MLF. 

More important than understanding the details of each of these programmes (most of which are truly vast) is understanding what they signify: the US government is demonstrating its willingness to buy up the debts of US consumers, firms and states in order to prevent insolvencies and raise asset prices. 

On the one hand, this seems like a positive short-term measure – no one is suggesting that the Fed should simply allow personal, corporate, state and municipal bankruptcies to soar. But it also represents a profound shift in the nature of modern capitalism. The US state is telling its domestic businesses that no matter how much debt they accrue during the upswing – and no matter what purposes they use this debt for – when the crisis comes, they will be bailed out. 

The implications of this message – which is also being sent by many other central banks around the world – are profound. The risks of running a business have been socialised, whilst the gains have remained private. Firms are free to pollute, slash wages and avoid tax in the pursuit of profit, and they’ll still be able to count on a bailout from the state when things go south. Investors are protected while the public and the planet pay the price. Over the long run, QE infinity will simply push up asset prices – including house prices – exacerbating wealth inequality.

The realisation that central banks are willing to do almost anything to backstop their domestic corporate sectors and protect private wealth is what has driven the stock market rally. The rich and powerful know that no matter how far the real economy falls, the state will be there to pick financial markets back up again.  

Meanwhile, ordinary consumers – not to mention many small businesses – have been left out in the cold. While the job numbers that came out in the US last week were surprisingly positive, commentators quickly spotted a glaring error in the numbers: most agree that unemployment stands at around 20 million – nearly 20% of the US population, the highest it has ever been. In the UK, employment is currently being protected through the furlough scheme, but most medium-term estimates assume that unemployment could reach similar proportions.

Small businesses have been provided with grants and loans, but these are not likely to continue forever. Moreover, they provide nothing more than a sticking plaster over a much deeper structural problem – the massive increase in corporate debt that has taken place throughout much of the world over the past 12 years.

Before the crisis hit, many observers saw a bubble in US corporate debt – and the UK was not far off. Banks have warned the UK government that when its so-called ‘bounceback loans’ come to an end, between 40-50% firms could default. 

In short, the stock market rally tells us little about the fate of the real economy. In part, it is being driven by the concerted actions taken by central banks around the world to backstop falling asset prices. But it is also normal to see a rally in the midst of a crisis: stock markets rallied in mid-2007 as policymakers talked down the risks associated with rising defaults on US sub-prime mortgages. 

Today, the bomb waiting to go off is not mortgage debt, but corporate debt. Even the Fed won’t be able to save the global economy from meltdown if a significant portion of US – and indeed the world’s – businesses default at once. But that doesn’t mean it won’t try. 

When this crisis finally does come to an end – which is unlikely to happen for another 9-12 months – states are likely to own significant portions of the assets in their domestic economies. The question they will then face is what to do with this power: use it to piece back together the status quo, or to build a fairer, more resilient and more sustainable economy.