Governments have shut down supply and destroyed demand: the past is no guide to this crisis

Nothing quite like this has happened before in the modern world. 

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Long history suggests periodic economic crises, including financial crashes, are inevitable. It also tells us that pandemics cause recessions. But the past seems to be little guide to the multiple-faced crisis through which we are presently living, even as, paradoxically, recognisable history has returned to the financial markets. 

China’s economic collapse this quarter, and the one for Europe and North America in the coming quarter, will be unprecedented, whether judged by previous pandemics or the beginning of the worst economic depressions. This economic cessation has been screeching and sweeping. Governments across the world have deliberately chosen to shut down supply and destroy demand.

Nothing quite like this has happened before in the modern world. Usually, when economic crises begin, governments endeavour to reverse them, even if they sometimes erroneously choose policy instruments that make them worse in the short to medium term. To ask in this instance for a policy response to breathe life back into the world economy misses the point. The flurry of policies announced in the past few weeks have been formulated to protect the basic conditions of daily life, starting with people’s ability to buy food and other essentials.  

The 2020 financial crash is also very large by any historical standards. Only the share market crash on 19 October 1987 was larger than the percentage fall in the Dow Jones index on 16 March, and the fall on 12 March was also significantly bigger than any in 2008. There is a vast dollar shortage in a world economy that runs off dollar credit, with several currencies tumbling against the dollar in the week beginning 16 March. There has been an exodus of capital out of emerging market economies several magnitudes higher than the cross-border flows seen at the peak of the 2007-08 crash. The Federal Reserve has had to extend dollar liquidity to central banks excluded from the swap line facilities it established in 2013. 

A number of emerging-market economy states and corporations whose central banks do not have access to American central bank financing will soon be unable to service their dollar debts. The only silver lining thus far is the absence of capital flight from China, because China’s dollar shortage problems have constrained world economic growth since at least 2015, when the People’s Bank of China devalued the yuan. 

Meanwhile, the oil price crash that began on 9 March is severe, and disastrous in its short- to medium-term implications. Oil demand is probably collapsing at a faster rate over a short period of time than at any time since oil drilling began. In the world economy as it is – rather than as we might hope it may one day become – big slumps in oil demand reflect deep economic crises. Yet one of the world’s three largest oil producers, Saudi Arabia, has reacted to this ferocious fall in demand by sharply increasing production. 

The rickety structure to world oil markets provided by the three-and-a-half-year-old alliance between Saudi Arabia and Russia collapsed over the weekend of 7-8 March. The Saudi determination to claim market share rather than reduce the damage to prices puts at risk the American shale sector, which cannot function with very low prices. Since the shale sector has been fuelled for a decade by cheap debt in junk bond markets, and significant amounts of credit were already precariously moving towards maturity, the 2020 financial crash and the investor search for ultra-safe assets can only darken its prospects. 

Nor will the geopolitical and financial problems at work in the oil crisis readily lessen. Stabilising the supply side of oil markets would require Saudi-Russian-American co-operation, because for any protracted period of time two states will not cut production for a third to benefit in market share. Yet the geological and financial issues around shale oil extraction mean that American producers cannot discipline output without destroying the sector. There has been enormous collateral dysfunctionality at work for some time where oil is concerned, and the reckoning may well have begun. 

Seen as a whole, this economic crisis compares to the 1930s depression not because we are heading for a slump of anything like the same length but because it too was a multi-faceted crisis. Then, a share market crash and an oil price slump produced a banking crisis, a debt crisis and an unemployment crisis. In the economic collapse, the weak geo-political order established in the mid-1920s around a US-German economic relationship shattered.

What, nonetheless, makes this crisis qualitatively different from any we understand from past history is that it comes when we had already ventured far into unknown economic territory. Monetary policy never went back to normality after the 2007-08 crash; nor did financial markets. From the second half of 2009 until this month, share prices relentlessly climbed, largely indifferent to risk beyond central banks’ deeds and words. Even as trouble in the repurchase markets last September suggested that another financial crash was an imminent possibility and the Federal Reserve Board returned to quantitative easing – albeit under the pretence it was simply dealing with technical problems – the share bubble continued to inflate.  

Even the previously most bearish investors and commentators had begun to wonder if, in this brave new monetary and financial world, central banks could perhaps keep bubbles going indefinitely, at least within any market perspective of time. Past financial history was, it appeared, becoming immaterial. Now, we know risk cannot be dethroned and recognisable history has returned. Having learnt the limits of what central banks can do, we must set forth into a new unknown world.

Helen Thompson is professor of political economy at Cambridge University and a regular on the Talking Politics podcast. 

This article appears in the 25 March 2020 issue of the New Statesman, The crisis chancellor

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