- The coronavirus crisis could transform economic behaviour for decades
Economic firefighters around the world have a problem they’ve never seen before: a lightning-fast economic collapse strapped to a virulent global pandemic and wild, whipsawing financial markets threatening to amplify the damage.
From Washington to Brussels to Frankfurt to Berlin and beyond, officials in advanced economies are rolling out the biggest fiscal and monetary policy bazookas they’ve ever imagined. Some of the players, notably Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin, have forged a close firefighting partnership echoing their predecessors’ during the 2008 financial crisis. Officials who confronted the brink of economic calamity during a European debt crisis that began a decade ago – such as German Chancellor Angela Merkel and the new European Central Bank president, Christine Lagarde – are revising their playbooks and trying to avoid renewing the divides of that conflict.
Economists, traders and average citizens are all too aware that those efforts can’t stop the coronavirus, which is causing a once-in-a century human and economic catastrophe that’s still playing out with no clear end in sight. They’re starting to brace for a longer and deeper downturn than any of them imagined just a month ago when the mass shutdowns began across the global economy. And they’ve yet to grapple with the consequences of the economic damage rippling from the largest and strongest economies to the smaller and weaker ones with fewer resources.
The world’s finance ministers and central bankers will gather virtually this week for the International Monetary Fund’s semi-annual meeting of 189 member nations – a pandemic-era replacement for the usual in-person gathering in Washington. At the top of the agenda will be charting a course for fighting a global economic collapse unlike any other in the IMF’s 75-year history.
“The depth of the recession, just in terms of jobs lost and fallen output, will not compare to anything we’ve seen in the last 150 years. The only question is duration,” said Kenneth Rogoff, a Harvard professor and former IMF chief economist who has studied every recent downturn. “The economic tools we are using are important, but it’s a natural catastrophe or war – we are in the middle of it and just getting out of it is kind of the main thing right now.”
The massive infusions of cash from central banks and governments around the world will help. But new approaches will ultimately be required, Rogoff argued, including possible global debt moratoriums for emerging-market economies such as India likely to be slammed by the virus. He also said central banks such as the Fed may be forced into unprecedented steps to revive growth – such as lowering interest rates below zero, a move the central bank has long resisted in part because of mixed evidence of its effectiveness.
The big institutional players in this global economic drama are battle-tested veterans at spraying foam on the runway in the form of giant spending programmes and an alphabet soup of lending facilities and central bank interventions. The US Fed and Treasury just last week announced efforts designed to dole out more than US$2 trillion in loans to businesses and municipalities, on top of trillions of dollars already promised through other lending and stimulus efforts.
But this is a beast unlike any of them have seen.
Other major downturns in recent decades grew out of market bubbles or economic policy mistakes, from runaway inflation in the 1970s and early 1980s, to the savings and loan crisis and Asian market meltdowns in the 1990s to the dot-com crash in 2000 and the 2008 financial crisis.
This time really is different.
And while central players including Powell, Mnuchin, Lagarde and Merkel are mostly using tools that worked in the past, few seem to be wrestling more broadly with how fundamentally the world is changing and what economies may look like once the coronavirus pandemic is finally brought under control, a date that remains largely unknowable and beyond the ability of economic policymakers to control or even influence.
The Great Depression transformed economic behaviour for at least a decade. Many who lived through it never returned to their previous ways. The coronavirus crisis could do the same, suggesting the old playbook may help put out some short-term fires, but an entirely new approach may have to emerge from policymakers around the world.
“The Fed and Congress have done an outstanding job so far,” said Liaquat Ahamed, a former World Bank official and author of the Pulitzer Prize-winning Lords of Finance: The Bankers Who Broke the World, a history of the Great Depression. He cited trillions of dollars worth of emergency lending from the Fed and a congressional rescue package worth 10 per cent of the economy.
“Whether that’s enough, I suppose, depends on how long you have to do it for. But when this is all over I think we will have to ask the question of, what it is about the US economy that makes it so unstable when it gets hit?” Ahamed said. “Europeans have mechanisms in place to deal with this that are a lot better than we have. All these lines outside unemployment centres show we don’t have the institutional mechanisms to deal with these kinds of shocks.”
Here’s a look at what some of the biggest policymakers are doing now in the world’s two leading advanced economies – the United States and Europe – and what they may have to contemplate in the months and years ahead.
Trump’s trusted Treasury secretary joins arms with the Fed chair
Mnuchin, though generally calm and subdued in public appearances, has been a frenetic actor behind the scenes, consistently on the phone and in meetings with the Fed chair, congressional leaders and White House officials as the economic point man for President Donald Trump – one of the few top officials to maintain the president’s confidence throughout his term. Mnuchin personally shuttled between congressional offices last month negotiating between a Democratic House speaker and Republican Senate majority leader for a US$2.2 trillion programme to save major industries, rescue small businesses, issue cheques to most Americans and bolster unemployment benefits.
He’s racing against grim signs of damage across the economy, including 17 million new jobless claims in the US in just three weeks with millions more on the way. It’s a scale of devastation beyond what the US saw across the entire course of an 18-month recession tied to the 2008-2009 financial crisis.
Over the last two weeks, Treasury and the Fed have held calls every day at 5pm, led by Mnuchin and Powell and including other senior staff. But Mnuchin and Powell talk multiple times a day on their mobile phones, often well into the night – “sometimes five times, sometimes 30 times”, according to the Treasury chief.
The calls reached fever pitch last Wednesday, as Treasury and the Fed prepared to jointly announce the massive US$2.3 trillion intervention by the central bank, timed to hit the news wires just ahead of another disastrous report on unemployment claims on Thursday morning, which wound up showing 6.6 million Americans filed for benefits.
The plan included multiple facilities with complicated names to plough money into the cratering economy. Staff at Treasury and the Fed worked until well after midnight Wednesday night putting the necessary documents together to make the moves legal, which under section 13(3) of the Federal Reserve Act required the signature of the Treasury secretary.
After a brief respite, work on the papers began again at 5am Thursday, with Powell and Mnuchin resuming their phone conversations as the clock ticked toward the 8:30am release of the devastating jobless figures.
The final documents bearing Mnuchin’s signature authorising the giant intervention did not arrive at the Fed until 7:55am, five minutes before the central bank planned to send out an embargoed press release to give reporters time to prepare stories that would hit right at 8:30am.
The frantic effort largely upstaged the market impact of the job losses. CNBC immediately switched from covering the unemployment news to offering details of the Fed’s intervention. Investors also ignored the jobless claims figures on Thursday and celebrated the Fed’s moves, sending stocks up hundreds of points.
On the financial markets side at least, the Powell-Mnuchin power pairing appears to be working. After bottoming out on March 23, stocks have mounted a remarkable comeback – celebrated by Trump on Friday – though the Standard & Poor’s 500-stock index remains around 18 per cent below highs hit in February.
It was a moment reminiscent of the partnerships between then-Fed Chair Ben Bernanke and Treasury Secretaries Hank Paulson and Tim Geithner during the 2008-2009 financial crisis. Bernanke, first with Paulson then with Geithner, often timed announcements to beat the opening of Asian markets on Sundays – their attempt to calm tanking markets and get ahead of grim news.
A dealer with Democrats in a bitterly partisan era
Mnuchin is serving as the administration’s economic deal-maker by building functional relationships with Democrats, the result of a lesson learned from Trump’s biggest economic legislation before now: the 2017 tax cuts.
People close to the Treasury secretary say that during that effort, when Mnuchin took a back seat to top officials such as then-National Economic Council Director Gary Cohn, he learned during the highly partisan debate that building relationships with Democrats on Capitol Hill really mattered. Also key was being viewed as speaking directly for Trump, to the limited extent that anyone but Trump himself can do that.
“After tax reform he’s been very careful to solicit Democratic members’ concerns, as well as Republicans of course,” one person close to Mnuchin said. “Quite frankly, over the three years he’s been there, he’s figured out Washington better, certainly better than when he first got there. He’s learned to play the game.”
Mostly, Mnuchin grabbed the lead slot on the rescue package by getting tighter with House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer. “I think they’ve come to view him as not that political a guy, not a backslapper,” this official said. “He kind of just says what he means and I think Democrats sort of figured that out.”
A second official close to Mnuchin said that in Hill meetings, as discussions skidded into partisan rows, the secretary often served as the person to keep them focused on the core items – moves that ultimately satisfied Democrats and enlarged the rescue package. “He was the most uniquely positioned person to do this for Trump given he has the president’s confidence and knows with as much certainty as anyone how the president will react to things.”
During the frenetic, often late night talks over the rescue package, people close to the matter say Mnuchin relied most heavily on White House Legislative Affairs Director Eric Ueland; Deputy Treasury Secretary Justin Muzinich, who has deep experience on Wall Street; and Treasury General Counsel Brian Callanan. Despite the large staff at his department, Mnuchin has long preferred to lean on a small group of trusted advisers.
Mnuchin on Friday morning helped broker what appeared to be an agreement with Schumer to open bipartisan talks on the next chunk of coronavirus relief from Congress. But partisan lines over the money hardened again over the weekend, and it remained unclear whether Mnuchin could actually play any kind of peacemaker role.
While Schumer has complained that Senate Majority Leader Mitch McConnell didn’t reach out to him and McConnell’s allies say Schumer isn’t negotiating in good faith, there have been few Democratic complaints about Mnuchin. At the same time, the Treasury secretary doesn’t exactly speak for the ideologically diverse Senate Republican Conference, leaving some negotiations akin to a game of telephone. It can appear to succeed one moment, then fall apart the next.
Mnuchin has also emerged as one of the key players in a variety of largely amorphous groups inside the White House working on plans to reopen the economy as soon as possible, a top Trump priority in regular tension with the advice of the president’s top health advisers. On Thursday, Mnuchin said he thought the economy could reopen in May.
The Fed, backed by taxpayers, creates bazooka after bazooka
Working remotely like almost everyone else at the nation’s central bank, Powell is on the phone for most of the day from his home office – as much as 12 hours straight – while his television is tuned to CNBC, or occasionally Bloomberg TV. On the other end of the phone line is a laundry list of policymakers: his staff, fellow Fed board members, the heads of the regional Fed branches, members of Congress, foreign central bankers, as well as Mnuchin and his deputy, Muzinich.
Powell’s in-person press conferences have been replaced by teleconferences. What were once highly anticipated public events are now webcasts. And the audience he’s trying to reach is broader than the usual world of policymakers and traders.
His stated goal is to work both within and outside the Fed to help the US economy make it to the other side of the crisis – and ensure the central bank’s stunning array of actions keep their potency against endless scepticism about the strength of the Fed’s ammunition.
“The Federal Reserve is working hard to support you now, and our policies will be very important when the recovery does come, to make that recovery as strong as possible,” the Fed leader said in a rare TV interview on NBC’s Today show.
Together, the Fed and Treasury have announced nine emergency lending programmes so far, part of an effort to ensure households and companies have the ability to borrow money and that financial markets don’t fall apart.
The emergency programmes are the backbone of the government’s economic response. Most of the US$500 billion set aside by Congress for businesses, states and cities is allotted for Treasury to facilitate loans from the Fed by covering any losses on those loans. The central bank also announced an effort to bolster the US$350 billion in the congressional relief package for government-backed loans to small businesses.
Fed staff shoulder the bulk of the work on designing the programmes, with direction from Powell; Randal Quarles, the central bank’s vice-chairman in charge of bank oversight; and Lael Brainard, the last remaining Democrat on the Fed board who chairs its committee on financial stability.
Many of the programmes rolled out by the central bank are reruns from the 2008 financial crisis. But Treasury’s engagement has taken on greater importance as the Fed strays further outside its typical role – of simply keeping money flowing through the economy – and moves into directing credit to specific sectors. The Fed has prioritised help to borrowers that Congress specifically said should receive aid – namely, non-financial businesses and municipalities.
The central bank’s actions are finding a response officials did not get in the 2008 financial crisis: praise from lawmakers for forceful, pre-emptive moves.
“The Fed has taken massive and necessary action,” said North Carolina congressman Patrick McHenry, the top Republican on the House Financial Services Committee, in an interview.
Congress handing the Treasury Department taxpayer dollars to facilitate the Fed’s efforts cleared the path early. “We now have the fiscal house in front of the central bank,” McHenry said. “I think that is healthy and right. We don’t want the central bank playing politics.”
The central bank has worked for weeks on a “Main Street” lending programme aimed at medium-sized businesses, although it will likely be weeks before that offering rolls out. The Fed also has yet to open the doors of its corporate credit programmes, under which it will purchase debt issued by large companies. But just the announcement of those programmes has helped corporate bond markets start running a bit more smoothly.
Still, the Fed faces a tough balancing act in using its lending to help companies that merely need cash to get them through the next few months while not propping up firms that are in trouble because of bad decisions made leading up to the crisis, such as loading up on too much debt.
Meanwhile, it’s been an ongoing struggle for the Fed to ensure proper functioning in the market for US government debt, which influences all other interest rates and is a key investment globally.
The institution is also working furiously to keep the US dollar – used around the world to trade, invest and borrow – available in other countries, as investors around the world seek refuge in the US currency. The Fed made it easier for some foreign central banks to exchange their currencies for dollars, a move designed to prevent the value of the dollar from rising too high as other countries experience dollar shortages, which could have unwanted spillover effects in the US
But it won’t be able to entirely shield the domestic economy from longer-term wounds abroad, including in major emerging economies that might not have the resources to contain the virus before a vaccine is widely available.
“The Fed is serving as an international lender of last resort,” said Ramin Toloui, a professor at Stanford University and former Treasury official across three administrations. “But it’s beyond the capability of the Fed to address what might be a solvency problem that could be emerging as a result of the real economic harm that’s being done by the spread of this epidemic around the world.”
In Europe, Germany breaks its taboos and unleashes its weapons
Merkel’s long political career took an unexpected turn in early March.
Up until then, the German leader had been riding out her tenure as chancellor ahead of her planned retirement in 2021. Her top priority had been to broker a solution to the brewing refugee crisis on the Turkish-Greek border and quietly steer the process of finding a successor.
But news on March 8 that Italy’s prime minister had placed the northern half of the country – including the country’s industrial heartland – under quarantine forced Merkel to change focus.
With the number of dead and infected in Italy rising exponentially, Merkel knew that the hopes in Berlin that Europe could dodge a major economic crisis had been dashed.
During a 7-hour meeting with coalition partners in her cavernous Berlin office that evening, Merkel won approval for billions in stimulus and other measures to cushion the impact of the incoming storm.
It turned out to be just a first step. Within days, as the potentially catastrophic impact of the coronavirus became clearer, Merkel’s cabinet had agreed, in the words of Finance Minister Olaf Scholz, to “put all of our weapons on the table.” That meant generous tax relief for companies both small and large and credit guarantees worth nearly €€500 billion.
“This is the most extensive and effective guarantee we have ever made in a crisis,” said German Economy Minister Peter Altmaier.
Just weeks before, Altmaier, one of Merkel’s most trusted advisers, had downplayed the economic threat posed by the coronavirus. But now, with the entire German economy facing a shutdown, the stakes were clear. The Germans were falling back on the playbook they followed in 2008 in the wake of the Lehman Brothers bankruptcy, when Merkel’s government stepped in to prop up the country’s banks with hundreds of billions of euros in guarantees.
This time, guarantees alone weren’t going to be enough.
With large swathes of German industry on hold, the government needed quick cash for the legions of self-employed and to inject funds into hospitals and the small- and medium-sized businesses that form the backbone of the German economy.
Even in an emergency, securing those funds would be complicated. Doing so would mean breaking the biggest taboo in German politics – running a deficit. One of the keys to Merkel’s enduring popularity is that Germany has recorded a surplus since 2015, what Germans call a “black zero”. But with economists predicting the crisis could cost the German economy anywhere from€€250 billion to €730 billion, it was clear to Merkel and her advisers that the black zero was history.
Under Germany’s constitutional “debt brake” – a rule adopted in 2011 to tame deficit spending – governments need parliamentary approval to exceed budget limits. Merkel planned to ask for €156 billion for 2020, an increase of nearly 50 per cent over the current budget. In addition, the government planned to seek approval for further loans and credit guarantees, bringing the total value of the rescue package to nearly €€1 trillion. Relative to the size of Germany’s US$4 trillion economy, the package would be among the most aggressive of any country’s, including the US rescue package that was a tenth of its economy.
Germany’s parliament, the Bundestag, fought tooth and nail for months over smaller sums for Greece and other euro zone countries during the region’s debt crisis. Now it was being asked to approve the largest financial rescue in the country’s history in a matter of days.
Just as the chancellor’s team was putting the final touches on the plan, it hit an obstacle when Merkel was exposed to the virus. A doctor Merkel had visited on March 20 for an immunisation shot had tested positive for the virus, and she was placed under quarantine.
That meant it would be up to Scholz, the finance minister and vice-chancellor, to take the deal over the line.
“What we need now is solidarity,” he told legislators on March 25, as Merkel watched from home.
They agreed, approving the package by a comfortable margin.
Europe debates debt (again) as the ECB revisits ‘whatever it takes’
Putting together a European package has proved more complicated.
With Italy and Spain, the euro zone’s third- and fourth-largest economies, effectively shut down as they try to bring the spread of the virus under control, leaders in both countries have been looking to Frankfurt and Berlin for help.
Neither country has the fiscal space to undertake the aggressive stimulus Germany is pursuing.
Just how exposed those countries – which bankers like to call the “Club Med” – really are became clear on the afternoon of March 12 during Lagarde’s regular press conference. Lagarde, the former IMF chief who took over the ECB in November, was annoyed that national governments weren’t acting more forcefully to confront the pandemic with aggressive fiscal measures. She worried members of the 19-member euro currency bloc would once again put the onus on the central bank to act through asset purchases, a course many economists argue is little more than a short-term fix.
“We are not here to close spreads,” Lagarde told reporters, signalling the ECB was not prepared to intervene in the market to keep a lid on southern Europe’s borrowing costs. Lagarde also said she didn’t intend to represent “whatever it takes, No. 2”.
In the space of a few seconds, Lagarde appeared to have reversed her predecessor Mario Draghi’s famous pledge during Europe’s debt crisis in 2012 to do “whatever it takes” to save the euro.
Italian bonds posted their steepest drop in a decade following Lagarde’s remarks, prompting frantic calls from Rome. Spooked by the market reaction, Lagarde, a trained lawyer whose suitability for the ECB role some questioned, went on CNBC to repair the damage.
She insisted she was “fully committed to avoid any fragmentation in a difficult moment for the euro area”.
But the damage was done. The next day, she apologised to her colleagues on the ECB’s governing council who had gathered for a conference call.
With the crisis worsening by the hour, it had become clear that, like it or not, the ECB needed to go big.
In the days that followed, Lagarde’s team at the ECB’s Frankfurt headquarters – an imposing structure resembling a giant glass shard – assembled a sweeping €750 billion package to stabilise the markets through asset purchases. While the bank had pursued a similar strategy in the past, this time Lagarde was proposing going even further by lifting the controls on how much debt the central bank could hold of each individual member. Those constraints were put in place during the euro crisis to shield the bank from accusations it was effectively printing money without limit to keep its members afloat, a point of particular concern to Germany and other northern members of the currency bloc.
Less than a week after insisting she didn’t want to mimic Draghi, Lagarde was trying to convince the ECB’s governing council to go even further.
During a conference call on March 18, Lagarde told the head of the euro zone’s national central banks that the pandemic had created “severe strains in the financial markets”.
While some members of the ECB’s governing council expressed reservations about lifting the controls on bond buying, they relented.
Lagarde ensured the central bankers that governments were now signalling more willingness to play their part with spending initiatives.
Still, the problem in southern Europe wasn’t willingness to act on the fiscal but the ability to. In Rome, Italian Prime Minister Giuseppe Conte worried the shutdown he had mandated would leave the country starved for cash, a shortfall it could only fill with the help of its wealthy northern neighbours.
During a videoconference summit of European leaders on March 26, Conte repeated a call for the introduction of “corona bonds” backed by all countries in the euro zone. Proceeds from the sale of such debt could be used to help the likes of Italy and Spain. The advantage is that with Germany’s backing, the interest rate on the bonds would be much lower than other countries could secure on their own.
“We need to react with innovative financial tools,” Conte told his counterparts.
The idea of mutualising euro zone debt came up during the Greek crisis as well. For Germany and the Netherlands and other northern European countries, it’s no less controversial today than it was then. They worry the introduction of corona bonds would open the door to further mutualisation down the road, saddling their countries with the burden of Southern Europe’s debt.
Even as she’s writing blank cheques at home in Germany, Merkel has so far responded to her European counterparts with a strict nein, infuriating southern Europe’s leaders.
“Do you not understand the emergency we are going through?” an exasperated Spanish Premier Pedro Sanchez asked Merkel during the videoconference.
The German leader insisted she did. Even so, corona bonds remained off the table.
That’s mainly because she knows her own party would never accept a deal requiring Germany to take on other countries’ debt.
The European summit nearly collapsed over the issue with Conte and Sanchez warning of dire consequences if there wasn’t an agreement.
The leaders punted the issue to their finance ministers. Last week, after an angry debate during an all-night session, they finally agreed on a €540 billion package of credits and loan guarantees to help flagging members.
The only question is whether it will be enough.
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