Copying and distributing are prohibited without permission of the publisher.

Watermark

Borrow like there’s no tomorrow

By Jon Hay, Toby Fildes
19 Mar 2020

“There are decades when nothing happens; and there are weeks when decades happen.” So said Vladimir Lenin, although the founder of Soviet Russia probably didn’t write this with the capital markets in mind.

We’ve had what feels like 20 years’ worth of events in just 10 days. Two weeks ago, the Institute of International Finance cut its 2020 global growth forecast from 2.6% to 1.6%. Yesterday, after the profound, sudden stop across major capital markets, it downgraded its growth projection to 0.4% and forecast recession in the US, eurozone and Japan.

Governments and central banks have tried to quench the fires by promising fiscal rescue packages with astronomical price tags, slashing rates, launching huge quantitative easing programmes and relaxing regulations put in after the 2008-9 credit crisis.

The speed of deterioration has dumbfounded capital markets. And this is before we see the real and terrible impact on companies and banks.

In this hurricane, capital markets will have plenty to do. The UK’s gross financing requirement — already higher than planned after last week's Budget — will balloon in this coming fiscal year, as spending swells and tax receipts evaporate.

The same will surely have to happen across the world, and the pain, as ever, will be worst in emerging markets.

Core capital markets have been severely rattled this week. US Treasuries, Bunds and Gilts have wobbled at various stages. Currency and interest rate swap liquidity evaporated. The commercial paper market has been gasping for life.

But there is a silver lining: these strains in the guts of finance have given central banks a reason to step in with huge programmes of liquidity support.

To market participants used to a decade of ultra-low government yields, seeing Treasuries and Gilts gap out in a crisis is like peering into the abyss. But it does not mean investors have lost faith in Western governments.

These are meant to be high quality liquid assets that investors can sell to raise cash urgently. The wild swings show the market is functioning, even if this work is an inelegant spectacle.

Equally, market participants should not despair if stock markets keep plummeting, even after stimulus and liquidity injections. Equities were priced for perfection but they are going to find themselves part of a savaged economy. They belong lower.

The real test will be in the real economy. What happens when car companies cannot sell any cars? When no company is buying new machinery? When no one is buying clothes, shoes or haircuts?

A big part of the answer will be borrowing. Companies can borrow money to get them through this pain. Normal financial markets will work up to a point, but lenders are not going to throw money away. Governments will have to take on risk, becoming nannies to the whole economy. And that means, ultimately, governments will have to borrow a lot.

So far, it looks like they have understood the need. It is not clear they know how to implement the detailed, on-the-ground policies needed. No one has tried it before in living memory. Even in wartime, governments could encourage people to pursue normal life as much as possible.

The effort will have a little in common with the Communist drive to energise the Russian economy after 1917. The analogy does not go very far, but policy makers would be wise when deciding how much money to throw at this to heed another dictum, sometimes also attributed to Lenin: “Quantity has a quality all its own.”

By Jon Hay, Toby Fildes
19 Mar 2020