While a downturn in the business cycle appears a foregone conclusion at this point, how severe the recession will be, and in particular whether we see something akin to a depression, depends on whether we see a downturn in the financial cycle. Without state action, there will almost certainly be such a downturn.
Given the collapse in cash flows, it is inevitable that the chains of credit that constitute the monetary economy will come under stress, fray, and, left to their own devices, break. Therefore, avoiding a downturn in the financial cycle is dependent on the extent to which authorities are willing and able to expand their own balance sheets to offset the contraction of private-sector balance sheets that is driving the collapse in cash flows and incomes. If a downturn in the financial cycle is to be avoided, authorities must be successful in preventing idiosyncratic credit stress from mutating into a systemic credit event.
Large swathes of society are faced with a cash-flow crisis and, with many agents in the household and corporate sector highly leveraged, failure by governments to offset lost incomes will inevitably lead to an insolvency crisis and an economic depression. Rather than ‘too big to fail’, this time it is a case of ‘too many to fail’. It is thus unsurprising that the policy response has been unprecedented. Western governments have already committed to providing compensation and support on a scale never seen before.
In the UK, we have seen a Conservative government tear up 40 years of small-state, free-market doctrine, first promising to spend £350bn1, and then committing to pay 80% of the wages of workers who have had to down tools, and 80% of the incomes of the self-employed, with “no limit” on the funds available. Indeed, the UK, the US and Germany have all announced economic programmes amounting to at least 10% of nominal GDP, and other countries have also announced large programmes. Just as there are few atheists on a sinking ship, there are no free marketeers in a pandemic.
Brendan Mulhern, global strategist, Newton Investment Management.