Extremely stressed markets and investors rushing to exit through an increasingly smaller door have contributed mightily to the recent wild swings in stocks worldwide.
It’s a highly disruptive phase that will pass, though not without collateral damage. But it is being underpinned by an underlying dynamic that is more critical both in the immediate and longer term.
It involves a race between, in one lane, the coronavirus shutting down the global economy while also spreading fear and uncertainty and, in the other lane, the economic and financial policy responses.
Policies will ultimately prevail, but the means and the timing will determine what the subsequent landscape looks like. Everyone, from governments to companies to households to investors, can do their part to achieve a better outcome.
It has become abundantly evident that the cascading economic sudden stops unleashed by the virus have reached critical mass not only in the most systemically important economies but worldwide. This results in a huge and simultaneous destruction of supply and demand. Neither notional demand nor notional supply can become effective.
Households facing crushing restrictions on their activities because of the necessary dominance of health priorities are increasingly worried not just about their incomes and finances but also finding enough staple goods. Companies have already started to lay off employees in a significant and worrisome way. And, with several credit markets virtually shut down for now, the economy faces a growing risk of otherwise viable companies having liquidity strains that tip them into insolvency.
With such fear and uncertainty in households and companies, it should come as no surprise that investors have rushed to try to liquidate so many parts of their portfolios. With the historical backdrop of excessive risk-taking and under-appreciation of liquidity risks, the desire to do so is proving stronger than fund managers’ ability to execute. It’s a situation that leads to generalized sell-offs in unusually volatile markets as well as genuine concerns about their ability to function.
These factors have all contributed to a shift this week in the policy approach to an “all in/whatever it takes” paradigm to catch up to, contain and eventually reverse the spreading economic and financial damage that not only guarantees a global recession but also increasing the risk of something worse, a near depression.
Policy now has to catch up to a coronavirus that is well ahead and still building momentum stealthily. Many existing policy approaches are both unfamiliar with and not well suited for this terrain.
New techniques are having to be developed on the run, and they are not simple: for example, how to replace clogged transmission mechanisms and under what conditions companies should be bailed out, to name just a couple. Meanwhile, crucial analytical underpinnings lack a sufficient understanding, let alone modeling, of economic sudden stops and virus economics.
Also, to quickly narrow the gap with the destructive impact of the virus, policy has to quickly shed habits, behaviors and mindsets that have limited its effectiveness such as prolonged overreliance on central banks and unhealthy codependency with asset prices.
The economic and financial policy response will be in a much better, and most likely decisive, place to win the race when medical advances allow for better containment and treatment of the virus as well as increased immunity. Until then, everyone must stay engaged and cheer for it to catch up quickly.
For households, this involves resisting the urge for excessive self-insurance, including running to the store and emptying one shelf after the other. For companies, it is about fighting the natural reaction to lay off people just to protect their short-term bottom lines. And for investors, it is about resisting the inclination to liquidate even fundamentally strong holdings in an all out flight to cash.
Each of these is difficult, especially at a time of great instability and fear. They involve tough uncertain trade-offs between the immediate and the longer term and, even more difficult in some cases, between social responsibility and what is seen as individual responsibility.
The reality is that we are all in this race together. The temptation to leave the stands early because policy is already so behind risks us all losing, not just now but also in terms of the damage to the post-crisis landscape.
We will win this race. We will do it earlier and better by placing appropriate emphasis on collective and not just individual responsibilities.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
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