The Covid-19 pandemic is turning out to be more of a financial crisis than a health crisis. Comparisons are being drawn to the 2008-2009 financial crisis as well as the Great Depression.
However, every crisis is different although it might bear some resemblance to the previous crisis. Let’s see what differentiates the current financial crisis to the Global Financial Crisis.
When the stock market sell-off began earlier this year, US President Donald Trump emphasized that it is not a financial crisis but a health crisis. As things stand currently, the financial repercussions are possibly more severe than the health impact. No wonder governments and central banks are acting swiftly and taking almost unprecedented measures. Now, while its quite fashionable to compare two crises, the current environment is a lot different from the 2008-2009 financial crisis.
The origins of the 2008-2009 financial crisis lay in the US housing market. This time, the origin is in China or as President Trump likes to say, ‘the Chinese virus.’ Also, the 2008 crisis started in the financial system and spread to the real economy. Or, to put it in a sexier way, the crisis spread from the Wall Street to the main street. The 2008 crisis was more of a demand shock. This time, it is a combination of both supply and demand side shocks. Supply side because businesses are shut due to the covid-19 fears. Now, as businesses shut down, many are left unemployed and we have a demand shock as well.
In the 2008 financial crisis, there was an almost synchronized global action to tackle the slowdown. While everybody knew the origin of the crisis, there was no blame game. This was also partially because of the fact that the world was a different place in 2008 and it was still a unipolar world. It’s a bipolar world now due to China’s rise. The disarray is not only on the global level. Even within countries, there is a game of political brinkmanship. This holds true for many democracies. While those in high seats of power want to be seen as handling the crisis well, oppositions too want to score some brownie points.
The current crisis is a black swan event or an unexpected event. That said, in years to come, we would possibly read that yield curve inversion correctly predicted yet another recession. While we may anyways have encountered a recession, the current crisis has got nothing to do with the yield curve inversion. Going back to 2008 crisis, it was not a black swan event. From equity market valuations to bubble in the housing markets, there were a plenty of warning signs. But then, those signs were happily ignored. Notably, valuations were getting overstretched this time around too.
Since the current crisis started off as a health crisis, let me borrow a few analogies from the medical terminology. Before the 2008 recession, global economy was hale and hearty. All medical parameters were encouraging. Also, given the strong growth in preceding a couple of years doctors (central banks and governments) had plenty of medicines (monetary and fiscal stimulus) to treat any disease.
In 2020, the global economy was anyways a stage or two below going on a ventilator. Last year, global economic growth was the lowest in a decade. Fiscal deficits were much higher than we had in 2007. As for interest rates, they never really got to normalized rates anyways. This basically means that both central banks and governments have a lot less room to maneuver this time around.
The coronavirus crash is already given us the sharpest US bear market in history. Watch out for more dubious records on unemployment, fiscal deficits, and GDP contraction. While stock market rally suggests that the worst is behind us, in my view, the worst for the main street is yet to come.
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