The COVID Crash

While COVID19 is on all our lips – this is an extraordinary economic story. You will tell your children that you lived through the greatest challenge to the global economy, certainly in a hundred years and maybe ever.

That is because this financial crisis is unprecedented, the usual tools to revive and recover the economy are so far proving ineffective and the health crisis and the financial crisis are feeding off each other. 

There’s uncertainty about how the Coronavirus will affect our financial future and whether the economy is sick or in hibernation. This crisis is not structural (1929 Great Depression), nor was it caused by a confluence of dozens of factors (2008, Financial Crisis), nor is it a Trading Event (1987, Black Monday). This crash, if it becomes a recession, will have been caused by a microbe that unleashed panic on a scale unprecedented in history.

But if you aren’t familiar with the language of economics then let’s first try and make sense of some of the biggies. Before we do a quick note on semantics – we’ll speak of stimulus packages because it is the best shorthand for the plans governments are executing. However, this crisis is different to other crises and the “stimuli” we will detail below are not actually stimuli – you can’t stimulate an economy that is on deliberate lock-down. This is about emergency relief to keep people fed, housed, and safe, and to keep businesses from bankruptcy. But to keep it easy we’ll refer to stimulus. 

Let us begin; 

Stimulus

Governments have a series of tools at their disposal to impact, and move, economies. 

When used they are often referred to as stimulus packages and can be broadly divided into two categories; 

  • Monetary which refers to the changing of interest rates or other ways of increasing how much money or credit is available 
  • Fiscal which is the use of government spending and taxation to influence the economy.

Whole textbooks have been written about each of these and they are enormous subjects but at the simplest level these represent two levers – how the government uses its money, how the government encourages us to use our money. 

To tackle the current crisis governments around the world are pulling both levers and so far the impact has been minimal. Imagine firing a bazooka at a house and you break a window and you start to get an idea of how ineffective the stimuli have been so far. It is important to note though that these things can take time and often it is long after the intervention that its value is determined.

Fiscal: The government has been pumping money into the economy. In his first Budget, Rishi Sunak, the Chancellor, unveiled a financial package worth a little over £1bn. It was huge news on the day the UK recorded 8 covid19 related deaths. Less than a week later he added an additional £350bn of new measures.  All this money – to keep people in work and keep the money flowing through the economy.

Why do we need to keep the money flowing? Because at the simplest level, economies are driven by consumption. People buy stuff from people (and companies) who use that money to pay their staff, pay their taxes and buy other stuff from people and companies and so on and so forth. 

This is known as the multiplier effect. The multiplier effect is when an injection of money into the economy causes a bigger increase in the national income. This is how economies grow. But the multiplier isn’t really working because even if people’s salaries are supported they are buying the basics and stashing the rest because they don’t know what’s going to happen next. Money that isn’t spent isn’t helping the economy.

Monetary: the Bank of England (BoE) lowered the Base Rate to 0.25% and then lowered them again to 0.1%. They have literally never been that low since the BoE was Established in 1694.

 

What is the Base Rate?

The BoE Base Rate is the official borrowing rate. It is the interest rate that a central bank – eg the Bank of America will charge commercial banks for loans – it affects the interest rates offered by Banks, Building Societies and other financial institutions. By changing the official Bank Rate, the Bank of England seeks to influence overall borrowing in the economy

The government sets the Bank of England an inflation target to keep it in check and the Banks’ Monetary Policy Committee (MPC) then decides on the interest rate in order to keep to inflationary targets.

Lowering the base rate means it becomes cheaper to lend and if it’s cheap to lend it becomes cheaper to borrow. The higher the interest rate the fewer people borrow – you wouldn’t buy a house on your credit card because 19% interest on a mortgage would be nuts. Conversely, people are more likely to borrow when rates are low – you may well consider going on a holiday, doing a home extension, buying new clothes etc if your credit card was 1%. 

More importantly, if companies are able to secure cheaper funding; that restaurant might invest in a second site in another part of the country, that car factory might expand and produce electric cars as well as diesel, that technology company might invest more in research and development and the local council might build a new bridge. When companies borrow they often also create jobs.

The lower the rate, the more you borrow, the more you borrow the more you spend, the more you spend the greater the multiplier and the bigger the economy grows.

But that’s not what’s happening. Companies are nervous about taking on debt because they are uncertain about the future. And we know that because stock prices are crashing.

Stocks

So far these stimuli are not steading the economy and we know that because stock markets around the world have gone into free fall despite the multi-trillion dollar packages that have been thrown at them by central banks around the world.

Despite rescue efforts made by central banks around the world trying to prop up their respective markets, markets continue to fall.

Markets hate uncertainty and at the moment there is an awful lot of that. There are worries about COVID-19 affecting global trade, travel, reduced confidence in earnings and economic growth, and fear that the coronavirus might result in a global economic slowdown and possibly even a recession. There is a big fear of the unknown.

Stock crashes are either great or terrible or both depending on who you are. 

If you were just starting to consider entering the stock market there are some fantastic bargains to be had (imagine if your dream property was suddenly slashed 43% in the space of a month).

On the other hand, if you are about to retire you may well have seen your pension pot take a massive hit and be worth 43% less just as you want to start taking your money out and retire to the seaside.

It is important to know and understand what you are getting yourself into and the risks involved. To learn more take a look at our Investing Pathway.