The Physics of Economic and Financial Distress
Rick Rieder, Russ Brownback and Trevor Slaven contend that even as markets were rocked by uncertainty as the coronavirus lockdowns began, the seeds of stability were sown in the massive fiscal and monetary policy response. The key is to know how to manage through this period for the long haul.
Over the last several years, we have continuously referenced the incredible influence that technology and demographics are having on economies and markets. On one side, technological innovation is rapidly changing corporate investment and business models, while also delivering persistent consumer-friendly disinflation. On the other, aging and slower-growing populations in the developed world equate to more subdued growth profiles with significant shifts in consumption patterns, and to a tremendous demand for financial market income. Between these two forces, the result has been historic stability, with economic volatility at, or near, all-time lows. The COVID-19 pandemic has disrupted that relative economic peace in a generational manner, as we described in our May 7 call with clients, and summarize here.
For every action, an equal and opposite reaction…
The economic steadiness of the last few years reminds us of Newton’s cradle, a device named after 17th-century English scientist Sir Isaac Newton, which demonstrates remarkable stability at its center, absorbing energy from forces that strike on the exterior. Using this analogy, under normal circumstances this feedback loop is fairly gentle and predictable; as policy, the financial markets and the real economy send benign reverberations through the economic system, ultimately maintaining an equilibrium. The COVID pandemic, however, hit the economic cradle so severely that it threatened to topple that entire framework.
Indeed, the COVID pandemic encircling the globe felt like an unstoppable force, throwing all the balls of the cradle into disarray, crushing the real economy and destroying wealth up and down the capital stack. Fortunately, Sir Isaac also taught us that every action has an equally powerful, and opposing, reaction. Over the last five weeks, financial markets strongly suggest that the unstoppable force met an immovable object in the form of an historic “whatever it takes” fiscal and monetary policy response.
In the U.S., which has nearly a third of the world’s documented COVID cases, bipartisan fiscal initiatives have been delivered to provide immediate relief to households, businesses and local governments. Importantly, bold and truly historic monetary policy has been set to dovetail with these Federal programs. To be sure, real-economy demand will need to be rebooted in an organic way to get output fully restored; and while we believe this will absolutely happen eventually, the timing is nearly impossible to know with any kind of precision. In the meantime, however, this epic global policy response coordinating monetary and fiscal initiatives is providing a credible bridge over the real economy gap created by the shock resulting from the virus spread and subsequent economic lockdowns.