After having read multiple articles on the tragic virus attacks and their impact, I started to reflect on what learnings on the economic impact we may extract from our experiences after the 2008 financial crisis. Obviously, the virus is first and foremost a human tragedy. In that context all that follows below is of secondary importance.

Image of Svein Harald Øygard

The learnings build, among others, on the 90 interviews on the 2008 crisis that I conducted as I wrote “In the Combat Zone of Finance”.

I see seven learnings on the economic impact:

1. Country and segment size determines the economic impact

The world has seen many crises, in various countries and industry segments. The 2008-crisis originated from imbalances in the largest segment in the then largest economy, the housing market of the US.

Other crisis, in contrast, as the 1998 Russian crisis, the Argentinian crisis of 2001 and 2019 and the Asian crisis of 1998 had modest impact on global markets. In the latter case the US equity value index S&P 500 dropped 16% through two months of decline.

However, S&P returned to its past peak within only 4 months.
The 2008 crisis translated into a 53% drop, first through 16 months of decline. Here 65 months were needed to return to the prior peak.

No one can yet predict the fundamental impact of the virus.

But, remember the learning; a large multiple of segment size and the size of the economies hit has historically been what has made the big difference.

2. It may take time before the full impact is seen

The first sign of danger that pre-warned the October 2008 crash, could be observed in April 2007. That was when investment bankers started having trouble finding buyers for non-secured US mortgages.

The first collapse followed August 9, 2007, as a fund of a French bank shut the stable door to stop the stampede. Then all got worse, up until the Lehman Brothers collapse September 15, 2008.

3. Watch out for the dynamics that may be triggered

Plant closures and break-down of international supply chains are unfortunate events. Cancelled conventions and conferences become striking symbols. I though see a big paradox; the most forceful measures seems to be implemented for those least vulnerable to the disease, namely otherwise healthy individuals in their working age.

Returning to the numbers, if one third of an economy runs at half speed in four months a four percent GDP-drop will follow. That´s unfortunate, but should, frankly, as such cause no major concern. This is, however, what´s discussed by most.

A comparison with the impact of the financial crisis may again be of interest; The US saw a GDP drop from 2007 of below 3%, the EU28 4,1% and the UK 4,5%, all touching the bottom in 2009. They were back at their 2007-levels in 2010, 2011 and 2012, respectively.

But, then, Spain was only back in 2016, Portugal in 2017 and Italy and Greece are still not back at their 2007-levels. Hence, the dynamics triggered is what makes the difference.

And, worse, the 2008 crash exposed the vulnerabilities of the fiscal balances of the EU-countries, triggering the 2012 and 2013 euro-crisis, adding up to a decade of sluggish growth.

This leaves us with one learning, the initial hit is of importance, but even more so all that it may trigger.

4. Financial imbalances is what makes systems tremble

A financial crisis always has five stages; 1) Too much debt; of businesses, households or governments, 2) A loss of liquidity; Old liabilities can´t be refinanced, 3) A loss of solidity; Businesses and even banks are threatened by default, 4) A lower level of economic activity and employment, and 5) Weakened government finances, as tax income falls, banks must be saved and the cost of stimulus and support measures increase.

Gross debt levels globally have increased by 50% as percent of GDP since 2008. Luckily fewer countries are exposed, but the government debt levels have risen in some countries, most notably in the US, Brazil and India. Corporate debt levels have also risen in some countries and segments, most notably in China. High accumulation of debt can also be seen in some Western economies, e.g. among buy-out funds in OECD-countries and in parts of the US. 

Some industries also base themselves on high debt levels, e.g. the airline industry with vast customer pre-payments and export credit facilities on their purchases of planes and equipment. Similarly, with parts of the travel industry. 

Now, connecting the dots, this points to some areas of concern; how will a stoppage of the economic activity influence these sectors and their ability to serve their debt? Which dynamics may this trigger in an even more leveraged global financial system?

5. Some political measures were effective, some not

Looking back; the actions taken by the monetary authorities after the 2008 crash were effective and largely well managed. Even more so, as the ECB stepped-up and intervened in response to the euro-crisis.

All in all, after the collapse, forceful and all-in-all impressive policy responses could be seen in countries as Ireland, Portugal, Spain and Iceland and in many countries in Eastern Europe.

Still, fundamentally, the euro-crisis and the era of sluggish growth could have been avoided if more forceful policy actions had been implemented at an earlier stage. Or worse, the politically decided fiscal responses immediately after the 2008-crash, that partly weakened budgets after years of fiscal sloppiness, helped to trigger the euro-crisis.

A similar risk exists in 2020. A fall in US GDP, combined with improvised policy actions to stimulate the economy ahead of November 2020, may accentuate the doubts on the long-term solidity of the US public finances, on and on how the debt will be managed, i.e. through austerity of inflation.

6. The Central banks carry a big bazooka

One question arises; as the economic impact hits, is it mainly a demand or a supply side chock? This influences, to some extent, the choice of policy. 

Some say it’s a supply side chock. Workers stay home. Factories close. If so a demand stimulus may not work. It may even cause harm, if it creates demand for goods that can´t be produced.

On the opposite, a lack of demand can be mitigated by monetary and fiscal stimulus and other policy measures. Now, with almost zero inflation, there is almost no limit as to what policy tools the Central Banks can deploy. Rates can be lowered, even below zero. They can, again, ramp-up their programs to buy securities. And, yes, they can dish-out helicopter money over the economies.

But, here they better get it right. A supply side chock coupled with demand stimulus may, as the pessimists may say, trigger stagflation.

7. Most often markets run in front, but not always

When the global financial crisis hit, the S&P 500 started its decline already in April 2007. It reached its minimum in March 2009. In sum, the market index saw what was coming, both on the way up and on the way down.

Amazingly, this almost perfectly mirrors a pattern; after market corrections the market may return quite rapidly.

Macroeconomic shocks, tough, call for some more patience. Here, on average, based on a review of a dozen cases, markets again start to climb 7 quarters after the pre-crisis peak.

* * *

This all adds up to a check-list. Again, what matters most are the measures to combat the disease. The above, in addition, provide some pointers as to how to deal with its economic impact.

(Updated March 4th)