Fed applies a placebo to market turmoil and investors can get ahead of the game

The US Federal Reserve has cut interest rates, on this occasion the result could actually be negative. Investors can get ahead of the markets.

Article updated: 6 March 2020 2:00pm Author: Michael Baxter

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From an economic and investment point of view there is one big difference between the Coronavirus driven crisis in 2020 and the 2008 crash. The difference lies with the difference between demand and supply.

The 2008 crash was about weak demand. During the build-up to the crash, consumer demand had been propped up by debt, supported by surging asset prices. At a superficial level the crash occurred because credit dried-up — credit crunch. The deeper cause was that debt had reached unsustainable levels, meaning that banks’ balance sheets started to look shaky. As a result consumer demand plummeted, the money-supply contracted.

A myth was then born: the myth suggested that low interest rates and quantitative easing combined with surging government debt made soaring inflation inevitable. Such a view was based on a misunderstanding of what caused the crash and what causes inflation. You don’t get runaway inflation when demand is plummeting. Balance sheets recessions are not accompanied by severe inflation.

At first, post-2008, the gold price rose for good reasons — it was probably too cheap before the crash. But a view that inflation pressures made gold a safe harbour were wrong. Predictions that gold would carry on rising and rising were everywhere and they were based on a false understanding.

This time it's different

Today, it is very different. Sure, globally, debts are dangerously high, in that respect there are similarities with 2008, but for as long as interest rates remain ultra-low, most debts are sustainable.

Coronavirus is spreading exponentially. I set a test last Friday. It was a test in my head only, a little personal experiment. At the time there were 16 cases of Coronavirus in the UK. I thought if by Tuesday next week (that was March 3rd) that number had reached 32, we would know that the virus is still doubling every five days, that it’s still spreading exponentially. Alas on March 3rd, it was revealed that there were 51 cases — if anything the exponential rate had increased. So let us watch together. If the number of cases passes 100 by the end of the weekend, the exponential rate is intact.

And that does scare me, because if the exponential spread continues for another six weeks, by mid April there will be 12,000 cases in the UK. And of it continues for another six weeks the number will top a million.

As it happens, I suspect that the exponential rate will slow during the course of April and I think a million cases is unlikely.

The main reason why I think the number of cases will not reach that number is that we will change our behaviour, we will go out less. We will holiday less, we will go to fewer events less often, and we will go shopping less frequently.

Our demand for essentials will remain undiminished But the hit on supply will be greater.

Ask yourself the question, what is the biggest cause of the super low inflation we have seen this century? The answer is cheaper manufacturing largely because of the rise of China. There will be a massive shortage of these cheap goods.

Meanwhile, panic buying is leading to shortages on the shelves in supermarkets, meaning that shares in supermarkets have done quite well during the crisis.

And if the virus does spread like I suggested above, people will avoid public transport. Can you imagine anything worse than being packed in on the tube, surrounded by fellow commuters, doing such unsociable things as breathing and touching surfaces, when you think some of the passengers might be carrying the virus.

The hit on business will be considerable — the supply chain will wobble.

Unlike the 2008 crash, this time supply will be the biggest casualty. This will be inflationary. The inflation effect may not last and as the virus spread diminishes things may get back to normal.

This may take quite a while though.

And the Fed cuts interest rates just before prices are likely to rise.

The recovery

I think markets will fall a lot further yet and this time the gold price will go up. Companies that supply essentials or goods and services we can consume locally will flourish.

I don’t think the long run economic impact will be as great as the 2008 crash, so recovery will be quicker. However, I think shares will fall further before they recover, but within 18 months they will have re-gained lost ground.

The only long-term risk is that the virus may be accompanied by a further backlash against globalisation, reducing global output.

On the other hand, I expect the benefits of the fourth industrial revolution to show up in the economic stats in the next few years — and that will create a good time for shares.


These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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