Is this Coronavirus Economic Crisis Similar to 2008’s Economic Crisis?

A global recession is on our doorstep, and we all know it’s going to happen. It’s rare actually, that for once we can see it coming before it actually does. Early March, Dow fell by its biggest day points drop in its history — that was the first signal that the market knew it’s coming too.

Whilst no future market direction is guaranteed, it seems inevitable. Those that work in stores, cafes, bars and even some offices aren’t going to work. Not only are those not getting paid, but money isn’t being spent in those places. With the fear of being in lockdown for months and a potentially deadly infection from COVID-19, our propensity to save is rising. This mentality is shown by the mere fact that toilet paper, pasta and the like are running dry — everyone’s preparing for it, and if confidence is that low, a crash is unavoidable. 

The good news is that Governments in many countries are doing a good job and are putting in place precautions. For example, the UK are paying 80% of the salary of both employed and self-employed people should they become affected by COVID-19 (i.e. fall sick, or simply their work shuts down operations and thus wages).

This should limit the harm to the economy, as people will keep spending if they know they have some safety net. Whilst this doesn’t represent all countries, it does put forward a good argument that this crash could be less catastrophic than 2008. Having said that, we’ve only looked at the indirect implications of COVID-19 so far. If 60% of the world contracts the virus, like some experts suggest could happen, then there is no telling just how deep this recession could be. 

The fact that some civil servant scientists are stating we need 60% to become infected in order to have herd immunity, then this spells another kind of trouble. Given that we’re constantly being told that “flattening the curve” is the most important thing (i.e. spreading infections over a longer amount of time instead of all at once as to not overwhelm the hospitals), then we’re looking at a drawn out recession, instead of a hard and fast one. In fact, for it to hit levels of 60% at this rate of infection where there are lockdowns in many major economies, we could be looking at 18 months of lockdown measures. 

As touched on earlier, this imminent crash appears to have different features than the 2008 recession. Let’s explore exactly what differences and similarities they share.

Is this economic crisis different from the crisis in 2008?

• First and foremost, the biggest feature of the 2008 crisis was an overvalued section of the fixed income market. This debt-based economy got out of hand, Collateralized Debt Obligations being sold in which no one even knew the value or risk within them. This was mostly a symptom of the Mortgage-backed securities being used as collateral in some markets. 

All of these debt securities were underpinning our economy, and the whole thing came crumbling down. The biggest difference between this and our current crash is that in 2008, we were questioning the very foundation of our economy — can capitalism work?

• Whilst 2008 was a crisis of debt and defaults, this crash will be spurred on by a lack of demand and spending. Instead of the floor being pulled out from underneath us, this crash is more likely to be slow and long. We could even enter a deflation trap similar to what Japan suffered for over 10 years.

• Another difference is the tools in which we can fight this crisis with. In 2007 before the crash, interest rates were fairly high. This meant we had a lot of room to drop them and significantly change the monetary environment. Today, they’re already as low as they can be — so any monetary policy attempts to fight this will be futile. Instead, we will need fiscal spending, which means debt spending.

• Lastly, the way to end a usually economic crash like 2008 is through economic policy. This crash is different. We may be able to limit some of the damage to the economy, but ultimately this is a humanitarian crisis as much as it is an economic one. People are dying, a virus is spreading, and we have no cure. Thus, it might be as simple (or as impossible) as finding a vaccine to prevent a deep recession — no amount of quantitative easing is going to solve this.

Similarities

• A lot of the 2008 crisis comes down to believing that the housing market only ever rises, and that you can get away with giving anyone and everyone a mortgage. This kind of casino banking stacked the chips too high and they fell. Some would argue we can only blame ourselves (and by ourselves, I mean bankers), whilst others would suggest this came off the back of banking deregulation by the government. Likewise, if the meat market reason is the true cause of Coronavirus, then some comparison could be drawn. Many may blame the traders for this (this time meat sellers, not derivative sellers), whilst others will blame the lack of regulation (the Chinese Government requires few permits to sell such “risky” meat).

• The current crisis may not be debt related yet, but who’s to say the fixed income market isn’t still overvalued? There’s still a lack of regulation, and still the moral hazard of knowing governments will bail you out as a large bank. If the current crisis gets severe enough, it could have a knock-on crisis that is more 2008-esque.

What can we learn from economic crisis history that can help us now? 

In terms of hindsight, or even merely preventing another pandemic (one that could have a much higher death rate), it’s clear that regulation is important. Chinese meat markets do not require paid permits or much administrative regulation at all. It’s all relatively archaic, which is ironic for a Communist government. Even if this is only analogous or even metaphorical, we could have used the 2008 loosely regulated banks as an important allegory in the importance of government control and red tape.

One thing that we can learn from the 2008 crisis is that it ended after 8 months, and the following 10 years saw some strong growth. This is important for anyone to hear that has investments, or a general hopelessness. Just because the aggregated crisis is horrendous, it doesn’t mean all of us have to be eaten up by it. Many sold their homes in periods of negative equity in the midst of the 2008 crisis. This is the worst thing to do. What we’ve learnt is that staying solvent at all cost is essential, and to not panic. It will end, and prices will go back up. Fortunately, we can actually see the crash coming this time, so for those that aren’t liquid have their chances now to sell. If not, it may soon be the time to buy the dip.