Global economic crash is inevitable and nothing to do with coronavirus

In the UK, the FTSE 100 index of shares in leading UK companies registered its sharpest weekly fall since the financial crisis of 2008 – a drop of 13% in just five days. In cash terms, more than £210 billion was wiped off the value of the UK’s biggest businesses. As most of those shares are held by pension and savings funds, that’s your future income disappearing down the proverbial plughole. The ostensible cause of this share slide: reaction to COVID-19, the new strain of coronavirus that has spread from China around the world in a matter of a few weeks. At least, that is the superficial take on what is happening to the economy. In fact, there’s much more involved.

What’s not in question is the extent of the economic carnage on a global level. Shares across the world plummeted around 10% last week. A fortnight ago, President Trump was crowing that the US stock market had reached its highest value ever. At the start of February, the respected University of Michigan monthly survey of investors found that 66% of respondents expected share prices to go on rising this year. But last Thursday saw a record single-day fall on the price index for the largest US companies. The black swan of unexpected events has pooed smack in the middle of the American election campaign.

Why are share prices falling so precipitously and so quickly? First, and obviously, because investors believe (correctly) that earnings will plummet in the sectors most vulnerable to the travel restrictions (eg airlines) or disruption to global supply chains (eg cars and computers) caused by the virus. But there is much more to it than that. For starters, half of global share trading is now conducted by artificial intelligence algorithms which automatically sell when there is a whiff of market instability. This reinforces any downward trend in the financial markets. Then there are hedge fund traders (mostly friends of Boris) who are short selling company shares as a gamble – the equivalent of betting on a horse to come last. Most important of all, investors know in their bones that shares values across the globe are absurdly and artificially high.

Everybody has been expecting this asset bubble to burst. By accident, COVID-19 may be the pin that bursts the balloon. Share prices across the globe are far higher than they are worth on any rational calculation. Some event at some point was going to send them tumbling. We may not be there yet, but the coronavirus could be it. Which is why – even though the current (and sad) death toll due to COVID-19 is still low – this epidemic is causing the entire international economic and monetary system to shudder.

Everything goes back to the big financial crash of 2008 when it looked as if the banking system (and capitalism) was going literally bankrupt. In response, governments and central banks invented a new wheeze called quantitative easing. QE involves state central banks creating special electronic money (called “reserves”) and using it to buy up existing government IOUs (called bonds) at a high price. This procedure is very techy. All you have to understand is that it lowers interest rates across the economy and gives ordinary high street banks extra reserves (from the QE) to boost lending.

As a result, industrial companies can borrow at near-zero rates from the banks and use these loans to buy back their own shares at higher prices. You’d be correct in thinking this is (a) whacky and (b) nothing to do with boosting real productivity or profitability. But it artificially raises share values independently of true profits, while netting company CEOs big bonuses. Welcome to the world of modern capitalism, where a worldwide glut of capital ensures that financial speculation always trumps over making things or providing ordinary folk with basic necessities.

This speculative insanity has reached its apotheosis in Trump’s America. The Donald has appointed his cronies to run the American central bank, the Federal Reserve. In turn, the Fed increased quantitative easing in 2019 to stimulate an artificial boom in share prices, the better to let Trump win the 2020 presidential election. As a consequence, the average ratio of share price to company earnings in the US (before coronavirus) was around 32. In other words, you’d have to pay $32 to get $1 in dividends. Not that you’d care about the profits, because it’s the ever-rising value of the shares in your portfolio that counts. Except that last week, share prices suddenly cratered.

What outcome can we expect, regardless of the spread of coronavirus? First, of course, we’ll get more quantitative easing – lots more. But the medicine might not work this time round. One reason is that industrial companies have already borrowed so much that they are awash with debt – to the tune of $1.1 trillion worldwide. Even if QE lowers global interest rates again (and they are near zero as it is) it might have no real impact. In fact, the current disruption to global supply chains might tip many firms into making losses – meaning they can’t pay their bank debts. This is especially true in China.

Of course, there are always countervailing forces at work. The fall in world oil prices by 15% since the epidemic began will cut industrial and consumer costs. And the Chinese regime has moved quickly to boost domestic lending to keep companies afloat. The crucial issue is consumer confidence. During the SARS outbreak in 2003, global consumer spending dipped, especially on white goods and cars. Fortunately, the dip was short-lived. However, global supply chains have become more interwoven since 2003 and social media more dominant. That makes the situation more fragile. Throw in the stock market meltdown, and we are in uncharted waters. Oxford Economics, a very respected consultancy, warns: “Stock market losses have already exceeded those that we modelled in our ‘global pandemic’ scenario.”

For now, though, financial analysts are playing it cool. We have seen 10-point share drops before and financial markets have recovered. I expect another round of QE could stabilise things temporarily, at least for this year. But the underlying fundamental concern remains: we are in the middle of a gigantic asset bubble that has to burst sometime. When it does, the value of companies, savings, properties and pension pots will collapse. This will intensify global trade wars and cause currency values to fluctuate wildly.

What about the impact on the Scottish economy of such turmoil? This is a particularly sensitive issue given the proximity of an independence referendum. In the immediate short term, I urge the SNP Government to get the new Scottish National Investment Bank (SNIB) to take control of those parts of the domestic economy outside of international ownership – particularly construction and housebuilding. The SNIB also needs to become a deposit taker, to allow Scotland to escape consumer and business lending being manipulated by foreign banks such as Nat West. The central watchword has to be “local control of the local economy” – new Cabinet Secretary for the Economy, Fiona Hyslop, please note.