Asleep at the wheel at the Federal Reserve
Desperate economic times call for desperate economic measures. Yet, despite the clearest of evidence that the coronavirus epidemic is spreading and roiling global financial markets and the world economy, the Federal Reserve is taking a wait-and-see attitude before acting. By so doing, it is heightening the risk that both the U.S. and global economies might be in for a very hard landing.
Fears of the epidemic’s long-term financial and market impacts are wreaking major financial havoc. Global and U.S.-equity markets have declined by around 15 percent in a matter of days. This has wiped out around $4.3 trillion in U.S. wealth alone. According to the Federal Reserve’s own estimates, such a reduction in wealth, if sustained, could cause U.S. consumers to cut back on spending by a full 1 percent of gross domestic product (GDP).
The carnage in financial markets has not been limited to the global equity markets, either. Indeed, there has been a marked spike in interest rate spreads on high yield and emerging-market debt as investors have become markedly more risk-averse. If past is prologue, such a sharp dialing back in risk could be the start of a global credit crunch. That, in turn, could cause a sharp slowing in both the U.S. and global economies.
The plunge in equity prices and the marked rise in interest rate spreads are not the only financial market indicators that should be ringing alarm bells at the Fed. Indeed, the collapse in long-term U.S. Treasury market yields to historically low levels should be alerting the Fed to real trouble ahead. This is especially the case considering that, in the past, the bond market has been a very reliable predictor of economic recessions ahead.
Still other indicators that should be keeping Fed officials awake at night are the collapse in international commodity prices and the marked weakening of emerging-market currencies as investors repatriate funds from the emerging-market countries to the safe haven of the U.S. dollar. A stronger U.S. dollar is going to make it more difficult for American exporters to compete abroad. Meanwhile, the abrupt reversal of capital flows from emerging-market economies, coupled with the collapse in international commodity prices, could bring about yet another round of emerging-market exchange rate crises.
A particular concern for the global economic outlook is that the economic damage that financial market dislocation is now causing is coming at a time when the coronavirus epidemic is inflicting considerable direct damage to the global economy. With major countries like China, Italy and South Korea all severely restricting the movement of their workers, these economies are bound to experience the equivalent of economic cardiac arrests. Meanwhile, as Apple and the global automobile makers keep reminding us, trouble in the Chinese economy is causing major disruptions in global supply chains at the same time that the international travel industry is grinding to a halt.
The only justification for Fed inaction at this late stage in the crisis would be for us to believe that the coronavirus will soon peak and will soon be brought under control. But it would seem that one would have to be delusional to entertain such a belief. With the virus now having reached every corner of the globe and with the number of new coronavirus cases outside China now exceeding those in China, there is every reason to think that the epidemic is bound to get worse before it gets better.
With financial markets experiencing turmoil reminiscent of the 2008 global market meltdown, and with China – the world’s second largest economy – having ground to a virtual halt, one has to wonder what more evidence the Fed needs before acting decisively.
Indeed, one would have thought that the least that the Fed should now be doing to calm down global financial markets would be to cut interest rates now and not wait until its next scheduled meeting on March 17-18. Preferably, to get more bang for the buck, the Fed should do so in coordination with the European Central Bank, the Bank of England and the Bank of Japan.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.