Europe and the United States are facing an almost unprecedented economic crisis: debts are rising faster than ever while growth has plummeted. But investors have decided not to focus on the dark side of the moon, but to look on the bright side of life instead.
This is testified by the Euro Stoxx 600, the main European stock index, having risen by a quarter since its lowest point at the end of March. The S&P 500 has staged an even stronger recovery. The rise of the stock markets is mainly based on hope - that the global economy will soon recover from the coronavirus and the lockdowns that followed.
The number of Covid infections appears to have peaked, while the gradual opening up of the economy and society fuels the expectation that a strong recovery in economic growth will be possible in the second half of this year. Financial markets are anticipating this and, for the sake of convenience, seem to pay little attention to the damage the economic damage the pandemic will leave behind, much of which will turn out to be permanent.
What’s more, investors have decided not to let the dramatic economic and political situation in the world’s biggest economy, the United States with its 40 million unemployed, mutiny in the streets and rising tensions with China spoil the party.
Powell put
The extraordinary monetary policy by the world’s major central banks seems to tip the balance in favour of stocks markets. For example, the so-called “Powell put”, the massive monetary stimulus the Fed introduced in March, has far exceeded expectations: the S&P 500 has since risen by more than 35% and is hovering close to its all-time high again.
The situation is very similar in Europe, where the ECB also introduced an unprecedented stimulus package in March, and has given clear signals it is willing to do more. Christine Lagarde even felt compelled to repeat Mario Draghi’s 2012 pledge to do ‘whatever it takes’ to save the euro.
Nothing better to characterise investors’ mood than the song from Monty Python’s film “Brian’s Life”: Always look on the bright side of life.
Some things in life are bad
They can really make you mad
Other things just make you swear and curse
When you’re chewing on life’s gristle
Don’t grumble, give a whistle
And this’ll help things turn out for the best
And
Always look on the bright side of life
Always look on the light side of life
But massive central bank stimulus is of course not uncontroversial. Their task is to ensure the stability of the financial system. They seek to fulfil their mandate by injecting a lot of liquidity into the system, but it’s doubtful an ‘inclusive policy’ that benefits all citizens will be achieved.
The theory is that the money that central banks pump into the market is passed on to the real economy through banks. However, this monetary transmission is only limited in practice: quantitative easing mainly leads to the formation of asset bubbles. Low interest rates mean renting or buying apartments or houses will only become more difficult, and savings will yield almost nothing.
Debt explosion
Economists are therefore critical of the lack of causality between stock and bond markets on the one hand and the economy on the other. For example, the national debts of eurozone countries have exploded since the 2008 crisis: last year the eurozone had a total debt ratio of 86% of GDP. This year, as a result of the coronavirus crisis, it will jump to 102%, before falling back to 98.8% in 2021.
Southern European countries are close to collapse: such as Greece with national debt of 196% of GDP in 2020 and 182% in 2021; Italy follows with 158% and 153% respectively. As government debt rises above 100%, an economy is considered to be vulnerable and sometimes even rudderless. Rising interest rates could be a deathblow.
This is the reason why the discussion about Eurobonds has flared up again and the European Commission, under German President Von der Leyen and Chancellor Angela Merkel, are determined to fire a financial bazooka. Mirroring the 2012 crisis, the survival of the euro, is at stake once more.
This bazooka is the €750 billion EU Recovery Fund which, according to a simulation by Oxford Economics, will lead to 1% higher economic growth in 2024 (see graph below), and will mainly help the struggling southern member states.
Undoubtedly, economists are thinking about policy measures to bridge the harrowing fiscal deficits caused by the crisis: a European tax on digitally operating companies has already been mentioned, and with investors having benefited handsomely from central bank’s monetary policy, an additional tax on (fictitious) returns and assets is no doubt on the table as well.