In the Spring of 2020 the Coronavirus led to the quarantine of 800 million people in China. As the virus spread to other countries, economies were forced to close in order to limit the spread of the virus and protect populations.
As economies implemented social distancing policies and closed down, unemployment skyrocketed and GDP plummeted. The economic impact was faster and more severe then the Great Financial Crisis (GFC); some even compared conditions to the Great Depression of the 1930’s.
In April 2020 PIMCO sponsored a virtual forum with Dr. Ben Bernanke. Bernanke is a senior advisor for PIMCO and a policy advisor at Brookings. Bernanke was chairman of the Federal Reserve during the GFC and is an expert on the Great Depression. His insights during the current crisis are valuable on many levels.
Bernanke was asked how is this crisis different from the GFC?
He answered, “In 2008 the problem was in the financial system, we had a problem in mortgages, we had a cut back in credit… The financial system dysfunction led to economic dysfunction.”
“Here in 2020 we have what’s effectively a natural disaster, a pandemic that’s affecting the entire world. That’s leading to social distancing, to lockdowns and an economic slowdown. One piece of good news; we come into this crisis with a very strong banking system plus Congress has already approved aid.”
Bernanke added, “Differences in the crises means policy response is going to be quite different… In 2008 we needed to stabilize financial markets, we had to stabilize the economy, and create policies to promote recovery. In 2020 the response is in medical policy, the financial policy response is really just to support the economy until normal conditions return, allow people to pay their bills, make sure businesses don’t go bankrupt…. The real issue is how long does this last; if it lasts a quarter the economy can come back without too much damage. If it lasts a long time we will see bankruptcies, people permanently laid off, we will see a disruptive recession and a longer recovery.”
Bernanke emphasized, “The critical piece is the public health response.”
As markets plunged in February and March the Fed responded. The Fed has pursued multiple policies including monetary policy and lending policy.
“The Fed has done a great job building on the playbook we developed in the 2008 crisis. Some of the new programs are modeled on TALF so banks and policy makers have confidence and experience… In 2008 TALF was an innovation and had many hurdles we had to overcome” said Bernanke.
Since the beginning of the crisis the fed has instituted programs to support treasury borrowing, muni bonds, corporate lending, dollar swap lines, expanded repo facilities, among others. This was an unprecedented level of financial support.
For monetary policy the fed has reduced interest rates to nearly 0%, engaged in QE buying securities, and used forward guidance to get the economy on track and guide toward growth and 2% inflation. The basic tools from 2008 were there and ready to be applied in this case
Bernanke explains this in more detail, “It is important to remember that monetary policy is a place holder… The credit facilities are important in that they are intended to keep the patient alive while the economy is under lockdown. We are not yet at the stage of helping the economy recover.”
Bernanke is realistic in looking at the long-term impacts of the crisis. “Suppose after the lockdown ends people become more conservative (Joachim Fels of PIMCO expressed a similar point of view) and like after the great depression people don’t want to spend and unemployment remains high; there may be need for additional monetary and fiscal policy to get us back to full employment. I expect the fed to maintain an easy policy stance even for some time after we begin the opening-up process.”
From an investment perspective liquidity and risk management is key. Opportunity comes out of crisis. It’s important to be disciplined and exercise patience.
When Bernanke was asked about the possibility of negative interest rates in the US he said, “negative rates are not that unusual. If you have a safety deposit box you are basically paying a negative interest rate. Negative rates are not a freak of nature and are part of the economic environment. Japan and Europe have used negative rates and found it helpful.”
That being said, he continued, “I don’t expect us to see negative rates in the US in the foreseeable future.”
Bernanke refocused the conversation, “I see it (the virus) as a natural catastrophe and the financial policy as relief program.”
While I understand his perspective, this point of view minimizes the larger systemic issues that have worsened over the past 5 years. It shows a limited view of problems facing the economy that are deeper and more systemic including income inequality, issues around corporate debt, and larger threats like climate change.
When asked to discuss the potential issues around rising government spending and increased indebtedness Bernanke explained, “At some point we are going to have to do a better job of budget planning. We will have to put more emphasis on long term structures around spending, but for now we need to support the economy.”
Bernanke was asked ‘what are your thoughts on the damage to the economy?’
“A lot will depend on the medical situation and new outbreaks into the Fall. Many of the economic numbers are going to be similar to the Great Depression (many expect -30% GDP in Q2), but if we have a recovery in 2021 it’s possible to minimize damage. But I would remind people that the Great Depression lasted 12 years and only ended because of WW2. Clearly for emerging markets this is a tough situation… they don’t have the financial resources, they don’t have the medical resources, declining commodity prices, budget deficits, currency disruptions…”
He continues, “One of the strengths of the United States is we have a lot of institutions to help pull us through. It’s not just the federal government, but we have governors and mayors, university leaders, CEOs, who are independently contributing to improve things.”
Bernanke summarizes his thoughts, “I do think Long Term behavior will change… people will become more cautious, savings rates might go up and that might affect unemployment and hiring. Clearly the industrial mix will be affected… from cruise ships to movie theaters, behaviors will change. One area where I’m very concerned is small business. The economy has become more concentrated in recent years with large companies dominating. This has implications for innovation, competition and consumer pricing… if many small businesses fail because of this crisis this will add to this larger problem.”
Managing risk in the years ahead will be key as Dr. Bernanke points out. The current economic crisis is not expected to be a short-term event. Planning for retirement will require investors to have an increased awareness of a complex, changing economy.
After the 1929 market crash it took 25 years for the market to make new highs. That is a far different dynamic then we have seen over the past 40 years. (2)
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