It is business as usual on Wall Street. Forget that the US economy shrank by almost a tenth between April and June. Forget that the official unemployment rate is 11%. The only news that matters is that the stock market has topped pre-crisis levels.
That’s not only true in the US. The Financial Times index of global shares is almost back to where it was in the happy days when only a few health experts had heard of Covid-19. There is much talk – almost all of it the product of wishful thinking – about a V-shaped recovery from the pandemic. The one place it is certainly happening is in the world’s bourses.
Britain is one of the exceptions. Here, shares have made up around half the ground they lost in the market panic of late February and March. That’s not for want of trying, though, because as was the case in the global financial crisis of the late 2000s, the Bank of England joined other central banks in action designed to send stock markets higher.
It wasn’t put that way, of course. The explanation for the unprecedented central bank intervention this year was to calm financial markets because they were threatening to become dysfunctional, which was indeed true. Acting in concert, all the world’s major central banks pumped trillions of dollars, euros, yen and pounds into their financial markets. Share prices perked up immediately, even though this was the period when output was collapsing everywhere.
The rapid bounce in stock markets helps to give the impression that everything is under control and the economic crisis is drawing to a close. Traditional wisdom has it that share prices anticipate events so rising stock markets reflect the fact that the world is on course for a rapid recovery that will see life return to normal in 2021. This might be true for the high net-wealth individuals invested in hedge funds. For almost everybody else, it is nonsense on stilts, as the 7,000 Marks & Spencer workers earmarked for redundancy over the next three months would readily testify. The gulf between what is happening in the real world and what is happening in the financial markets has never been wider.
The reason for that is simple. Financial markets were once seen primarily as places where businesses and governments could raise capital for productive investment. Over the years, the centre of gravity of western economies – and the US and the UK in particular – shifted from production to speculative finance, most of it debt-fuelled.
Financial markets have become so big, and so vulnerable, that policymakers will do anything to prevent them collapsing. Investors believe that they will be bailed out if things get rough enough, and they are right. The policy regime of the past decade or so has involved ultra-low interest rates and the purchase of assets through the process known as quantitative easing. Just like Rishi Sunak’s furlough scheme, it was supposed to be temporary. While the chancellor’s wage subsidies are already being phased out, there is not the slightest prospect of an increase in interest rates or a reversal of QE any time soon. There is a permanent welfare safety net for financial markets.
In the world of economic textbooks, low interest rates and the money generated by QE result in a surge in investment because banks are awash with cheap cash that they lend for productive purposes. In the real world, they have led to an increase in speculative buying and asset-price inflation. The lesson of the global financial crisis is that shares, bonds and property go up in value but investment in the “real economy” remains weak.
At which point, readers might be asking the following questions. Doesn’t the constant bailing out of financial markets simply encourage reckless behaviour? To which the answer is yes.
Is there any evidence that allowing markets to behave in this way leads to faster growth in investment, productivity or living standards? No. On the contrary, as financial markets have grown in size and become less regulated all these indicators of economic success have deteriorated.
If low interest rates and QE don’t lead to investment in productive enterprises, is there anything to prevent governments from bypassing the financial system and investing itself in things like green infrastructure? Not really. Central banks say this would undermine their independence by getting them into the world of political decisions, but this suggests that steps taken to boost asset prices are not political decisions, which of course they are.
In the past, governments responded to financial crises by taking steps designed to prevent a recurrence. Today, measures taken to cope with one crisis bring forward the date of the next one. Reluctant to adopt measures that might prevent speculation from spiralling out of control, policymakers try to clear up the mess they have helped create.
Governments can’t say they haven’t been warned. Tobias Adrian, the financial counsellor at the International Monetary Fund, said recently that emergency action by central banks had boosted asset prices, but added that these “unprecedented actions could have unintended consequences, such as fuelling asset valuations beyond fundamental values simply on expectations of lasting support by policymakers”.
The risk is that a still unfolding economic crisis will be made worse by a financial crash. In their new book, Boom and Bust, William Quinn and John Turner note how after the Wall Street crash there was no major bubble for 50 years, but since 1990 there has been one on average every six years. “The global economy has essentially become a giant tinderbox, susceptible to any spark that may come its way.” The world is not exactly short of potential sparks.
• Larry Elliott is the Guardian’s economics editor