The exceptional market volatility and global economic impact that has come with the COVID-19 pandemic has brought an equally exceptional response from global policy makers….
Notwithstanding a readiness for more stimulus if needed, we have already seen unprecedented commitments from the Bank of England in the UK, in the form of £300 billion of asset purchasing and rate cuts to historic levels; the government of the US, who have passed legislation for $3 trillion in stimulus; and the leaders of the EU, who have promised over €1.4 trillion in aid.
When looking to pension schemes, it is easy to justify these measures as a vital stabilising hand for financial markets, with the c20% falls in global equities (local terms) of the first quarter of 2020 weighing heavily on both defined-benefit funding levels as well as growth assets for defined-contribution members.
Key messaging from governments has positioned COVID-19 as the greatest challenge that many nations have encountered since the Second World War (even bigger than the great financial crisis of 2008/09).
Viewing the current environment through that lens creates the opportunity to compare the current response with the Marshall Plan, the (at the time) ground-breaking project to try and restart the global economy following the end of the Second World War.
The Marshall Plan, known formally as the European Recovery Program, takes its name from the then US Secretary of State, George Marshall, and comprised $12 billion in loans to nations across Western Europe with the aim of restarting the European economic engine.
Adjusting for inflation, this equates to c$128 billion today. Whilst today’s measures are being brought to bear in an effort to stem the current turbulence, their focus will shift on to helping the global economy recover when the spread of the virus looks to be contained. In this sense there are similarities between the two, but they diverge in terms of the size and implementation of stimuli.
Whilst the size of the Marshall Plan stimulus comprised around 4% of US GDP in 1948, today’s measures by the US government are expected to be closer to 10% of US GDP. Simply put, adjusting for inflation, the value of US GDP in 1948 in today’s money is approximate in size to the current US stimulus package.
The Marshall Plan transferred funds directly to amenable governments whereas today’s measures are much more sweeping; comprising rate cuts, asset purchasing, state-backed wage guarantees, business loans and rates relief. Given the breadth of fiscal and monetary policy measures being enacted, keen followers of the global economy could be forgiven for expecting to see the kitchen sink at some point soon.
Did the Marshall Plan work? Absolutely, the decades initially following the end of the Second World War saw some of the fastest growth in European history with standards of living and economic output increasing dramatically. Making comparisons with the implementation of similar measures during and after the 2008 financial crisis we can see that asset purchasing and rate cuts have done well to stimulate sectors of the economy in the decade since. Some have argued that this ‘growth’ has been hollow, whilst markets have enjoyed record highs over the last decade, the topic of wealth inequality has increasingly moved into the forefront.
Perhaps the most important question amidst the current measures is simply, who is going to pay for them? In the UK, any notion of moderating the budget deficit has been put to one side. In practical terms this means the UK Government issuing and selling a significant amount of gilts to investors. The predictable ‘flight to quality’ by investors, in which they sell riskier assets in favour of buying safer ones such as government bonds, should see a market for these new gilts. However, some have expressed concern that investors are favouring not only government bonds but specifically those which are denominated in dollars, potentially impacting demand for these new gilts. Demand remains high for now and, more significantly, the Monetary Policy Committee (who are the decision making centre of the Bank of England) has also been buying gilts. Against this backdrop, the first quarter of 2020 saw huge volatility and a flight to quality, which has continued into the second quarter (despite a recovery in growth assets). Gilt yields remain depressed and close to record lows.
The intervention of central banks has supported asset recovery in the second quarter and helped pension schemes recover some of their funding level and asset falls, despite continued low gilt yields. Pension schemes should continue to expect volatility, as the pandemic evolves, and remain diversified – this is a fast moving situation and kitchen sinks may yet be needed!
The current approach by policy makers amounts to economic firefighting. The speed and size of the economic response to COVID-19 could make for difficult decisions when it comes to switching it off again.