The Haunting Ghost of 2013
Central banks indeed have rescued the capitalist, financial asset owners and investment management institutions, but they have not helped the ordinary businessmen in the real sector that must fight for their daily life in the streets.
SUPPOSEDLY, the condition of the financial market should reflect the real economy. If the economy is growing, the prices of various financial assets will cheerfully go up with it. But now the market is suffering an anomaly. The Covid-19 pandemic has upended that logic. Global financial markets are now anxious when the economy is showing signs of recovering.
The root of this upside-down logic lies in central bank operations. To fighting Covid-19, central banks around the world are pumping in unlimited liquidity. With good intentions, after all, they are trying to save the economy.
Ironically, those funds that rush in like flash floods from central banks are not helping the economy. Economic growth in all developed economies around the world is down into the negatives. The real economy withered under the pandemic. Central banks have failed to prevent economic downturn, even though it has expended extraordinary amounts of money.
The ones who reap the sweetness of the central bank policy are the financial markets. The plentiful showers of money have driven the prices for all financial assets to jump abnormally since April last year. When the pandemic first hit, the market did slump for a certain period. That was still in line with the normal logic. The financial market was panicked and prices were collapsed everywhere as investors anticipated an economic slump due to the pandemic.
That market melee, however, only lasted for a short time, and not even a month. The conditions immediately changed once central bank leaders from developed economies, led by the Federal Reserve, reaffirmed their commitment that they will do anything and spend unlimited amount of money. The financial market returned to life. In the meantime, the real economy was still down in the dumps.
Central banks indeed have rescued the capitalist, financial asset owners and investment management institutions, but they have not helped the ordinary businessmen in the real sector that must fight for their daily life in the streets. Various business sectors slumped as stock price indices everywhere broke records. The financial market ballooned into a huge bubble as the pumps of the central bank continued working and injecting unlimited money into the market.
Now, the situation has changed with the emergence of a vaccine for Covid-19. The winds of optimism have come to the real sector that were previously unaffected by the money flood from central banks. A paradox has arisen wherein the financial market is worried when the real economy improving. If the economy’s recovering, inflation might follow it. And that will be a signal for central banks to reduce the supply of liquidity.
Preceded by collapsing bond prices, the financial markets have started to melt on the last week of February. Stock prices plummeted. The market has started to anticipate that the injection of central bank liquidity, which has been the main driving force for the market, can be reduced at any time. This should be an early warning that cannot be ignored. The prices of various financial assets have been frothing so thickly, like the milk on a cup of cappuccino, and they must dissipate any time. Market correction is a certain eventuality, and the only question is when.
For investors in emerging markets, this situation is a callback to 2013. At that time, The Federal Reserve started reducing its liquidity injection that had been done since 2008. That policy caused a taper tantrum: investment funds exited emerging countries en masse. As a result, there was serious pressure on the balance of payments for various countries, which in turn ate away at their currency.
That happened to the rupiah as well. In July 2013, the rupiah was at Rp9,850. By January 2014, it had collapsed to Rp12,200, losing nearly 24 percent in just six months. If a similar shock happens now, the consequences are unimaginable in scale.
Liquidity injections from central banks right now are multiple times larger compared to 2013’s. And in a similar vein, the pressure that befalls emerging markets will be greater should such a reversal of investment capital happen now.