In March 2020, the world witnessed ‘one of the most dramatic stock market crashes in history’ (Mazur et al (2020)). Stock market indices across most G20 countries lost 30% of their value, followed by a speedy recovery. Nearly five months later, countless studies seek to explain what happened and how financial turbulence is linked to the ongoing COVID-19 pandemic.
This blog critically examines mainstream economics’ views on the ‘COVID-crash’ pointing to a persistent lack of stuctural analysis. While the wedge between financial markets and the ‘real’ economy remains ever so pronounced, mainstream economics fails to explain convincingly what happened in March 2020 or why.
What’s the mainstream story?
Much of mainstream economic analysis of the ‘COVID-crash’ sets out to answer one particular question: how did stock markets respond to COVID-19? This from the outset assumes a link between the pandemic and the crash. However, even with this narrow research frame, results are mixed.
Multiple and contradictory arguments abound: stock markets reacted promptly (Ramelli and Wagner); stock markets reacted sluggishly (Capelle-Blancard and Desroziers); lockdowns negatively affected stock markets (Baker et al); lockdowns mitigated the effect of COVID-19 on stock markets (Bach Phan and Narayan); growth in death and confirmed cases both are negatively correlated with daily stock returns (Al-Awadhi et al); daily stock returns are only significantly correlated with confirmed cases, not with the amount of deaths (Ashraf), and so the list continues. Despite differences in conclusions, a few common denominators exist.
First, there is a general interest in the importance of news: many contributions obsessively regress stock market returns on a proxy for the quantity of COVID-19 news (newspaper articles, online or print, fake or real, social media or Financial Times). The larger the increase of COVID-related news a day, the worse it looks for investors, or so the argument goes.
Secondly, the question of fundamentals gained new attention. This relates to what appears as a detachment of financial markets from the ‘real’ (productive) economy, as stock markets recovered while unemployment numbers broke records and industrial production was still to a large extent locked down.
Lastly, a large number of articles conduct comparative studies between the recent financial turbulence and instabilities of the past by comparing the COVID-crash with the great financial crisis of 2007-2009 or the Spanish Flu and other epidemics.
So what’s wrong with it?
Many will remember the Elon Musk tweet from 1 May this year, when he opined that Tesla stocks were overvalued causing an immediate fall in their price. This serves as a clear example of the impact of social media activity or other online content on stock prices. But is it merely a matter of volume of news, as some seem to suggest? And is there a pitfall in overstating the predictive power of news?
Even from the perspective of a long-run fundamental analysis, where short-run ‘noise’ such as the aforementioned tweet (and the stock market crash in March) plays no part in long-run pricing, the news-focused analysis falls short. For, as stated above, there has been a clear decoupling of the productive economy and financial markets recently – which even mainstream economists can no longer ignore.
Paul Krugman, for one, declared that ‘the stock market is not the economy’ in an opinion piece in The New York Times in late April this year. While his explanation of the decoupling partly includes a systemic analysis, this is far from a general case. Instead, regressing the volume of news, or search trends to establish statistical significance in predicting the movements of asset prices, serves as a desperate attempt to find some rational explanation to stock price fluctuations – now that ‘fundamentals’ such as the content of the news can no longer account for the movements.
Without engaging with deeper structures of financial markets, or financialisation, a panicking population and the overproduction of COVID-19 news can be blamed for the instability. For Cepoi (2020), the problem can then be fixed simply by ensuring clear channels of communication of information to the markets. Just like last time the markets severely crashed, mainstream economists see no need for systemic change according.
The comparative studies fit in this line of argumentation, suggesting that reactions of stock markets to COVID-19 were unprecedented compared with previous pandemics. Baker et al (2020), for instance, found that rather than the lethality of the virus, the lockdowns were the main driver of the financial instability. This conclusion is inferred from a comparison with the Spanish Flu.
However, what this study and similar comparative studies neglect is the different socio-economic contexts of the two pandemics and how financialisation has fundamentally changed the scene. In essence, the COVID-crash was unprecedented not because of lockdowns, but because a global pandemic of its prevalence is unprecedented in the time of global financialisation.
Financialisation and autonomous finance
Without an understanding (or acknowledgment) of the structure of global financialisation and financial markets, mainstream analysis oversimplifies what happened and why. For, when finance has reached a level of autonomy, it becomes critical to ask exactly why a pandemic creates financial turbulence, and why financial markets have recovered as the productive economy heads towards a grave recession.
Taking the structure of globalised finance, financialisation and global liquidity into account is essential to make sense of the events in March. Capital did not just flow out of the global south to the global north in March 2020 because the global north suddenly was overflowing with sound investment opportunities (see Romero (2020)). Neither would companies have had to default over the last few months in such large numbers if they had been less leveraged (see Redman (2020)).
Most importantly, state intervention aiming to mitigate the economic consequences of the pandemic might not have primarily taken the shape of market maker of last resort if the structure of financial markets and its relation to the economy were different.
Heterodox economists have been warning since 2009 about a coming crisis. This is not because they knew about COVID-19 before the rest of us, but because, as long as underlying structural fault lines in contemporary financialised capitalism remain unchanged, crises are inevitable.
Marie Meyle is studying for an MSc in International Finance and Development at SOAS, where she is currently writing her dissertation on the 2020 stock market crash and recovery.