Understanding Government's responses to the economic fallout of COVID-19 | Merchant West

Articles | Understanding Government's responses to the economic fallout of COVID-19

COVID-19, the Coronavirus, SARS-cov2; it goes by many names and is on the world’s lips at the moment. This devastating disease is not just taking lives and overwhelming healthcare systems, it is decimating the global economy. In response to this, we have seen governments mobilize in a way that is unprecedented during peace time.

If one watches the news, they will have repetitively heard terms like “stimulus package”, “quantitative easing”, “helicopter money” and a whole lot about central banks cutting interest rates. If you are wondering what this all means and what all the fuss is about, it is worth taking a look at some of the history of economics, as well as its major schools of thought.

In early 1776, Adam Smith published his seminal work, The Wealth of Nations, and economics as a school of thought was born. The theories he portrayed in this work were to become the foundation of the classical school of economic thought, and one tenet carried through ahead of all others, and is still believed by many economists and policy makers today. This principle states that free markets are efficient (and would tend towards full employment, assuming labour was flexible on wages) and government intervention should be kept to a minimum as this would only introduce inefficiency.

Fast forward to the early 1930s and the world is gripped by the Great Depression. To the eyes of the world, the free market had failed and the global economy was entirely stagnant. John Maynard Keynes, a British economist and Mathematician, argued that free markets did not always lead to a fully employed and efficient economy, and that the overall amount of spending in an economy is correlated to employment. To get out of the depression, he advocated strongly for fiscal stimulus in the form of increased government spending. Although it was, in fact, World War II that necessitated this government spending, many nations adopted his view. The resulting improvement in economic fortunes to many observers vindicated Keynes, with his thinking become common place in the decades that followed.

A few decades later, a new crisis contradicting traditional wisdom occurred and a new iconoclastic thinker emerged to provide an answer. Much of the Western World experienced something considered impossible at the time, called ‘stagflation’ (high inflation combined with depressed economic growth). Traditional theory suggested there was a trade-off between the two, so this proved a mighty contradiction. Famous American economist Milton Friedman once again shifted the paradigm of thinking here by revisiting the free markets thinking. He also asserted that the amount of money in the market and not the amount of spending influenced economic activity. His answer to the stagflation issue was the use of monetary policy to change interest rates and therefore control the amount of money in circulation, while allowing the economy to work its own magic.

There have been several shifts in thinking and schools of thought that have emerged since then, but how does this relate to us now? Well, economists and policy makers are using principles like these on a high-level to do what they believe will stimulate the economic machine that has been brought to a standstill by international travel and supply chain disruptions. Governments are using fiscal stimulus, in the form of increased spending, while central banks are using monetary policy, in the form of reduced interest rates and increased money supply, to try and prop up the global economy.

This crisis has proven to be a completely unforeseeable tail-risk event, and highlights the need for effective risk management, especially in foreign exchange markets. Risk can be mitigated through efficient treasury policy formation, the use of Options and FECs and an efficient system to track exposures and commitments. If you have found yourself without these in place then a possible solution for you might be to use an active currency management strategy to improve your effective rate.

At Merchant West Capital Markets one of our core functions is to help both businesses and individuals transact in the foreign exchange market at great rates, as well as making use of techniques to help our clients manage their foreign exchange and treasury risk. We can advise on market timing, treasury policies, the use of Forward Exchange Contracts and Options and more to help you have peace of mind should a tail risk event such as this occur. We can also help you optimize your rates through orders and order management, active currency management and risk sharing.

 

To find out more about our Capital Markets service offerings, email us at info@merchantwest.co.za