The Crisis That Won’t Go Away

The Crisis That Won’t Go Away

K.M. Chandrasekhar

K.M. Chandrasekhar

The stock market crashed all over the world, including India, on 9th March. Reuter’s reported that the market capital of 5 trillion dollars was wiped out in a day in the US market. In India, Reliance Industries, which had been riding high as the top company in terms of market capital, yielded its position to TCS. The fall of the major indices, Sensex by 1941 points, and NIFTY by 538 points, on March 9th, is stated to have been the biggest ever fall in a day’s operation. That was until the 11th, when it fell again by a whopping 2700 points. In between, there was a day when it remained flat.

The immediate cause of the present decline was apparently the surge of panic created by the new Covid 19 virus, which started in China late last year. The number of lives it took in China would not have spooked the markets so much as the fact that global business had invested heavily in China. China had become an indispensable part of the global value chain. The emergence and rapid spread of a highly infectious virus strain rocked the very foundations of global business. When the virus relentlessly established its footprint in other countries and as unprecedented measures had to be taken to contain its growth, the business world trembled in fear.

Not that the virus itself is the worst the world has seen. Mankind in the past has handled far more deadly, incredibly more destructive diseases with less medical knowledge and competence. The Covid 19 virus is, of course, highly infectious and can spread easily. However, its mortality rate does not seem to justify the degree of fear it has aroused. The rate of mortality is estimated to be not more than 1% to 2% on the average, even though it killed 15% of infected senior citizens in China. Even the common flu has more destructive potential, killing 646,000 people annually. The flu, too, like the new virus, picks on the aged and the infirm. The difference is only that our bodies, accustomed to the flu virus, have created antibodies to resist it and our scientists and pharmaceutical industry have had the time to develop vaccines. Covid 19 came like a typhoon and threatens to sweep all before it. It will take time for the world to adjust to the new menace and to take it in its stride.

Even as the world was trying to cope with the possible havoc that could be wrought by the new virus, the Organisation of Oil Producing and Exporting Countries (OPEC) decided to spring another surprise. The economic woes of China would undoubtedly affect the markets for oil, coal and other sources of energy. To retain prices at remunerative levels, production would have to be curtailed. Saudi Arabia and Russia could not, however, agree on the volume of reduction. Both went their own way and, instead of restricting production, they chose to ramp it up. A sudden crash in oil prices was, therefore, inevitable. Brent crude oil prices fell by 30% in a day. The Dow John industrial average in the US came crashing down.

At the same time in India, the financial sector underwent another convulsion with the noisy takeover of the Yes Bank by the RBI. This was not the first bank that collapsed. Earlier, the Punjab & Maharashtra Cooperative Bank (PMC) had fallen under the burden of its own fraudulent transactions. PMC was, however, a relatively small bank. Yes Bank was considered to be in the big league of private banks in India and though its struggles were known to the market, its fall further accentuated distress in the troubled financial sector.

The stock market is no barometer of the health of the economy. It will no doubt continue its gyrations for the next few weeks until, hopefully, it settles once again.

Human history has confronted and overcome many a crisis in the past. In the financial sector, the Great Depression of the 1920s and 1930s could, perhaps, be considered a parallel event that could teach us a few lessons, particularly because there is an eerie resemblance between the two, at least so far as stock market crashes are concerned. The starting point of the depression was the immense fall in stock prices in October 1929. The previous few years had witnessed a big boom in stock prices in the US. The stock market gained not only from investment by the rich and moneyed, but also by the middle class and even the poor. To make matters worse, there were many who engaged in margin trading, in the process borrowing huge amounts from banks. The American banking system was fragile, dominated as it was by a large number of small banks. They lent money not only for buying stocks but also for consumer banking. As personal debt increased, demand slowed and this had its inevitable impact on production and investment. At the same time, taxes were raised to buy surplus produce of farmers.

On Thursday, October 24, 1929, over 12 million shares were suddenly dumped by investors, losing 2% of their aggregate value. The large bankers got together and decided to restore confidence by buying key stocks. As a result, the market rebounded on Friday, but this was short lived and there was a big crash on October 29, famous even to this day as “Black Tuesday”. The fall of the stock market created a panic run on the banks. In one year over 700 banks were forced to close and by the time Herbert Hoover left the American Presidency in 1933, another 4000 banks had collapsed.

It is recognised that President Hoover was too conservative to handle a crisis of such dimensions. The crisis in the US spread also to other advanced countries, to Germany, to France and to the UK. By 1932, unemployment in the advanced countries had gone up from 7.2% in 1929 to 31.4%. Deflationary pressures had emerged in the economy, trade volumes declined and real GDP fell. There was visible poverty, many had to sell their houses and move to shanty towns, ironically called “Hoovervilles”. Bread lines became common and even well off people had perforce to move to poor homes. Failure of crops in the early thirties, land erosion on a big scale and massive dust storms, together named the Dust Bowl, ravaged the countryside. There was mass migration of farmers and agricultural workers across the country, immortalized in the novel, “The Grapes of Wrath” by John Steinbeck. Hoover did nothing practical to alleviate the problem except to ask industry to retain wages at levels then prevailing, but this only aggravated the problem of unemployment.

The situation changed only after the election of the Democrat Franklin Roosevelt, who replaced the Republican Hoover. Roosevelt was influenced strongly by the theory propounded by the British economist, John Maynard Keynes, who felt that in moments of cyclical crisis, laissez faire and inaction was really not an option for governments that active measures have to be taken to push up demand and consumption. The first 100 days of Franklin Roosevelt was a period of unparalleled change, which set the template for future Presidents. Roosevelt was a man who believed that “the only thing we have to fear is fear itself”. He believed also that “it is common sense to take a method and try it. If it fails, admit it frankly and try another. But, above all, try something.”

Roosevelt’s first 100 days were characterized by a flurry of economic measures. To begin with, banks were closed for four days. Those banks that had a possibility of revival were given funding, while others were closed. The Federal Deposit Insurance Corporation was created to guarantee deposits up to a certain amount. The Federal Security Act was enacted putting curbs on margin trading of stocks and the Security and Exchange Commission created to be a watchdog over the financial sector. The National Industry Recovery Act created a National Recovery Administration to regulate competition in industry. Measures were enacted to promote labour rights, including the right of workers to form and join unions and for promoting fair practices in labour. Funding was provided to farmers who reduced production on their farms, thus dealing with the problem of surpluses in agriculture. While this did create some unemployment amongst agricultural labour, the Civilian Conservation Corps and the Tennessee Valley Authority created a large number of jobs through heavy investment in electricity, flood control, irrigation, roads and other public works. In addition, the Federal Emergency Relief Act provided a large sum of money to be distributed to state and local agencies for poor relief.

All these would not have been possible had Roosevelt rigidly adhered to norms of fiscal prudence like his predecessor. But the architects of the New Deal, as it was later called, were clearly pragmatic. As one of the participants in the brains trust formulating the New Deal, Raymond Moley, wrote later, “For the New Deal was not of one piece. Nor was it the product of a single integrated plan. It was... a loose connection of many ideas - some new, most borrowed from the past - with plenty of improvisations and compromises. Those of us who participated were too busy for mature reflection or to create a system of an overall pattern.”

As our country faces a similar crisis today, what can bale it out is not conventional economics, but bold action of the kind we saw in Roosevelt’s New Deal. Merely repeating the mantra that the fundamentals of the economy are strong and that exogenous factors are responsible for the crisis will not make it go away. There is need for risk-taking in government economic policy and the will to experiment with new solutions. When the problem is clearly one of lack of effective demand, it has to be addressed upfront. The problem is not one that can be handled on the monetary side alone it requires strong fiscal response too.

Of course there are exogenous factors also. Ever since the ascension of Trump, market access has become far more difficult and cooperation on the trade front, which governed international trade since the Bretton Woods Conference and the Uruguay Round, has declined. The World Trade Organisation has become a toothless entity. The benefits that India enjoyed as a poor and developing country, as defined by the United Nations, have now been taken away by the US. Yet, when Trump came to India, much time was spent on fanfare and defence deals, too little on issues that would make a difference to the livelihood of indigent people, not merely in India, but in other countries in Asia, Africa, Latin America. India is large, populous, and despite its immediate economic problems, it is recognised everywhere that we have the strength to grow. India’s voice must count in the comity of nations on the economic front. For the good of the world and its people, economics must trump politics in the priorities of our nation. There is no option; there are too many of us too poor and deprived.

There is a nursery rhyme that has been a perennial favourite. It goes something like this:

Humpty Dumpty sat on a wall,

Humpty Dumpty had a great fall.

All the king’s horses and all the king’s men

Couldn’t put Humpty together again.

Will the King’s horses and the King’s men in our country act wisely and fast to mend the broken economy?