Monetary policy restrict

IO – One of the points raised against the proposed reactivation of the policy to limit the spreading of the novel corona virus (Covid-19) in Greater Jakarta, known by the Indonesian acronym as PSBB, was raised by a Cabinet Minister on September 14, 2020, warning that it would have the effect of knocking 5% off the Jakarta Stock Exchange Index. I refrain from joining the debate on the policy itself, while resolutely supporting views and accepting any well-thought-out policy to quench the pandemic, based on reliable medical and scientific data. Public health is the ruling consideration, and this is how I happen to see the policy as now enforced. 

I have also been writing op-eds, pointing out how the Covid-19 pandemic and the steps taken to suppress lopsidedly impose a burden on the poor. The virus inflicts relatively more suffering on the poor because of their embedded condition, including their own precarious health. Meanwhile, the steps to be taken in the policy to stretch out and limit the effect of the pandemic, known as “flattening the curve”, also impose a burdensome cost – some term it a “misery curve” –borne relatively heavier by the poor. A simple illustration: if we compare the plight of daily workers vs. that of salaried employees (let alone the rich), a complete or even semi-lockdown for one month means daily workers immediately lose their survival income – while those on salary are not so sharply affected. The government cannot afford to ignore the issue of providing an extra safety nets; policies should in general aim at striking a balance between the flattening of the curve and the burdens or costs that inflict more acute suffering on the poor. Impoverished Indonesians are in a dilemma: they may either fall sick from a viral infection or suffer the devastation of being devoid of a livelihood. 

My narration here is not about this particular concern, but rather on the economic issue which I think is worth pondering. In reference to reports on the working of the market in developed economies, such as that in the US but also globally, as well as anecdotal evidence, serious students of economics propose the argument that what is in fact happening is a decoupling of capital market behavior from the actual state of an economy. Let us discuss this issue, what it means and what are its implications. 

Decoupling of the capital market from the state of the economy 

I start by referring to an editorial opinion carried by the August 23, 2020 edition of The South China Morning Post (SCMP), a well-known Hong Kong newspaper, entitled “Stock Markets are divorced from the state of the global economy”. This essay suggests that capital markets have in fact been behaving strangely during this Covid-19 pandemic. The editorial states that the New York Stock Exchange and Nasdaq in New York, with their famous S&P 500 index and Nasdaq Composite, along with the Shanghai Stock Exchange with the Shanghai Composite, Hong Kong with Hang Seng Index among others, uniformly report bullishness, even record highs of their indices, despite all the scary news about the Corvid-19 Pandemic and its adverse economic impact, manifested by a recession and unemployment. Market players, investors and financiers must be expecting and predicting a strong economy is on the way, resulting in a renewed heavy demand for equities. The editorial pointed out that this is unrealistic – even a bit cynical – stating “In the word of one well-known international investor, the markets are just nuts.” (my Italics). 

The editorial went on to declare that at these levels, an attitude of caveat emptor has never been more appropriate – the Latin dictum. “Caveat emptor” is a Latin advisory to the buyer, in a trading contract involving the purchase and sale of goods or services. It basically means that a given contract is based on the understanding that the buyer takes on all the risk, concerning the type, volume and quality of goods he or she bought, once a transaction is completed. If the specifications delivered are not as he or she expected, so be it. A buyer may only ask for a replacement if it is specified in the contract (receipt) that he or she is allowed to receive a refund or exchange of goods. In this context, this note sounds like a warning that predictions of investors have been terribly wrong, and they will at some point pay the price for their rashness. 

That editorial is however not the only one making this argument. Prof. Robert Shiller, a respected economist from Yale University, wrote a paper proposing a similar argument: “Understanding the Pandemic Stock Market (Project Syndicate, July 7, 2020). In this paper Prof Shiller demonstrated how stock markets in the US were behaving very strangely, contradicting genuine news, events and theory. He further wrote that the worse economic fundamentals and forecasts become, the more mysterious do stock-market outcomes in the US appear. Thus, when genuine news suggests that equity prices should be tanking, stock market indices shoot skyward. His alternative explanation is based on crowd psychology, the virality of ideas, and the dynamics of narrative epidemics – all of which could shed some light. 

When we dig a little further, we find that the question about the accuracy of interpreting the development of and volatility of stock market indices as a predictor for the state of the economies associated with capital markets has been historical. The SCMP editorial did not neglect to point out this issue, by quoting from a somewhat cynical quip of the late Economic Nobel Laureate in 1970, Professor Paul Samuelson of MIT, that the stock market had successfully predicted nine of the past five recessions. What he meant was that the stock market was in fact a poor guide to indicate the actual health of the economy. There is a decoupling or “divorce” between markets and the state of the economy, both nationally and globally. This is certainly not implying that we should not monitor or study the behavior and dynamics of the stock markets, of course. But do not take the volatility of its index as necessarily reflecting the current state of the economy. 

But what then does the dynamic of stock index actually reflect? 

The authorities responsible for the management and development of the national economy should be concerned and study carefully the ups and downs and the general behavior of the stock market. This is part and partial of their duties and responsibilities: to address the issues, exert a calming influence on markets, deal with adverse implications, reduce uncertainty and maintain overall stability. 

The dynamic of both domestic and global market behaviour indicates that stakeholders cannot afford to maintain a “business as usual” attitude. Here, what I alluded above is important, in that we are all aware at least. Economics is less and less a hard science as some would lead us to strongly believe. The bullishness of stock markets, which is supposed to show that the economy will shortly rebound, an environment where ostensibly responsible news and serious economists argued the flaw as mentioned above should not be ignored, just like data and advice from public health doctors regarding Covid-19 cannot be ignored. 

The bullishness of the capital markets, as reported in news of record-breaking surges of stock indices, can be better understood by looking at the aggressive policy taken by monetary authorities, in support of the extraordinary government expenditures undertaken by many countries and even globally to contain the Corvid-19 pandemic; the belief is that it was a measure which had to be taken when fiscal space weakened in most countries due to past budget deficits and Debt-to-GDP ratios, steep at the outset. In the US, during the GFC in 2008, over the span of two years the Fed poured more than USD 3T of additional liquidity into the economy. In 2020 approximately the same amount of liquidity was added to the economy within the space of just a few months. Similarly, in Europe, the ECB in EU and the BoE in UK embarked on an identical policy, adding tremendous liquidity into European economies. 

Much of this additional liquidity did not in fact do what it was intended to: it failed to flow into so ciety for the public to spend. Thus, there has been no real impact on general prices, let alone the hyperinflation that conventional monetary analysis would predict. The funds from additional liquidity are still in the hands of big corporations and the financial sector. In my view, this is plainly what seems to be the liquidity pouring into the capital markets and driving stock indices up and up, sky-high. The popular explanation, stating that capital markets behave like that because they are dominated by speculators or that capital markets work like casinos is not helpful in understanding the issue. 

However, it is correct to say that this development has been used as ammunition in politics for the incumbent to justify claims of excellent economic performance, as we keep reading news of President Trump making self-congratulatory remarks for his success in managing the US economy during campaign rallies for his re-election. But, for Democratic Candidate Joe Biden, this is a cover-up of the reality of a dismal performance of President Trump in managing the fight against the pandemic and the economy, which honestly sounds more likely. 

Serious news, data and the explanations of economists demonstrate that capital market development does not necessarily reflect the real sector and the state of the economy. It has also been in the news that world-famous investor Warren Buffett has demurred to make any investment in the form of stock purchases this year. He states plainly that he has not been finding any equity worth buying at this time, as they are mostly overpriced. In other words, he is on the same page as those serious economists like Prof Shiller, who argued that the US economy is facing long struggle to make economic activities revive to normalcy. Recovery may well be an “L” shape rather than a “V”. 

I would like to conclude my exposition with a conjecture regarding the argument for directly relating the announcement of the reactivation of PSBB to its triggering an adverse economic impact, specifically a five percent downturn of the Jakarta Stock Index. I take this criticism as arguing that a fall of the stock index is directly caused by the PSBB policy announcement. My elaboration shows the tendency in developed economies – or even in fact globally – for a decoupling or even divorce of the capital market from the actual state of the economy. The studies referenced or cited are cases of increased stock price indices. But there is no strong reason to argue that any difference would result in a “reverse case” of a stock index correction downward either.