Thursday, April 9, 2020
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OPINION AND ANALYSIS | 14-03-2020 07:43

An infected market meets a pandemic flu

Global financial markets had relied on monetary stimulus to carry an unsustainable rally for too long. Finally, the Covid-19 outbreak broke the camel’s back, and it’s tough to see where the light at the end of the tunnel will come from.

It is impossible to escape the spectre of the coronavirus this week, as it has been wrecking global havoc with its exponential infectious growth. Even though it could end up being no more powerful than a common flu, its impact on the world economy — and the global psyche — will leave a jarring scar.

Yet, the wound is still open and the pain it causes will probably intensify, as it has become the catalyst of a worldwide financial crisis that could match the 2007-2008 global financial meltdown that began with the subprime mortgage crisis in the United States. Already, Wall Street has suffered its fifth worst day in history, and the most calamitous since Black Monday in 1987, as tens of millions have been put in quarantine throughout China and Western Europe.

In a globalised world, the fear of contagion has led to a closing of borders as nations scramble to repatriate estranged citizens while prohibiting incoming flights from “infected areas,” which according to preliminary statistics from John Hopkins University now represent 117 nations with more than 135,000 cases having caused over 5,000 deaths worldwide by press time. The brutality of the market’s reaction to the coronavirus pandemic, coupled with potent declines in oil prices due to a cock fight between Saudi Arabia and Russia, have catalyzed a cycle that has already caused irreparable damage to the global economy, exacerbated by governments’ overreaction to a major public health issue. Despite a “dead cat bounce,” we’re in for some serious trouble.

Before getting into an analysis of the violence of the market correction — which is intimately tied to a global market that has been propped up by monetary largesse that appears to have lost its power, therefore setting the stage for intense financial volatility across the globe — it’s important to put the reaction of governments across the globe in context. The current Covid-19 outbreak has been declared a pandemic, and it follows in the footsteps of at least eight severe pandemics since the 20th century. While it is unlikely that an infectious disease will wipe out humanity from the face of the planet, there are more than enough reasons to fear a potentially apocalyptic pandemic, as the Global Preparedness Monitoring Board explained in a recent report at the behest of the United Nations, indicating our lack of preparedness. The Spanish Flu of 1918 infected some 500 million people (about a third of the global population), killing 50 million over two years or nearly three times as many as World War I. The Asian Flu of 1957 and the Hong Kong Flu of 1968 each took out one million people, while AIDS is responsible for 32 million deaths since 1981, according to a piece by Perfil.

A proper government response to infectious disease based on scientific evidence and preventive action is needed, and indeed would generically cost around US$4.5 billion according to the World Health Organisation (WHO). Instead, the annual cost of influenza in the US from hospitalisations tops US$10 billion, along with 20.1 million days of lost productivity, says the US Center for Disease Control (CDC). Yet, ill-prepared nations and politically motivated action undermine noble attempts to contain the virus, such as US President Donald Trump’s initial mocking of the coronavirus outbreak, only to be forced to react once the stock market went haywire, unilaterally closing his nation’s borders with the European Union while pointing to China as the epicentre of the disease. The Donald is in electoral season, of course.

In a working paper for the US National Bureau of Economic Research authored by Victoria Fan, Dean Jamison and Larry Summers, they estimate the annual cost of pandemic flu to be between 0.2 to 2 percent of global income, similar to climate change, with some 700,000 deaths which, added to US$80 billion in income loss, take the figure to US$570 billion. A “moderately severe” pandemic could cause over two million deaths and cost four to five percent of global output, about US$4 trillion. It is clear that governments must react to avoid unnecessary loss of life, but also act in a coordinated and rational manner so as to not exacerbate the serious economic disruptions caused by infectious disease. Already we are seeing the impacts of the Covid-19 outbreak, with a global paralysis in industries including transportation and hospitality, a growing impact on retail and industrial production, and the slowdown of global trade. It is still too early to estimate the global economic cost of coronavirus, but there can be no doubts that the knock-on effects of the paranoid fear that has taken over will only exacerbate the macroeconomic disruptions. China alone could shave 0.2 percentage points off global growth, sending it to its lowest levels in a decade since the financial crisis.

ONLY PART OF THE PROBLEM

Coronavirus is only half of the problem, or even less. Global financial markets have been brewing a deep crisis that appears to have been kicked into high gear these past few weeks. Wall Street’s see-saw this week, tanking 10 percent on Thursday only to surge 9 percent yesterday, is but one of the several indicators that things are not right. And an oil price war between Russia and Saudi Arabia sending crude down more than 20 percent in a single trading session just adds jet fuel to a forest fire.

Since the global financial system imploded under the weight of excessive leverage and reckless lending in 2007-2008, it came down to the major central banks to save the day. Former Federal Reserve chairman Ben Bernanke took the lead through aggressive interest rate cuts which led to quantitative easing, or monetary stimulus. Europe soon followed suit, with then-European Central Bank president Mario Draghi telling markets he would do “whatever it takes to preserve the euro,” adding, “and believe me, it will be enough.” Soon enough major central banks were pumping billions of dollars, euros and yens into bond markets, pushing down interest rates close to the zero-bound, with yields in Europe going negative — which means bondholders were actually paying sovereigns to hold their debt — as a “wealth effect” in financial assets was expected to trickle down into the real economy.

Markets became hooked, as the Financial Times’ Gillian Tett put it, on monetary “morphine,” and every time the Fed tried to back off, they freaked, forcing the sitting Chairman to come up with a new “monetary fix.”

“Bad news is good news,” was a phrase knocked around Wall Street, indicating the Fed would come to the rescue in the face of negative economic indicators. And it worked, to a certain extent, having pushed stock markets — particularly in the US — to record high after record high, while unemployment has dropped to some of lowest figures on record. Yet, several market watchers have been arguing that these massive gains in asset prices were artificial, and that a major correction was inevitable. Keen investors like Jeffrey “the bond king” Gundlach and even the Oracle of Omaha himself — Warren Buffet — warned that asset prices were ridiculously high. Markets were completely distorted as valuations became excessively rich, yet this time the world’s leading central banks didn’t have the “ammunition” to face a severe crisis. According to Ámbito Financiero, interest rates in 2008, before Lehman Brothers went bust, were around 4.15 percent in major economies, and central banks cut rates to the order of 500 percentage points in the heat of the financial crisis. Today, the ECB is at the zero, while the Fed is expected to get there next week, after a 50 percentage point last week that was widely considered ineffective.

Furthermore, the Fed pledged US$1.5 trillion to support repo markets that provide short-term liquidity this week, but ended up seeing the yield on US 10-year bonds rise, indicating bondholders were dumping supposed safe-haven Treasuries amid an equity bloodbath, which is completely unexpected. Even gold prices dropped on Thursday when the market panicked, both of which suggest investors were forced to sell even the most valuable assets in the face of a liquidity crunch (so did Bitcoin). “Investors may be starting to contemplate a world in which financial morphine no longer functions,” Tett argues, “a shot of cheap money [no longer] works in the face of medical uncertainty, a global recession, looming corporate defaults and weak political leadership.”

UNNATURAL SWINGS

It’s unnatural to see 10 percent swings in massive markets such as the S&P 500, and yesterday rebound — possibly a response to Trump seeming to acknowledge the seriousness of the situation — is a clear sign of trouble ahead. This is extremely bad news for Argentina, as its main exporting partners (China and Brazil) have suffered a deep economic blow from the coronavirus-financial madness of the past few days, its major exports have seen prices fall off a cliff (soybeans and commodities in general), and the fall in oil prices makes shale production increasingly unprofitable, dooming Vaca Muerta in the short-to-medium term. Furthermore, it casts a major shadow over Economy Minister Martín Guzmán’s already complex plan to restructure a large debt pile, not only asking jittered bondholders to accept an aggressive haircut on their holdings of Argentine sovereign debt, but pushing bond prices very close to levels attractive to “vulture” hedge funds that are begging for a change to litigate.

Global financial markets had relied on monetary stimulus to carry an unsustainable rally for too long. Finally, the Covid-19 outbreak broke the camel’s back, and it’s tough to see where the light at the end of the tunnel will come from.

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Agustino Fontevecchia

Agustino Fontevecchia

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