Written by The Investor
17 March, 2020
“It will cost something to reduce mobility… but to fail to do so will eventually cost everything”
The GFC of 2008 was caused by financial imbalances that eventually bled into the real economy. The COVID-19 crisis is the reverse. This supply shock has slowed the economies of the world and will quickly impact the money system as people, companies and even countries won’t have money to make payments.
“Debt is agnostic to one’s circumstances. It must be serviced, otherwise you are bankrupt… if dollars don’t flow in from sales and payments, they have to be raised from banks.” says Andrew McLachlan of Coolabah Capital.
It seems that the share market is already anticipating the cash squeeze with falls not seen since the crash of 1987
“I’m looking at dozens of companies in the S&P 500 right now that can literally go bankrupt if the government doesn’t act together on this,” CNBC star Jim Cramer said on Squawk Box.
The US stock market had its largest point fall ever with the Dow Jones crashing 13 percent and President Trump announcing the US ‘may be’ headed into a recession.
The challenge is to get the world through the short-term hit—the next few months—without a wholesale economic and financial crisis. This is why some governments are throwing massive packages at a virus with a mortality rate of 1 percent.
The Reserve Bank of Australia made history on Monday this week announcing they will commence quantitative easing for the first time. The RBA will expand Australia’s money supply by buying government bonds. This is the modern way to ‘print money’ to stimulate the economy as reported last week.
So what should the governments be doing to help?
The key initiatives governments are proposing to contain the virus and avert a deep economic recession are:
- Crowd prevention
- Funding for widespread testing
- Cash payments to families and businesses
- Large-scale aid to ensure that people can access medical treatment
- Prevent a domino-style collapse of the banking system, as businesses and individuals default on their loans
Source : investopedia, ECB, RBA, various
* Germany and Italy only.
** US congress is currently debating a larger package mooted to be hundreds of billions of dollars.
Clearly there is a significant difference to the commitment level of government packages aimed at fighting the economic impact of COVID-19. Europe is well ahead of the rest of the world, and rightly so given that it is now the epicenter of COVID-19. Germany authorised its state bank (a bank run by the government, but not a central bank), KfW, to lend out as much as $610 billion to companies to cushion the effects of the coronavirus. All up 3.48% of GDP.
More than $A2 billion will be pumped into the NSW economy to counter the global coronavirus pandemic. Premier Gladys Berejiklian announced a $A2.3 billion stimulus package, consisting of $A700 million for healthcare and $A1.6 billion for job creation and tax relief. The Morrison Government previously announced a $A17.6 billion economic plan “Our targeted stimulus package will focus on keeping Australians in jobs and keeping businesses in business so we can bounce back strongly.” All up this represents 0.84% of GDP.
The UK is spending over 1% of GDP. China is yet to ‘officially’ announce an assistance package. However, the Chinese government has asked banks to extend the terms of business loans and commercial landlords to reduce rents.
As a point of reference China announced a massive $586 billion stimulus package in 2008 post the GFC. In 2008 China’s GDP was 4.6 trillion and this package represented 12.7% of GDP. A package of the same order today would be an enormous spend of $1.55 trillion dollars or 111% of Australia’s GDP.
According to Forbes China has already acted swiftly, in March:
- Banks to provide a grace period for the virus-hit small and medium sized enterprises (SME) immediately upon application in repaying the principal and interest of their outstanding loans until June 30.
- Waived penalty interest.
- Banks are providing special loan quotas for firms in Hubei and lowering the financing costs for SMEs.
- The Politburo called for accelerating the investment on “new infrastructure”, including 5G networks and data centres.
- Beijing waived social security taxes for SMEs for five months retroactive to February 1.
What is the US about to announce?
House Speaker Nancy Pelosi and Treasury Secretary Steven T. Mnuchin reached a deal on Friday for an economic stimulus package to address the coronavirus – Families First Coronavirus Response Act.
“The three most important parts of this bill are testing, testing, testing. This legislation facilitates free coronavirus testing for everyone who needs a test, including the uninsured,” Pelosi said.
At the time of writing the US had tested 40,000 people while NSW had tested 30,000 people, or 121 and 3,000 tests per million people respectively. This compares to 3,692 and 826 tests per million people for South Korea and Italy respectively. It now seems that South Korea has contained while Italy is in rampant outbreak. Clearly this must send a message to the US government which is currently testing seven times less than Italy.
The US bill is also expected to provide Social Security Administration funding for workers who don’t currently receive sick pay. People would be eligible to receive benefits amounting to two-thirds of their monthly earnings, up to $4,000, for up to three months.
The share markets are voting ‘no confidence’
Falls to share markets have been 20 percent or more over the last year and around 25 percent from the highs seen in February. What the markets are concerned about is the uncertainty relating to the size of the outbreak and length of the economic impact to business and consumer confidence. They are also concerned about when consumers will return to spending.
The recent falls are also off the back of a strong and long share market rise of more than a decade. In the US company executives have been buying back stock for a number of years to support share price increases and their compensation packages bolstered by their option incentive schemes. These buy backs were funded with corporate debt and created history for US companies which now boast historically high debt levels.
As the following chart suggests there is usually a recession that follows a period of a rapid rise in corporate debt. All it takes is some sort of shock to the system to flick the switch. In 2002 it was the post Y2K and internet bubbles, and in 2008 it was the housing bubble funded by highly engineered loans to people who could never repay those loans (sub-prime lending).
This time around is it s a good old fashion flu that caused a supply shock, a cash-flow crisis for companies, and large disruption to peoples lives.
According to the US Center for Disease Control’s “Pandemic Influenza Plan”, there are four distinct pandemic stages in terms of caseloads — initiation, acceleration, deceleration and preparation for the next wave.
Europe and the US are now in the acceleration stage. Hubei is in the deceleration phase, but this comes following two months of lockdown.
Nassim Nicholas Taleb, ‘black swan’ forecaster says “self-protective quarantine, lockdowns of outbreak clusters and testing are the best precautionary approach to pandemic outbreaks. It will cost something to reduce mobility in the short term, but to fail to do so will eventually cost everything,”
Governments will continue to announce packages for the rest of 2020. Many of these packages will be massive in dollar terms. But the real battle will be won or lost in the next few weeks defined by the actions of governments to contain this virus with lockdown action.
So, what will it take to re-boot the economy while everything crashes around it?
While the impact of COVID-19 is still playing out it would be wise for investors to sit on their hands as there are many unknowns yet to be factored into the world’s economies, stock markets, and dare I say it, property prices.
Please consult your advisor for specific recommendations. This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice. Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.