COVID19 – fighting at best, prepare for worst
We are fighting with the deadliest disease of this century with fullest hope that controlling the disease will return our life to normalcy. That’s not a future that we are likely to face at the end of this pandemic.
The biggest pandemic is yet to begin – the economic recession, if not depression. A severe recession can no longer be avoided, and some economists are already calling for governments to introduce measures to shore up aggregate demand. China, US, EU, UK, Australia and every government fighting the pandemic have introduced fiscal measures to help the economy running and increase the demand as a measure to keep the manufacturing and economic activity alive.
US, Italy and Australia are sending cash into people’s account, providing concessional access to fund for small businesses. UK offered to pay 80% of the wages for hospitality workers. This is sort of replication of short-term allowance that was tested in Germany to support underemployment and was tagged effective. China cut the policy rates. Others introduced concessional tax regime.
People are hoarding food in anticipation of stricter measures from the governments to control the spread of COVID19. However, the only country seeing some relief is China where no new domestic cases are reported. Despite efforts, all other countries are virtually seeking unprecedented rise in numbers of infections.
The life lockdown is likely to go weeks and months – as flu season is at the door in many countries including Australia. This will further pinch economic activities. The government measures at this stage is targeted in controlling further spread of the virus and least towards saving the future economy.
The cash splash into economy is not adequate. What’s the purpose of giving money to individuals when businesses are closed? The fundamental problem is supply – which the government should take care of. People quarantine at home while production chain is severed. Cash into people’s account will boost demand prompting acute shortage of supply. As demand overtakes supply, the situation leads to stagflation – weak or falling GDP growth and rising prices. This phenomenon was observed during 1970s oil crisis.
The measures the governments currently introducing replicate what US did during Great Depression. The depression of 1929-32 started after stock market crash in October that year – 10 years after 1918 flu in the US that killed half a million people. US administration provided cash payments to farmers, debt relief for mortgage holders, public-works projects for the unemployed, and low-interest loans to stricken banks and railroads. We know the history – it did not return expected result.
Real estate
Australia was hoping for real estate boom after a slump of several years. With expected job losses, it is likely to lower the demand in housing market. The rate cut by Reserve Bank of Australia would not help return optimism in the housing market. Lack of demand is likely to push the housing marking from boom to brink. It will not be shocking if we see large default rates in near future. The impact will trigger possible huge losses to Australian banking industry. And not to be shocked if we hear about banking bankruptcy.
In anticipation for that, banks ignored passing the rate cuts to customers on the latest rate cut by RBA. Rather, the banks looked into supporting small businesses with concessional rate or pausing repayments for several months.
The rate cut advocates also argue the need for liquidity support. The world is already overflowing in liquidity, with nominal interest rates close to or below zero. Further rate cuts into deep-red territory may help stock markets, but they also could trigger a run on cash.
The rate cuts have not helped boost the economic activity – albeit for a brief period. The rate cuts across the world continued since the beginning of this century but this never averted recession. Central banks’ policy of excessively cheap money and pooled liabilities caused an unsustainable bubble. The central banks are now not equipped to address the burst that we could be seeing in near future.
The governments and regulators must come up with fiscal measures to save companies and banks from bankruptcy once the pandemic is over. They require support to boost employment and economic activities. The businesses need tax breaks and reliefs. Distributing money at the beginning of the pandemic will not provide any employment opportunities or boost economic activities.
Current need is actively taking action against the spread. Health system requires money at this stage – ICUs expanded, more workforce hired, protective gear units and masks produced in mass scale, large scale testing and keeping records of individual case is important at this stage.
Oil prices and stock markets
Oil prices are benchmark of economy. Economies of many countries rely on income from oil supply. As people stop travelling, over supply caused the prices to fall. The war (or cooperation?) between Russia and Iran is destabilising the crude market. If prices continue to fall, countries in middle east and south America will go into recession early.
Uncertainly is a cliché in share market. But uncertainty invited by COVID 19 is exponentially uncertain – driven by fear. The efforts from the governments have created more fear than awareness about the virus. Investors lost confidence not on one stock but economy as a whole. The losses have surpassed the incidents we observed during GFC.
The Futures and Government Bonds are trading in negative territory. The government bond forms the last resort to assure minimising losses. Yet they have now been pushed out of comfort territory.
China lessons
When virus broke out in China, western democracies rushed to criticise the communist government of its failure to act early. They criticised when lockdown started in Wuhan pointing it as obstruction of human rights. China failed to pull the trigger early because it was not prepared for such pandemic.
However, the western countries had enough time to study the disease, prepare strategies and plan for any disruption. They neither prepared their health system nor their economy. Ultimately, they opted what China did – lockdown the public life. Hardly any industrialised nation has the capacity to ramp up emergency facilities like China. In case the epidemic rise to China level, we have no infrastructure to cope. We require years to prepare one infrastructure that China did to tackle the virus in a week.
Markets and public functions are still partially open in Europe and US – when I write this. Life is still in full swing in Australia – with exception of panic buying toilet papers. We still do not hear the Italians who expressed regret for not acting early. This will definitely not flatten the curve. We must learn to act quickly when issue is identified.
Prepare for recession
We not only now must fight with COVID19 but prepare ourselves for worst recession rising in the horizon. Bank of America has already pronounced recession in US. The bank projected GDP shrink by 12% in second quarter and full year by 0.8% for this year.
“Assuming an extension of the health crisis up to the beginning of June or beyond, the fall in economic activity in 2020 could be comparable to the contraction of 2009, the worst year of the Economic and Financial Crisis,” the European Commission said in a statement on March 20.
ECB projected euro-area output will shrink by 2% this year if a virus-induced lockdown in the continent lasts for one month, and by 5% if it stays for three months.
As demand plummets worldwide, manufacturing in China will certainly contract. It may be hard but not impossible for China to go into recession.