Markets are diving across the globe today, with fears of the negative impact of the coronavirus making most headlines. I made my view on this clear on Friday. The coronavirus is a potent threat to the global economy, and could even force the US economy into recession. While headlines focus on equities falling, my eye is on bonds, with the US 10-year trading just below 1.40%. The curve is now majorly inverted from 3 months to 10 years, but with the 2 year-10 year spread still at 10 basis points to the positive.
To me, it all suggests we do have time to manage a response. The question now is what policy makers will and can do to lessen the impact. A few thoughts on that below
The spread of the coronavirus
What’s getting markets spooked is the spread of the virus outside of China. We are now seeing the same sort of lockdowns in South Korea and Italy that we saw in China earlier. And since it isn’t yet clear how the virus spread to those regions, it is creating unease about what could happen next. At a minimum, we will see further supply chain disruption as South Korea is the world’s sixth largest exporter, with 90% of those exports intermediate goods.
But beyond that, the spread to South Korea and Italy could mean that the coronavirus turns into a longer-lasting global pandemic that lasts for long enough to cause major economic disruption. How do policy makers deal with that? For example, what would two twenty-five basis point cuts by the Federal Reserve mean in the face of a global pandemic? I don’t think this is a monetary policy issue. And it isn’t clear to me what the appropriate or best response is.
The Policy Response
I saw that Michael Pettis mentioned the Chinese government is ramping up their stimulus plans.He tweeted that:
“Spending plans are starting to come in. Last night Beijing announced that it would push forward CNY 252.3 billion of urban projects, which “will include 100 infrastructure projects, 100 livelihood improvement projects and 100 high-tech industrial projects.” The fact that there are a perfectly round 100 of each type of project suggests that these were not developed organically based on what someone thought Beijing needed but are rather the result of someone ordering Beijing to come up with 100 of each.
Also last night, I am being told (but haven’t been able to confirm), Yunnan, one of the poorer Chinese provinces, with a population equal to about 3.5% of China’s total population and a smaller GDP, announced CNY 3.6 trillion of infrastructure investment. This probably includes a proposed Maglev train (estimated at CNY 100 billion). To get a sense of magnitude, CNY 3.6 trillion is roughly 4% of China’s annual GDP, although I don’t know if the spending plan is just for 2020.
We’ll probably get more spending announcements in the next few days and weeks. NDRC announced this morning that major economic targets (including the GDP growth target) will be met this year. With the opening of the spending floodgates, already some of my well-connected friends are betting that GDP growth this year will match or even exceed 2019.
Is this the right policy response? Will it prevent the Chinese economy from falling? We don’t know. Bloomberg News writes:
With much of China’s economy still idled as authorities try to contain an epidemic that has infected more than 75,000 people, millions of companies across the country are in a race against the clock to stay afloat.
A survey of small- and medium-sized Chinese companies conducted this month showed that a third of respondents only had enough cash to cover fixed expenses for a month, with another third running out within two months. Only 30% of such firms have managed to resume operations due to a complicated local government approval procedure as well as a lack of employees and financing, a government official said at a press conference on Monday.
While China’s government has cut interest rates, ordered banks to boost lending and loosened criteria for companies to restart operations, many of the nation’s private businesses say they’ve been unable to access the funding they need to meet upcoming deadlines for debt and salary payments. Without more financial support or a sudden rebound in China’s economy, some may have to shut for good.
For me, the small business impact in China highlights the problem when much of the economy is shut down to prevent the spread of the virus. You can’t fix this with stimulus packages or rate cuts. How do you bail these firms out? Do you give emergency loans to these businesses? What if the disruption last longer?
If China, which is a more state-directed economy is facing these challenges, imagine what would occur in Italy, South Korea or other more market-oriented economies that faced the level of disruption China is now seeing. That’s the worst case scenario.
My view
I think we’re getting near the phase where policy makers will be tested. The fear that this virus is spreading is already tightening financial conditions and putting a damper on growth. You add in the supply chain disruptions and you have a significant problem. But all of that is occurring without a major outbreak in Western developed economies. WHat’s happening in Italy and South Korea hint at this possibility though. And if the coronavirus goes global, shutdowns, production losses, and lost consumption will lead to liquidity problems and an economic and financial crisis.
Right now, we’re just seeing some market jitters. That’s to be expected. And it’s nothing to panic about quite yet. The panic should come if this turns into a pandemic – because there are few tools policy makers have to ameliorate the impact of the coronavirus on the economy. The first priority is health and safety. And that means lockdown, lost production, lost consumption and declining growth or even recession.