Running out of firepower
Recently, there was an interesting video clip circulating around. It showed how people have changed their greeting tradition from “hand-shaking” to “leg-shaking”. Touching each other’s hands is a common way of transmitting coronavirus. It is at this time that, perhaps, the world would begin to value some of the traditional Asian ways of greeting, including that of Sri Lanka of palms joined together.
But getting closer to each other should be avoided too. Italy has already imposed a new rule for restaurants, groceries, pubs, etc – to keep the customers one metre away from each other.
At the same time, I came across another write up under the title “Quiet China”. It analysed how the Chinese life styles have changed from “busy mode” to a “quiet mode”. People are no longer busy out there in the office or the factory, on the crowded streets or in the public transport, in the shopping malls or in the cinema halls, in the coffee shops or McDonalds". They all now look like lonely places sometimes with only a couple of people, wearing face masks. Instead of being busy, people are now “calm and quiet” not walking or working, and spending time at home with their families.
People are also getting into panic buying which can cause supply shortages, which are already reported in some countries.
Let’s look at the flip side of the same. Whichever the way you look at the change, they all point to one thing – isolation. And isolation limits interactions and transactions. Then, it leads to limits on buying and selling, limits on distribution and exchange, limits on trade and investment, and limits on production and consumption. Thus the status of “quietness” ultimately leads to an economic recession.
Infected markets
The markets of all types and everywhere in the world are now virus-infected. While controlling and eliminating coronavirus is one issue, curing its infected markets is a different issue. The problem of infected markets would ultimately melt down to an economic recession.
The world economy was actually heading towards a second recession even before the coronavirus outbreak, as we have elaborated several times in this column. The world did not actually recover from the 2008 global financial crisis. The problem was only postponed with painkillers – money and credit -, which have become the source of the new problem.
The IMF too had already downgraded its world economic growth forecast from 3.4 per cent to 2.9 per cent for 2020 due to sluggish growth performance in emerging economies, US – China trade issues and, the no-deal Brexit possibility.
Now, the coronavirus has aggravated the wound. As it stands now, world economic growth is no more than 2.4 per cent in 2020, but it could be worse with further spread of the coronavirus until the summer time in the middle of the year.
The infected markets would cause businesses to contract, incomes to fall, jobs to lay off and, thereby the world economy to shrink. The major economic power houses in the world – the US, the EU and Japan, all have taken defensive positions, but apparently with losing firepower.
Pinch of the coronavirus
While Chinese economy is slowing down, the world economy is feeling the pinch of the coronavirus which transmits the effect in two channels.
The first is the spread of the virus itself across the world mainly with people’s travel and interactions. While the US, Italy, South Korea, and Iran have been affected already, many other countries all around the world have confirmed cases of infections. It leads to precautionary measures which would inevitably slow down the economic machinery.
The second is the global impact of the repercussions of the slowdown in economic machinery itself. China, being the second largest economy in the world and one of the most integrated economies in the world, has caused tremendous economic implications all over the world. While the busy industrial and commercial cities in China are already in a lockdown condition, Italy has initiated far-reaching restrictions to control the spread of the virus, which would inevitably slow down the economic machinery. In Italy travel restrictions have been implemented, sporting and recreation activities have been banned, schools and universities been closed, and public gatherings forbidden.
As countries get infected, markets get affected. The past few weeks were marked by historical changes – a rapid fall in oil prices, slump in stock markets, and unusual decline in bond yield.
Crude oil, which was over US$60 a barrel at the beginning of the year fell to $30 this week. Stock markets across the regions from the US to Europe, and, then the Asia Pacific have all plummeted, while some of them recorded historically rapid declines. The 10-year US bond yield, which was 1.9 per cent at the beginning of the year, fell to just 0.5 per cent. During the same period, the Chinese bond yield, which was over 3.2 per cent fell to below 2.6 per cent.
In the midst of all negatives in the above markets, gold prices started soaring. Gold is traded largely in the gold markets in New York, London, and Shanghai. Gold was $1,500 per ounce at the end of last year, and reached $1660 this week. Gold prices rise when other markets fall, because it is an attractive investment during periods of economic uncertainty. Speculative investors start shifting their investment from other assets such as stocks and bonds to gold, while this speculative market reaction itself makes the fall of the markets faster.
About 40 per cent of the gold demand in the world is accounted for investment purpose, with 50 per cent for jewellery and 10 per cent for industry. Therefore, the market implications of the changes in speculative investment in gold are not insignificant in the global economy.
Firepower to fight
Here is the policy dilemma: While the governments have to take measures to control the spread of the virus which would inevitably limit economic activities on the one hand, the governments have to take stimulus measures to keep the economic machinery running. The irony is that such stimulus measures have a limit too.
The world is now trending towards policy rate cuts. The US Federal Reserve in an emergency and surprise move, suddenly cut down its federal funds rate by 50 basis points to 1.00 - 1.25 per cent. It was considered to be the first emergency rate cut since the 2008 financial crisis. And the US government wants to do more.
The Euro area has no space to cut interest rates further, because its key interest rate is already zero for the past four years with the lending facility and the deposit facility rates remaining at 0.25 per cent and -0.50 per cent, respectively. Japan is in an even worse position, as its interest rate is already negative. China had already started slashing the interest rates and reducing the required reserve ratio (RRR) for commercial banks, as the Chinese monetary authorities have space to adopt such measures.
Many countries all over the world are moving to cut down interest rates as well as provide a fiscal stimulus. The idea is that credit growth and improved aggregate demand would keep the economic machinery running. Then it would protect at least to a certain extent people’s income and jobs, government’s revenue and spending, and finally economic growth.
The measures are, anyway, not new stimulus. They were already there particularly for the past 12 years since the global economy was struck by the economic crisis in 2008. Therefore, the world has already reached the limits of monetary expansion and credit growth, without much success. The firepower is running out as it already has in Europe and Japan. Neither canthe US go on indefinitely. Then, what next? What is available might be the “austerity measures” which could be a politically difficult choice for many countries.
The infected markets would cause businesses to contract, incomes to fall, jobs to lay off and, thereby the world economy to shrink. The major economic power houses in the world – the US, the EU and Japan, all have taken defensive positions, but apparently with losing firepower.