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Coronavirus Crisis – Great Depression Or Just Economic Indigestion?

The coronavirus crisis has the makings of a Great Depression but it doesn’t have to be. Patrick Tan argues why we have the policy tools to survive and recover

Apr 18, 2020 | By Patrick Tan

Editor’s letter: Another 5.2 million Americans filed initial unemployment claims this week according to the latest US Department of Labour release. This brings the total up to 22 million with the unemployment rate nearing 18%. It certainly doesn’t help when IMF Managing Director Kristalina Georgieva announced ahead of virtual meetings with the 189-nation strong World Bank that, “We anticipate the worst economic fallout since the Great Depression.”

First, a primer on global macroeconomics snd international trade: Exports create jobs and boost economic growth. Rapid advances in transportation, logistics and communications have resulted in greater interconnectedness among markets around the world and increased awareness of business opportunities in all corners of the globe: the consequences of this globalisation are now being felt as the producing economies and consuming economies enter national lockdowns.

What the coronavirus pandemic has revealed is that China as producer and consumer is both “chicken and eggs in one basket”. The crisis led to unprecedented lockdown of the Middle Kingdom, putting a grinding halt to global trade in one swoop. But now, as much as we are facing a second wave of covid-19 outbreaks, we are facing a second wave of a disaster of a commercial kind – According to the Wall Street Journal: Chinese factories are reporting that even if they resume production, no one is buying.

American consumers have long propped up the global economy in an unending cycle of consumption, it is a capitalist model which has kept the United States out of recession since the 2008 Global Financial Crisis, but as signs point to the greatest recession since the Great Depression, this consumption that has long held market correction at bay is about to bring a world of hurt into a system never designed to encompass such a great pause.

In this recent 2019 photo: Shopping frenzy during Black Friday in the United States.

Indeed, as numbers inch ever closer to the highest rate of US unemployment of 24.9% in 1933, during the Great Depression, some political leaders and heads of industry, with recollections of how immense poverty devastated countless lives, are now wrestling with a bonafide Sophie’s Choice: save lives and destroy the economy or save the economy and destroy lives?

LUXUO worked with Patrick Tan, Chief Executive Officer of digital asset quantitative trading firm Novum Alpha, to see whether there is truly light at the end of the tunnel, or whether we are staring at the headlights of an oncoming train.

“We anticipate the worst economic fallout since the Great Depression.” – IMF Managing Director Kristalina Georgieva

Coronavirus Crisis – Great Depression Or Just Economic Indigestion?

World War II lasted 6 years, killing over 75 million people before hostilities ended, and that was an enemy we knew how to defeat – one readily recognisable, in a uniform and one where even without requisite skill, the Allied Forces overwhelmed with superior production and logistics. Our current war is with an invisible enemy, mutated into 3 variants, your friends and neighbours could be hiding them unknowingly, and even those we thought were defeated only lay dormant is likely reinfecting the initial survivors; this war is going to last much longer than many would hope.

If we think one month of sheltering in place is tough, wait till we try one year.

Many have made a comparison between the coronavirus pandemic and the influenza pandemic of 1918, while others have compared the economic shock to that of the Great Depression – at the risk of curve fitting, neither of these analogies is adequately synchronous because the current pandemic has distilled the very worst elements of both calamities into a perfect storm.

People gather on the sub-treasury building steps across from the New York Stock Exchange in New York on “Black Thursday,” in this Oct. 24, 1929 file photo. Thousands of investors lost their savings in the worst stock market crash in Wall Street history on Oct. 29, 1929, after a five-day frenzy of heavy trading.Global stock markets extended their shakeout into a second day Tuesday, Jan 22, 2008 plunging amid fears that a possible U.S. recession will cause a worldwide economic slowdown. The dramatic declines in Asia and Europe were expected to spread to Wall Street, where stock index futures were already down sharply hours before the trading day began. (AP Photo)

Another Great Depression? Does it have to be?

Economically, the world enters our current time, ill-prepared and ill-equipped for the economic shock being dealt by the coronavirus. In the stuff of economics classes helmed by Nobel laureates, the world would be entering our current crisis with high interest rates and effective policy tools to get our economic house in order. But like the recalcitrant college student who binged on one too many Jägermeisters, we’ve come to the class late and unprepared.

We’ve had a decade since the last financial crisis to get our economic house in order, instead we have squandered our lead by sweeping those problems under a rug, and it has gotten too lumpy to avoid tripping over.

Alan Greenspan was the chairman of the US Federal Reserve between 1987 and 2006, and many economists blamed him for the financial crisis. The main criticism levelled at Mr Greenspan is that he kept interest rates too low for too long, encouraging a bubble in house prices to grow between 2002 and 2006

Looming risk of a financial panic and credit crunch has led central banks to use one of the few tricks in their bag: slash interest rates. But you can only go so low when you’re already close to zero and a golden rule about crisis-fighting is that in order to be credible, you should always have more ammunition available – by way of more room to cut rates.

And then there’s the problem of the efficacy of interest rate cuts – unlike the last financial crisis, which was centred mainly around banks and the global financial infrastructure, this crisis affects demand, supply and most importantly – confidence.

“It’s all about the bug. We’re along for the ride and responding as best we can.” – Dr. Mark Denison

Add to that the uncertainty surround the duration of the lockdown and severity of the outbreak, policymakers know that while interest rate cuts are an option, they also need to back those cuts up with fiscal and financial measures to help businesses and individuals withstand a temporary, but excruciating cash crunch. Because ultimately it will be the coronavirus and not politicians that will determine when this pandemic will end.

According to Dr. Mark Denison, Professor of Pathology, Microbiology and Immunology at the Vanderbilt Institute of Infectious Diseases, speaking to Bloomberg, “It’s all about the bug. We’re along for the ride and responding as best we can.”

Indeed, the magnitude of economic disaster is calculated on a timeframe of pandemic management. This is because the coronavirus hurts the economy by disrupting the supply of labor, goods and services – its effect is far more widespread and its economic impact far deeper, than an economic shock such as a sovereign bond default or credit crisis.

And because the coronavirus has the potential and evidently the willingness, to persist, both companies and households are likely to face an impending cash crunch soon (if not already).

As recently as January, a poll from Bankrate showed that almost 60% of Americans don’t have enough cash to meet a US$1,000 emergency and a sample of some 2,000 listed American firms revealed that 1 out of every 4 will not have enough spare cash to tide them over if revenues dried up for three months, while they continue to pay fixed costs such as salaries – which means that these companies will either need to borrow more, or retrench.

And even borrowing may not be so straightforward as the Bank of International Settlements – a clearing bank for central banks, found that over 12% of companies from rich countries already generate too little income to cover their current interest payments, forget about prospective ones.

As it stands: Macroeconomic conditions today

Under ideal economic circumstances, rich world central banks would face our current crisis with interest rates at somewhere between 5% to 6% and company balance sheets would be strong, with minimal debt.

As it is, rates in the rich world are either at zero or already very close to zero. This means that the world is drowning in a sea of corporate debt – estimated at some US$74 trillion – numbers so beyond imagining that they are no longer be meaningful. And while the past decade has seen banks get their balance sheets (more or less) in order, it was companies that came out of the last financial crisis hungry to pile on debt.

From 2009, global corporate debt has risen from just 84% of GDP to 92% of in 2019. In the United States alone, non-financial firm corporate debt has soared to 47% GDP from 43% a decade ago, according to figures from the Federal Reserve.

And to make matters worse, most of that debt isn’t even high quality “investable debt,” but rather “junk” or “BBB” debt (a level just above junk). Almost two-thirds of all non-financial corporate bonds in America are rated “junk” or “BBB” while outside the United States, that figure soars to 39%.

The system is what it is.

To exacerbate the issue, firms have slunk back to their bad habit of messing with the books, taking liberties with calculation methodologies to flatter their measures of profit, in relation to leverage.

The current pandemic is merely the world hitting “pause” on the global economy.

Then and now: Why this doesn’t have to be another Great Depression

Some have likened the economic conditions that the world is currently facing to the dawn of another Great Depression, but to such pessimists I would humbly suggest that the conditions now compared to then are vastly different.

Lasting a decade from 1929 to 1939, it started after the stock market crash of October 1929 and it persisted over the next decade, because consumer spending and investment dropped, which caused steep declines in industrial output, causing large scale unemployment.

During the Great Depression, political, sociological and economic ideologies were still being sorted out: Communism, socialism and capitalism were all vying for ideological supremacy.

Today however, capitalism has arguably won the day.

Back then governments and central banks sat on the sidelines during the Great Depression, unwilling to bail out companies and unwilling to cut interest rates or step in to ramp up spending, today citizens don’t even flinch at a US$2 trillion bailout package, with some even arguing that the package is too conservative. Today, the lessons from then are better learnt and with a wider variety of communication and policy tools at the disposal of central banks and governments, economic disasters predicated on a crisis of confidence like the one we face today can be better managed.

And even though the economic disaster we face even exactly one of confidence the way it was during the Great Depression, it is merely a symptom of the coronavirus pandemic. The current pandemic is merely the world hitting “pause” on the global economy.

It’s not as if any sector or any country has been left unscathed by the current economic malaise – even technology companies have been affected. The companies to fail quickest, would be the ones which have been padding their balance sheets all these years with mountains of debt.

Changi International Airport, the best and one of the busiest airports in the world has closed its Terminal 2 for 18 months: a sign of how deep the damage is expected to global air travel

In the worst affected sectors, only the fittest airlines and hotels, with enough cash to tide over this crisis will survive. Not to mention the debt-riddled oil fracking firms as well as other oil and gas companies which have been feeding off high oil prices, many will inevitably fail.

Yet governments, have demonstrated a willingness to backstop their most valuable companies, with the Trump administration providing a bailout for the aviation industry and the majority of America’s airlines. Even typically restrained European economies have displayed an appetite to help its firms tide over the hard times. Essentially, as long as everyone in the great daisy chain of global economics plays ball, waiting out the coronavirus crisis to end – the world can and will recover.

It’s all dependent on political willpower to stay the course

So why has the head of the IMF, predicted an economic fallout on par with a Great Depression? It is because while governments have shown a willingness to step in (something which they did not do in 1929 to 1939), that willingness may disappear if politicians underestimate the extent and depth of this current economic crisis.

When it was World War 2, governments were willing to spend its way out. Arent we fighting a world war now?

Governments may hold back, or suddenly become reluctant to take on more debt or print more money or prop up more companies.  Which is where global institutions need to step in to address the void. During the Great Depression, global institutions like the IMF or the World Bank hadn’t yet been created, nor had the United Nations, or the integral work of the World Health Organization.

These institutions, which no doubt have been undermined by Trumpian isolationism, have now come into their own and helped to remind the world of just how vulnerable and interconnected we truly are.

Since people and governments have short memories and especially during times of crisis, nationalist leaders can appeal to populist bases who are looking for bogeymen to vilify. So it’s crucial that the leaders of global institutions remind us just how important it is to act in concert to rescue ailing economies, companies and more importantly, households.

That’s why the IMF chief is predicting an economic fallout greater than the last Great Depression – it’s a sound bite that’s intended to scare governments worldwide to play ball and keep the bills paid.

And in the event that they won’t – the IMF remains primed at the ready, with US$1 trillion in lending capacity to provide support to countries that need help dealing with the coronavirus pandemic – these facilities didn’t exist in 1939.

Give It To The People: We can spend our way out of this

Help needs to be doled out to those who need it the most – households on the very edge of economic survival. Companies integral to civilised life need to be bailed out. Cash needs to be put into the hands of citizens so that they can start spending until they can find jobs again when we emerge from this crisis.

You can’t hit the “pause” button in isolation – it needs to be a joint effort.

People, confined to their homes for months on end will go out and want to regain some semblance of normalcy – and the life we’ve known is built upon consumption. People will be spending again. Businesses will rise to meet these needs while creating new jobs for people to pay for the things they want to buy. People will travel again and hotels will be full again.

When this will happen is unclear but governments need to be fully convicted of one of the solutions we do know – the willingness and determination to spend as much as it takes to prepare for when economic activity and global trade can resume.

With that in mind, this doesn’t have to be another Great Depression.


 
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