Sitting quietly

Blaise Pascal – for how long can he sit quietly?

At this stage in the coronavirus crisis, many of us consider ourselves experts on pandemics and biology. The speed of the coronavirus through our world is paced by the speed at which our concern and curiosity is fuelling a quest for information.

One thread that has become evident to me, is that historically epidemics have not always been greeted with calm and grace. In periods when medical knowledge was not as well developed as it is now, and when democracy and public health education were fledgling, epidemics were often met with violence and disorder.

For example, in the early 1830’s cholera spread across Europe but efforts to contain it in countries as diverse as Scotland, Prussia and Russia were greeted with public attacks on doctors, nurses, and quarantine officers. At times, anyone in a white coat was a target. The general fear was that authorities were using the cholera epidemic to poison people so as to reduce the burden on the state or that doctors simply wanted cadavers for anatomy schools. We trust experts more today!

Compared to the nineteenth century, what is remarkable today is the degree to which populations – mostly in Asia and Europe so far – have followed the lockdown guidelines. In general, adherence to the lockdown has been highest in countries where trust in government (and perhaps fear in some cases) is greatest.

The next stage of the crisis, coming over the next two weeks, will severely test this trust. Whilst I am now tired of reading commentators quoting Blaise Pascal’s ‘All of humanity’s problems stem from man’s inability to sit quietly in a room alone’, millions of people across the world will face severe stress in terms of how they sustain themselves. This much was made clear by last Thursday’s initial jobless claims figure in the USA. At the height of the economic pain of the global financial crisis (March 27, 2009) the jobless number hit 665,000. Last week’s figure was ten times that.

With the number of coronavirus deaths per capita, per day, in the US now higher than during the US Civil War, the pressure on the US economy and its healthcare system will grow. The same will be true of many other countries, and though part-time or partial work schemes in economies like France and Germany may lessen the economic uncertainty, it will still weigh heavily. For instance, the past week has already seen food shortages in Italy, mile long queues for food banks in Pennsylvania. In many cases, loans, compensation and government payouts in the US will not arrive in bank accounts for weeks.  

As this urgent, difficult stage of the coronavirus crisis develops, obligations on governments will grow. In Europe, there is an opportunity for what we might stereotypically call the ‘Northern’ countries to repair the diplomatic damage to the idea of EU solidarity of recent weeks (I am thinking of the Dutch in particular!) and undertake to ensure that food and basic staples can reach parts of the EU where they are needed.

In the USA, the past three years have seen a hollowing out of expertise in government. Consider that in 2017 and 2019 the Pentagon and White House economists respectively developed studies to plan for a coronavirus like pandemic, but the executive did very little to prepare for such an eventuality. In the longer-run, the state of healthcare and the fragility of the US labour market should become major political issues. In the meantime, I expect that both corporate America and the military will play a greater logistical role in meeting the needs of this next phase of the crisis in the US.

As this occurs, the debate on the marginal usefulness of the lockdown (in terms of its contribution to lives saved versus its economic impact) will grow. It has already been marked by what I call the ‘cure is worse than the problem itself’ brigade.

Two more weeks of lockdown in Europe will test the sanity of its citizens (though will I hope also show the value of this strategy) and business people. At very least, political leaders will have to outline some kind of roadmap to normalisation – the continued isolation of vulnerable members of society, wearing of masks, a gradual return to normal working patterns for example. Balancing this will be incredibly hard to do, and control. At this point, market volatility may give way to a pick-up in social and political volatility.

Have a great week ahead,

Mike

Why did nobody notice it?

Not amused

During a visit to the London School of Economics in November 2008 Queen Elizabeth II demanded about the debt bubble, “Why did nobody notice it?”. She might ask the same about the onset of the coronavirus crisis, particularly of her prime minister and her eldest son. The defining characteristic of the coronavirus crisis has been its speed. For example, markets have fallen by the same magnitude as during the dot.com crisis, but this time the fall took 16 days not 16 months.

The speed is explained by the sudden restriction placed on human movement by the crisis, and the fact that in general we are used to dealing with single set piece economic or financial crises (market bubble, classic recession, regional – EM or EU – crisis) and not five overlapping crises at the same time. The speed and drama of the crisis is heightened by the fact that it is breaking things – diplomatic relations, investment funds, political careers and economies.

The policy response has not, as I have outlined in previous mails – been well coordinated between fiscal and monetary policy, nor between nations. That so many policy makers repeat Mario Draghi’s mantra of  ‘do whatever it takes’, betrays the fact that the magic of those words is vested in Draghi himself.

Still monetary and fiscal support has come thick and fast and will help stem market pain. My worry is that given we are at the late stage in a very long expansion, it will be harder for policy to significantly boost trend economic growth. Of the other policy measures – the quest for vaccines and treatments is the most exciting, whilst Russia and Saudi Arabia’s adherence to their oil price war is the most disappointing.

From here, I see three scenarios.

Easter: Under this optimistic case (25% likely) the fruits of isolation in Europe begin to show, the race for treatments and vaccines is promising, while central bank liquidity dampens market distress. As such, workers, companies and governments begin to get a sense as to the parameters around the crisis and some visibility as to when and how it can be managed. A slow return to ‘normal’ then begins in Europe and the US in late April. Stock markets hit new highs in October and Donald Trump stays in the White House.

Summer: ‘Isolation’ is increasingly debated on ethical, economic and political grounds. It proves hard to enforce across America and harder still to prosecute in emerging economies. Under this ‘main’ scenario (55%) the second derivative in infections and macroeconomic indicators only begins to significantly improve in mid-summer. As a result, many businesses close or are near to ‘broken’, despite fiscal support. At the same time, investment in ‘newer’ industries – data (5G, AI, Cloud), healthtech and digital finance is accelerated. Still, high unemployment and low trend growth are significant policy issues into 2021.

Winter: Under this ‘pessimistic’ (20%) scenario, much of the world’s workforce is disrupted by the virus, and second waves become the norm. Social unrest, political disunity and a breakdown in diplomacy between nations (US and China for instance) are some of the resulting side-effects. Monetary and fiscal policies cannot contain the full effects of bankruptcies and unemployment, to the extent that central banking ‘accidents’ crop up. The 1930’s is the nasty template to follow here. Property markets and alternative asset classes like private equity are hard hit.

While broad scenarios are useful for framing problems, they are often overly simplistic. One distinction to draw here is between the short to medium term return to normal in terms of end of isolation and return to work, and the enduring long-term imbalances that result from, and are exacerbated by this crisis.

Ideally, following a two-month period of isolation in the US (taking us to mid-May) a return to normal might be in sight.

However, under the surface of the world economy the following trends will have been deepened by the crisis – the end of globalization and the resulting multipolar world, the biggest debt load since the Napoleonic Wars and central banks who are running out of effective policy measures. In the alphabet soup of U, V,L and W shaped recoveries that forecasters talk about, we might well have a cyclical V, followed by a structural L.

With three of the G7 leaders now in quarantine, world political leadership is under strain. It has two battles to fight – beating the virus, and then resolving the end of globalization in as constructive and imaginative a way possible.

With best wishes

Mike

Recession Rehearsal

Powell troubled by low rates

The last week has seen many different expressions of adaptive behaviour. First, the Democratic Party establishment and organisation have rallied around Joe Biden, and helped to push him to stunning turnaround in the Party’s campaign for President.

Then there has been widespread adaptation to the coronavirus – people have stopped shaking hands, travel only when necessary and it seems, lead incrementally more healthy lives (though a half-marathon I had entered was cancelled). In some cases however, stoicism wins out – the London Tube is as packed as ever.

In markets, investors – a great deal of whom are unsentimental robots – are adapting to extreme volatility. It has been one of the most extraordinary weeks in markets as investors try to position around the uncertainties introduced by the coronavirus. If and when we get it, a mid-twenties reading on the Vix volatility index would suggest that what might be described as ‘normal’ trading is getting underway. 

Then, policy makers have also been adapting, slowly. My sense is that to a large extent the policy reaction to the coronavirus is a rehearsal for how the next recession is met. So far, it has been a shambles. 

Jerome Powell, in making a 50 basis point cut in interest rates revealed that he is beholden to both equity and bond markets, and it seems, to politics. His action underlined the existence of the Fed ‘put’ – that the central bank will ride to the market’s rescue in times of turbulence.

The delivery of the rate cut was poor.  It focused insufficiently on the sense that this move would provide ‘insurance’ and on the ways it might combat the economic panic (e.g. risk of bankruptcies) associated with the coronavirus.

With the idea of a ‘rehearsal’ in mind, Powell’s move contributed to a feeling that when the ‘real’ recession comes, the Fed will have relatively little monetary ammunition and may, like the ECB and Bank of Japan (BoJ), have to resort to extraordinary measures like negative interest rates. 

If that is where the Fed is headed to, then the lesson for them from the likes of the BoJ, ECB and Riksbank in Sweden is not a happy one. The rush towards very low to negative rates in those monetary jurisdictions undercut banking sectors – a key reason why Europe and Japan have had weak recoveries, and also why to date US banks have outcompeted their international rivals. Sharply cutting rates, in tandem with a compressing yield curve, undercuts the balance sheets of banks, and in some cases can deepen a downturn. The Fed needs to study this carefully.

The second issue with the political response to the economic side-effects of the coronavirus crisis so far, is that despite G7 conference call and very general statement of intent, there is little apparent leadership and coordination.

The fracturing of international politics has made sincere collaboration difficult in practice (America might for example have announced a moratorium on sanctions on China). Moreover, the absence of a serious fiscal response in countries like Italy (the support measures announced come to only 0.3% of GDP), and the notable lack of open thinking on how deregulation might serve to boost business, is worrying.

I may be a little too critical here, but the sum of the week’s policy activity highlights depleted economic arsenals. Debt is too high and few countries have a decent fiscal surplus. Those that do, like Germany, don’t have the will to spend it.

It also points to a depleted international policy community – where the goodwill, leadership and force of mind that existed in the 1980’s or 1990’s (I am thinking of the likes of James Baker or Robert Rubin) is no longer visible. In Europe, Christine Lagarde has been strangely quiet.

There is now a need, an opportunity and hopefully time for someone like Kristalina Georgieva, or even departing Bank of England boss Mark Carney, to so a postmortem on the economic policy response to the coronavirus crisis. With world debt to GDP at its highest level since the Second World War, the next recession will be for real.

Globalization crashes

Coronavirus has spread internationally

That a rugby match in Dublin between Italy and Ireland can be cancelled because of a virus that germinated in a market in a Chinese city, may be a chain of events that appeals to amateur chaos theorists.

In my view, the panic caused by the coronavirus illustrates how easily interconnected the world has become, how fluidly people move from one location to another, and how national infrastructure and policy systems are still so very different.

Having written about the coronavirus a few weeks ago (‘Humanity and Adversity’, Feb 2, https://thelevelling.blog/2020/02/02/humanity-and-adversity/) I thought that markets at least would quickly work through the implications. That it has not been the case owes much to another form of sickness – overexuberance in financial marketplace. The catalysts provided by the coronavirus are now treating this (in the short run the sell-off is nearly complete, and we will rally mid next week).

Ironically, in an age of machines, and where social media companies are dominant in many senses, markets are responding to the risk that humans will have less physical interaction with each other and will enjoy less physical forms of consumption (travel, shopping and consumption).

As I write, it appears at least from official numbers that the virus is somewhat contained in China, and globally the number of cases looks to have peaked. Here though, the risk is that the Chinese authorities rush people back to work and, like the Spanish flu in 1918, there is a bigger second (and third) wave of the virus.

The passage of the virus across the world has, even at what might be an early stage, revealed and further provoked a number of changes in our world.

The first relates to trust. There is widespread suspicion inside and beyond China that the authorities there have not been upfront about the true extent of the virus. Some, like US Senator Tom Cotton even believe that the virus is man-made. To that end, while China’s handling of the crisis will on one hand reinforce the sense that it can marshal huge swathes of its population, on the other the trust of outsiders in the Chinese authorities will diminish. The Belt and Road Initiative may be a casualty here. Distrust can also channel itself in other ways. If in the future China has a debt crisis, investors are likely to sell first than wait for a true picture to emerge.

Within China this episode has clearly damaged the Communist Party, though it is very hard to see how this will play out in public life, or even through social media discourse. My sense is that the Chinese authorities will react in at least two ways. One is a fiscal stimulus made up of tax breaks, support for small businesses and an acceleration of infrastructure programs.

The other more interesting one is to take what has been done in the domain of social control and social credit scoring and apply this to healthcare. I can envisage a sharp rise in self-diagnosis, tech based medicine and a related set of incentives for people to allow their health data be monitored by the state. If it happens, many in the West would consider it insidious, though given the fear created by the virus, many Chinese might acquiesce.

The second effect of the coronavirus crisis is that it is yet another event that makes visible the arteries of globalization and leaves them atrophied. That there has been little to no coordination between nations speaks to a sense of a fractured world, and the performance of the WHO reinforces the view that like the WTO, its time has come.

There will be a sharp short-term hit to world trade from the coronavirus (hotels, airlines are the obvious ‘victim’ industries though I think that ‘elite’ forms of travel and healthcare will continue to thrive), but in the longer-term it will also reinforce the sense in governments and some companies that security of production is increasingly important.

To that end, the rise of national champions and the relocation of production to ‘home’ countries (pharmaceuticals is an example) will continue. In many different ways, the coronavirus, like the 2019 trade war, will force a rethinking of globalization by corporates.

Other megatrends may also be rethought. India and many parts of Africa are the only parts of the world where urbanization rates are still relatively low, though where the rate of urbanization is now picking up. The coronavirus crisis is a very clear reminder of ‘smart’ urbanization is terms of the health, data gathering and communication implications, and in this way the lessons for Wuhan are yet to be learnt. For example, it is only emerging that 40% of the coronavirus cases in Wuhan were transmitted in hospitals – and the same may be true of both Italy and Iran. 

As this adjustment process happens, there will likely be one constant, which is the vogue of central banks to meet any threat to growth and attendant dip in markets with more liquidity. Liquidity provision and rate cuts will not solve the process of adjustment away from globalization, and in the long run they may channel this process down the wrong path because cheap money increases the risk that investment decisions are badly made.

Have a great week ahead,

Mike

Humanity and Adversity

Change to come for the CCP?

Adversity for some often breeds humanity in others. It was not the case last week when US Commerce Secretary suggested that the coronavirus sweeping China would help bring manufacturing jobs back to the US, and in doing so would further reset the trade relationship between the US and China.

The virus is the first major domestic crisis that the Chinese authorities have faced since perhaps, the mini economic crisis brought on by the side-effects of the global financial crisis. As such it is a policy test, and a watershed moment in the relationship between the Chinese Communist Party and the people it governs. In this respect, China may join other large countries or regions where the social contract between the people and those who govern them is being severely stressed.

In the UK, the social contract has been left in tatters by Brexit, in the US the idea of the ‘American Dream’ is undercut by falling human development rates and stark inequality, while in Europe there is general confusion on the part of the grass-roots as to what ‘European values’ are in a tangible sense. So far, Asian countries have done better here, Japan is an example.

China’s social contract, which uncharitably could be referred to as a Leviathan one, is simply put, an exchange of liberty for prosperity. It has held over the past thirty years, largely due to the prosperity and startling physical infrastructure development that the CCP have engineered and very tight political control. To date, most policy challenges have been met with success, to the extent that a long article in the New York Times in 2019 referred to China as the ‘land that failed to fail’.

Given the tragic human cost and the consternation that the coronavirus is causing, there are reasons to think of this as a watershed of sorts for policy in China.

One is that the spread of the virus may highlight the limits of high economic growth in China. The intensive movement of people within the country, urbanization and a hyper connected transport network are economic assets, but also pose risks. In his book ‘How Nature Works’ the Danish physicist Per Bak likens socio-economic systems to piles of sand.

The sand piles can continue to build until, upon the addition of a marginal amount of sand, they collapse. Similarly, cities and nations grow until that growth produces side-effects (the health scares in the rapidly urbanizing London of the mid 19th century that gave us the engineering genius of Joseph Bazalgette, are another example).

There will be many side-effects of the virus crisis. One may be an economic stimulus program that is focused on upgrading healthcare infrastructure and health related education in China.

Another aspect is diet. One of the first thematic investment notes I put together (some ten years ago) was on the topic of ‘Feeding Asia’, or rather how diet in countries like China would come to resemble that in the West and as a result how demand for dairy products, fruit, meat would go parabolic (it did for a while).

This particular crisis may see another step change in diet in China, toward – and I am speculating – synthetic meats, a stronger tendency towards organic foods, greater demand for seafood related foodstuffs and for vitamins/food supplements generally.

Two other related areas are worth thinking about. The first is how this crisis reflects on China’s ‘Leviathan’ approach to government. Has technologically enabled central control of society allowed the authorities to prevent the spread of the virus? Or will this episode begin to sow doubts in the minds of Chinese in the government’s ability to safeguard them. Relatedly, China’s social media networks have both spread alarming scare stories, whilst at the same time served to coordinate people and facilitate remote family get-togethers over the holiday period.

Concomitantly, the crisis will serve the interests of those factions within the Communist Party who on one hand argue for greater central control of Chinese society, versus those on the other who argue that the next phase in China’s development is, like the USA in the 1930’s, to deepen its social welfare system. As such, it will deepen the numerus rivalries and factions within the Party.

Finally, more broadly, a few weeks ago (‘Peak Markets, Peak Trump’, 12 January) I wrote about markets ability to coldly appraise the financial impact of events. They are doing so again now with the coronavirus crisis, though it seems to me that markets are primarily pricing the cost of firm’s reactions to the crisis (i.e. cancelled flights, disrupted supply chains).

Economically sensitive assets – government bonds, copper, oil are all much weaker, and in particular emerging market currencies look vulnerable. I suspect that volatility will continue to spill over to stocks, at least till we are in mid February. ‘Peak Markets’ ay have been the right headline after all, I still wonder about ‘Peak Trump’.

Have a great week ahead,

Mike