Month: February 2020

Be prepared for the indirect consequences of COVID-19

February 23, 2020

The COVID-19 coronavirus has become the dominant global news story and the prime driver of financial markets’ sentiment, volatility and direction. Only recently, have some of the short and long term effects been examined. I’m writing about some of the potentially dire consequences yet to be mentioned in mainstream media.

For some time, media have been reporting the number of people in China in isolation (quarantine) by official order. People stuck indoors are unable to turn up to work or go out and spend. Factories in China are running at well below capacity, if at all. There is also a shortage of truck drivers, port workers and officials to process both exports out of and imports into China. All of this adds up to a threat to key global supply chains, manufacturing capacity and household consumption.

Not only is China the world’s most populous and number one export nation but it also supplies key components and ingredients to manufacturers around the world. Key food imports have become stuck at Chinese ports (e.g. US and European pork, US and South American poultry and Argentinian beef) or held back at the country of export (e.g. New Zealand and Australia crayfish). Other imported goods are also stuck in Chinese ports, e.g. logs. Exports from China are also stuck at Chinese ports and warehouses.

Prices of beef, coffee, corn, crayfish, logs/timber and dairy products have fallen since the outbreak of COVID-19, more so recently, as producers seek alternative markets or simply want to dispose of surplus inventory.

Car manufacturers, from South Korea to Europe and the UK, are reporting two to four weeks inventory of Chinese supplied components and parts that are essential for vehicle assembly. Sellers of electronic consumables in Asia, Europe and the US are warning about low inventory levels of key components. Shipping companies are experiencing a sharp drop in traffic and demand. Construction companies in New Zealand and Australia are warning about an inability to source building materials from China.

Worryingly, China is the world’s leading supplier of active pharmaceutical ingredients (API) used in the manufacture of pharmaceuticals. India, the world’s number one pharmaceutical manufacturer, sources more than 70% of its APIs from China, which together with China’s pharmaceutical exports means that China’s APIs feed into almost 45% of the world manufactured medicines.

More than 10 years ago, the then (and still current) Chairman of India’s Cipla, one the the world’s leading producers of APIs and generic pharmaceuticals warned that “if tomorrow China stopped supplying pharmaceutical ingredients, the worldwide pharmaceutical industry would collapse.” If anything, the pharmaceutical industry’s reliance on China has increased substantially since that warning was uttered.

The COVID-19 coronavirus, in itself, may or may not be as deadly as the SARS coronavirus but, in the 17 years since the SARS outbreak, China has become a global economic powerhouse, a key player in the global supply chain and a significant consumer. Not only has the world become a much more connected place, both personally and virtually, but it is also highly dependent on China for many essential products and trade. This gives the human response to COVID-19, rather than the virus itself, the potential to produce the greater global harm.

We can do without the latest car, phone, computer or television but, consider the potential life threatening implications of a shortage of antibiotics, anti depressants and pain killers.

Almost all of that human response is outside our control but it is up to us to assess and manage COVID-19’s risks to the personal, family and business aspects of our lives.

Just because you can doesn’t mean you should.

February 21, 2020

The US Constitution gives the President the power to forgive a federal crime. The Supreme Court has ruled that the President’s authority to grant pardons is unlimited. That authority also extends to commuting the sentence for a federal crime.

In the past week, Donald Trump granted full pardons to seven people and commutations to four others, all of whom committed their federal crimes some years ago. Like Presidents before him, both Republican and Democrat, Trump has used this power to benefit supporters, friends and friends of friends/supporters but for historical crimes.

Now the US media and Donald Trump are posturing about a pardon or commuting for just convicted Roger Stone, something that Trump has the power to do.

The US Constitution defines the three separate and independent branches of government – legislative (Congress), executive (President) and judicial (Supreme Court and Federal Courts). Each branch may influence, respond to and change some of the actions of the other branches through a constitutionally defined system of checks and balances.

It would be a shame, and a kick in the guts for the Constitution and the Judiciary, if Trump crossed the Constitution’s separation of powers with regard to Roger Stone so soon after the court’s sentencing was handed down because it smacks of interference in an independent judiciary.

The realist in me expects Trump to pardon Roger Stone after the November presidential election – whether he wins or loses. It is election year, after all. But the cynic in me expects an announcement much, much sooner.

Is history repeating?

February 17, 2020

A well known American politician, according to one of his biographers, Richard H. Rovere, was:
– “an essentially destructive force”
– “a chronic opportunist”
– “a political speculator”
– “a Republican who had started as a Democrat”
– “a fertile innovator, a first-rate organizer and galvanizer of mobs, a skilled manipulator of public opinion, and something like a genius at that essential American strategy: publicity”
– “a vulgarian”
– “a man with an almost aesthetic preference for untruth.”

Rovere also wrote that he:
– “faked it all and could not understand anyone who didn’t”
– “made sages of screwballs and accused wise men of being fools”
– was “the first American ever to be actively hated and feared by foreigners in large numbers”
– “favoured the third person
– was “a great sophisticate in human relationships, as every demagogue must be. He knew a good deal about people’s fears and anxieties, and he was a superb juggler of them. But he was himself numb to the sensation he produced in others. He could not comprehend true outrage, true indignation, true anything.”

In summary, Rovere wrote, “if he was anything at all in the realm of ideas, principles, doctrines, he was a species of nihilist” and “the haters rallied around him.”

At a Senate hearing, a counsel said to him “you have, I think, sir, something of a genius for creating confusion — creating a turmoil in the hearts and minds of the country.”

His closest and longstanding advisor, in a book about him, wrote that he:
– was “impatient, overly aggressive, overly dramatic”
– acted on impulse – tended to sensationalize the evidence he had”
– “would neglect to do important homework”
– had an “inattention to detail”
– was “gifted with a sense of political timing” and “on balance, his sense of what made drama and headlines was uncommonly good”
– was “the first important public figure to touch an exquisitely sensitive nerve in the thought leaders of our society. This small but immensely powerful group of intellectuals.”

Who is the subject of Rovere’s biography? Senator Joseph McCarthy.

Rovere met Donald Trump in the early 1970s and quickly became Trump’s trusted adviser and one of the most important people in Trump’s life at that time.

There is a significant parallel and potential here but, as with much in life and history, “Time shall unfold what plighted cunning hides:Who cover faults, at last shame them derides” (William Shakespeare – King Lear)

Invaluable selfless actions matter but they are not measured and therefore are NOT VALUED

February 13, 2020

This morning, I was preparing to write on a different topic but got distracted by an interview on Radio NZ with Professor Sir Partha Dasgupta about ‘Putting a dollar value on biodiversity.’ So, I put aside what I was writing and started this post.

Among the many points made by Partha Dasgupta, a few struck me.

Societies, encouraged by governments and businesses, convert virgin land into other uses – agricultural, housing, industrial and infrastructural. This human activity has imposed a cost on the environment. As the population increases, so does that cost. We measure that activity, mainly through GDP, but we don’t measure the cost on humanity and the environment, nor do we measure or assess the initial value of the environment.

A fundamental tenet of Economics is that the individual behaves in that person’s best interests or, according to Dasgupta, each of us is an egoist. However, Dasgupta acknowledged that many of us make selfless decisions based on what he called “socially embedded preferences” that result in us taking a cut in our standard of living because that cut will be shared by others in our community or will create a legacy. The outcome of such selfless decisions is a drop in GDP and the measured collective wealth. Dasgupta talked about shared communal behaviour but he missed what, in my opinion, are two more significant selfless but related actions.

Yes, we all want to be better off but we feel a need to make a net positive impact on the world – on those around us, those to come and the environment. Some of that can be achieved through measurable outcomes, such as earning an income and accumulating savings to house, feed, clothe, educate and support ourselves and our whanau, and developing and applying technological solutions to environmental challenges. But an awful lot is achieved by actions and outcomes that cannot be measured.

How can you put an economic value on spending time with family, taking time to teach valuable life lessons to our rangatahi, our tamariki (e.g. how to ride a bike, how to cook, how to play safely in our rivers and the ocean and along the way learning vital skills of problem solving and critical thinking), and doing voluntary work whether in the community or within our own whanau?

Our government is attempting to measure these selfless actions with its Well Being Budget, which received considerable international attention and acclaim when released last year, enthusiasm that was unfortunately not shared domestically.

The younger generation are showing more care and urgency about nurturing the environment in the face of increasing evidence of the damage already done to the environment and climate change. Yet, leaders of the main industrialised nations refuse to resist pressures from industrialists and businesses or, in some prominent cases, publicly deny any damage or change.

None of this matters to financial markets because it cannot be defined or empirically valued or traded. Yet, these are intrinsic elements in defining the quality of life today, what we leave behind and what we have to fall back on in times of strife.

Most people will say that not everything important in life can have a financial value placed on it but, without some attempt to measure its financial value, we will continue to make decisions that ultimately make us all poorer.

To find out more, email me at ital@cavanaugh.co.nz

Have we really escaped the GFC?

February 12, 2020

The slowdown in global economic growth over the more than 10 years since the Global Financial Crisis (GFC) seems to have bottomed out. Sharemarkets (by definition, an indicator of future company cash flows and profits) have had a stellar 2019 and started 2020 in the same vein, much to the delight of investors. Given that most of us are (or should be) KiwiSaver investors, that is good news.

Yet, other key forward indicators are proclaiming the opposite. Prices for industrialised commodities (e.g. oil, iron ore, aluminium and copper), global bond yields and official (central bank) interest rates not only are below 2019’s peaks but also are well below their respective peaks since the GFC.

Many (including the writer) attribute rising sharemarkets to historically low funding costs as a result of low benchmark interest rates and credit spreads.

Low benchmark interest rates are the legacy of central banks’ vigorous monetary easing since the GFC, to avoid a repeat of the economic and geopolitical devastation after the 1929 sharemarkets’ crash, and the interest rate markets’ response to still sluggish economic growth and inflation.

Low credit spreads are the result of investors chasing yield in a low interest rate environment but, in doing so, they are lowering their risk tolerance. That, in itself, is another worrying sign that the financial community has leveraged its investments. Leverage is a useful business tool but too much leverage reeks of greed. And, unlike a Gordon Gekko, I believe that greed is anything but good.

I really hope that the messages from sharemarkets and credit spreads presage the future. But I am not hopeful, although I want to be for the sake of my family, especially future generations.

Over-enthusiastic sharemarkets and credit spreads were signs of greed that preceded the GFC and the crashes of 1987 and 1929, among others. Furthermore, bond yields have been a more consistent forward indicator than sharemarkets and, historically, the longer that bond yields and sharemarkets have proclaimed divergent outcomes, the more reliable has been the message from bond yields.

I do not know the future. No-one does! A prudent risk manager assesses all the risks in the context of risk preferences, objectives and the intimate relationship between risk and reward.

To find out more, email me at
cavanaugh@theeconomicbutterflyeffect.com or
ital@cavanaugh.co.nz