Time for reasoned assessing and planning – not for panicking

The COVID-19 outbreak has hit the world just as governments, central banks and financial markets in many industrialised nations were seeing hopes of a recovery in economic growth after a slow down in response to the effects of major geopolitical events last year – the US/China trade war, Brexit and escalating tensions in the Middle East.

Those hopes promised governments and central banks some latitude to ease fiscal policy (i.e. spend) and to hold steady on monetary policy (i.e. not to worry about having to further cut interest rates that are already at record lows, or in many cases negative). But, COVID-19 has dashed those hopes, for now.

Governments are having to loosen purse strings through unplanned public sector expenditure (e.g. at borders and hospitals) while witnessing a slow down (or, in some cases, a complete halt) in household spending and business production, which will translate into governments spending more and earning less.

Central banks are scrambling to identify the problems so that they can take action, just as they did when the GFC hit.

Financial markets are keenly waiting for central banks’ responses, confident that central banks can again come to the rescue of markets and economies. This time though, the problems are very different and so the required responses most likely will be very different, and central banks have less ammunition to call upon. The central banks’ interest rate quiver, at best, has one, maybe two, arrows left and the bow string is frayed. So, they must look at other targets and take other measures.

The dramatic falls in sharemarkets have rocked investor confidence with such force that bond and credit markets have also reacted forcefully. Cash exiting sharemarkets has gone into the safety of government bonds but there has been collateral damage by way of a sharp spike in market volatility, wider credit spreads and, more significantly, stymied primary and secondary market activity in the corporate bond markets. In the case of the US, the CBOE Volatility Index closed Friday at its highest since August 2015 and the US corporate bond market has all but ground to a halt.

Indications are that central banks are very worried about the impacts of this latest disruption on the liquidity and stability of banking systems, which carry higher priorities for central banks than managing inflation, unemployment and growth through monetary policy.

On Friday, the Chair of the Federal Reserve (Fed) Board, Jerome Powell, reassured markets that “the coronavirus poses evolving risks to economic activity” and that the Fed “is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

Powell’s statement on Friday came a day after the Bank of Korea assured that “it will judge whether to adjust the degree of monetary policy accommodation, while thoroughly assessing the severity of the COVID-19 outbreak, its impact on the domestic economy, and changes in financial stability including household debt growth.” No mention of interest rates, rather a generic reference to “monetary policy accommodation” and a focus on “financial stability.”

Governments, central banks and (bank) economists are universally assuming that this will be a short to medium term event while planning for the worst over a longer period. Now is a time for governments and individuals to undertake reasoned and disciplined risk management planning, not to panic.

Be prepared for the indirect consequences of COVID-19

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.