I narrowly escaped coronavirus recently.
We left the hospital here in London with our newborn daughter just two days before an infected patient showed up, having arrived in an Uber…
The NHS staff sent the coronavirus carrier home by ambulance, completing the maximum number of infections possible from a single visit.
Not that our escape was perfect. A midwife visited our home the day after we were discharged and infected me with her cough…
Meanwhile, the in-laws travelled back to Japan at the height of the coronavirus news coverage.
Grandpa is a dentist there, with a very large stock of facemasks in the basement.
The local hospital is running short and the masks are selling for multiple times their retail price on the street.
Grandpa suggested it would be immoral to profiteer by selling some of his hoard.
It’s not a good idea to talk politics and economics with a Japanese father-in-law, so I didn’t point out his supposed virtuousness would result in less people having facemasks and that this was a nice demonstration of how the free market incentivises doing the right thing.
‘It is not from the benevolence of the butcher, the brewer, or the dentist that we expect our facemasks, but from their regard to their own interest.’
The faith in Chinese spending
Back to the topic — the effect the coronavirus will have on financial markets.
And it’s worth noting that the impact will be felt in Australia more than just about anywhere else.
China is our key export and tourism market. And their economy is shuddering to a halt. Curfews, trade disruption, travel restrictions, and quarantines are all preventing the economy from rolling on.
International companies have been more honest about the disruption than the Chinese, with production halts and manufacturing estimates falling.
But other local measures, such as road traffic and pollution, are signalling trouble too.
What’s remarkable is that none of this has had much impact in financial markets, yet. More on that from Jim below. But I’m beginning to believe the fallout will reach markets soon. In a way few are expecting. Especially in Australia.
My worries about China are straightforward.
The world currently assumes that China is about to rerun its economic policy of 2008. Faced with an economic crisis, the commies will do what they do best — a lot.
Stockpiling, infrastructure spending, output targets, bank lending, preventing loan defaults, and plenty more stuff known as ‘stimulus’ in some circles, and ‘waste’ in others.
After all, China isn’t like the West.
Its leaders can spend without scrutiny. Inefficiency doesn’t matter. Neither does debt — the banking system serves the people’s party. And the party has targets to meet, or else.
But I’m not so sure this works out well in the end…it hasn’t anywhere else, after all.
It’s only ever been a matter of time before things go wrong for central planners. And I am getting worried time is running out.
This headline from Bloomberg tells me not to worry. Which, of course, just makes me even more worried.
Sure enough, if you read the article, it directly contradicts the headline. ‘Cut unnecessary government expenses’ was China’s finance minister Liu Kin’s actual comment, not stimulus.
And the planned tax cuts which Bloomberg’s headline refers to are not exactly the stimulus anyone had in mind.
But it gets worse over at the Chinese Communist Party mouthpiece Qiushi, as summarised by China’s Global Times, with emphasis added:
‘With the Chinese economy taking a major hit from the outbreak of the novel coronavirus pneumonia (COVID-19), the central government appears to pursue fiscal austerity as part of the efforts to pull through the difficult times.
‘[…] given the past experience and the financial risks currently facing China, a flood of spending programs seems no longer on the financial regulators’ list of choices for stimulating the economy.
‘China will face decreased fiscal revenues and increased expenditures for some time to come, and the fiscal operation will maintain a state of ‘tight balance.’, Chinese Finance Minister Liu Kun wrote in an article published on Qiushi, a magazine affiliated with the Communist Party of China Central Committee. In this situation, it won’t be feasible to adopt a proactive fiscal policy by expanding the fiscal expenditure scale.
‘Liu’s article sent a clear signal that China would not stimulate the economy by rolling out another massive monetary stimulus.’
Read that Bloomberg headline again. ‘China Vows More Fiscal Support’ — sound right to you?
Snap back to reality
And now, snap back to reality. A serious economic shock in China without the stimulus to offset it?
That spells economic contraction in the engine room of the world economy. Just when the rest of that world economy is sputtering already. And with Australia more dependent on China than most.
Back in 2008, China didn’t have the debt loads it does now. The stimulus that saved Australia from recession back then won’t be forthcoming this time. It’s no surprise the Aussie dollar is closing in on financial crisis lows.
But back to China for a moment.
As ever, it isn’t the real economy you’ve got to worry about. It’s the bankers’ paycheques that are the priority, even in a communist economy.
Debt ratings agency S&P claims the virus outbreak may add $800 billion of new bad loans to the Chinese banking system, which is already facing record defaults. One bank was already seized and two rescued recently.
Conveniently, the Chinese just completed a bank stress test and even published the results. Bloomberg summarised them:
‘The impact of the spreading coronavirus risks bringing to life the worst-case economic scenarios contained in China’s annual banking stress tests. Last year’s exercise envisaged annual economic growth slowing to as low as 4.15% — a scenario which showed that the bad loan ratio at the nation’s 30 biggest banks would rise five-fold. Analysts now say that the outbreak could send first-quarter growth to as little as 3.8%.’
So not just worst-case, but even worse. The real worry is that the Chinese government seems to be using the banking system as the stabilising policy tool, Bloomberg continues:
‘“Social stability is of utmost importance to the authorities in China,” S&P analysts led by Tan Ming said in a recent report. “Therefore, banks have been asked to help carry the burden of this health outbreak.”’
Mr Tan is clearly mad. Using banks to carry the burden of an economic slowdown is like using dynamite to put out a house fire. It sort of works, but you’re missing the point.
When banks fail, they fail spectacularly, triggering widespread economic contagion (coronavirus pun intended).
This makes the banking system uniquely unqualified to bear the strain of an economic slowdown in China
If you want to prevent a crash, banks should be the most protected from the burden, as they are in the West.
All this adds up to a simple equation. Financial markets are expecting stimulus to rescue the Chinese economy banking system. But it’s not clear that’s what’ll happen.
If it doesn’t, that may well bring us the end of Australia’s 28-year, recession-free run. Just as the opposite — a Chinese stimulus package — saved us from recession in 2008.
But it’s the divergence in perceptions which is the key to a downturn in financial markets first — if they’re expecting China to spend and borrow, but China doesn’t…
Until next time,
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