Doug Noland: The First Major Pandemic Scare

January 31 – Bloomberg: “Chinese officials took issue with U.S. comments about the country’s response to the coronavirus outbreak, and promised they would bring the infection under control. ‘U.S. comments are inconsistent with the facts and inappropriate.’ Chinese Ministry of Foreign Affairs Spokeswoman Hua Chunying said… ‘The World Health Organization ‘called on countries to avoid adopting travel bans. Yet shortly afterward, the U.S. went in the opposite direction, and started a very bad turn. It is so unkind.’”

The World Health Organization (WHO) declared the coronavirus outbreak an international public-health emergency, while praising China’s virus containment efforts during its Thursday afternoon press briefing. The DJIA rallied 260 points, apparently on WHO officials’ opposition to travel bans and trade restrictions.

This is an extraordinarily complex developing crisis. Understandably, Beijing fears economic hardship could be pushed into an intractable downward spiral by the world essentially quarantining the entire Chinese nation. Meanwhile, Beijing has taken unprecedented Draconian measures to quarantine 60 million of its citizens. Photographs are circulating of roads surrounding Wuhan and neighboring cities blocked by large boulders and impassible mounds of dirt.

The number of confirmed coronavirus infections jumped 34% on Tuesday, 27% Wednesday, 26% Thursday and 22% on Friday. Almost reaching 12,000, the outbreak has escalated much more rapidly and has already surpassed the SARS peak. If cases expand 15% daily over the next two weeks, the number of infections would quickly surpass 80,000. The official tally of coronavirus cases is likely but a fraction of those actually infected.

January 29 – Bloomberg (Jason Gale): “The case of a 10-year-old boy who was diagnosed with the Wuhan coronavirus even though he showed no symptoms is raising concern that people may be spreading the virus undetected by the front-line screening methods implemented to contain the epidemic. The boy was part of a family who visited relatives in the central Chinese city over the New Year. While his parents and grandparents fell ill and were treated after they returned to their hometown, the 10-year-old appeared healthy and was only diagnosed with the virus after his parents insisted he too was tested, his doctors said, adding that he ‘was shedding virus without symptoms.’”

Today’s U.S. Coronavirus Taskforce press briefing was not comforting. A U.S. public health emergency was declared, with significant travel restrictions imposed for travelers from China. U.S. citizens returning from China are now subject to quarantine, while “foreign nationals” that have been in China within the previous 14 days will be denied entry. Risk to the U.S. public is said to be low. However, the Taskforce covered a list of factors that made the situation extraordinary, including asymptomatic virus transmission and issues with the accuracy of current coronavirus testing. CNBC: “CDC issues mandatory quarantine for first time in more than 50 years to Wuhan passengers in California.”

Hopefully, China’s herculean efforts are successful in rapidly getting their outbreak under control. In the meantime, this pandemic is replete with great uncertainty. It will surely be months before pilots and flight attendants feel safe flying into China. Tourists, business travelers, students and academics will avoid visiting for some time. WHO and Chinese officials are wishful thinking if it they actually believe travel and trade won’t face large-scale disruptions. Investment – business and financial – will be on hold. If things go poorly, a run on China’s financial assets and currency can’t be ruled out.

An assortment of Bloomberg headlines: “At Least Two-Thirds of China Economy to Stay Shut Next Week.” “China Plant Closures to Accelerate, IHS says.” “Shipping Rates Plunge 90% as Coronavirus Paralyzes Cargoes.” “Singapore’s Ban on Chinese Visitors to Have Severe Impact.” Other headlines: “Delta, United and American Airlines are Suspending All Flights Between the U.S. and Mainland China.” “There Could be More than 75,000 Cases of Coronavirus in China, Researchers Say.” “Coronavirus Outbreak Tests World’s Dependence on China.” “Trump Administration Temporarily Bars Foreigners Who Visited China.”

Welcome to The First Major Pandemic Scare for –after a most freakishly protracted boom – a highly integrated world. Moreover, unprecedented monetary stimulus, debt growth, financial flows and speculation ensure unmatched latent financial fragility – in China and globally. Throw in unparalleled mal- and over-investment and other economic imbalances and the world today confronts lurking economic fragilities. Central banks have ensured that markets (trading at near all-time highs) are keen to disregard myriad risks. This dynamic has greatly exacerbated the risk of global financial and economic disruption.

January 31 – Wall Street Journal (Mike Bird): “As the spread of the new coronavirus in China causes more factory shutdowns, the effect on global industrial supply chains could linger for years. China now makes up more than twice the share of global merchandise exports it did in 2003, when the SARS virus hit. Guangdong province alone exported more in 2018 than China did as a whole 17 years ago. Manufacturers already gripe about the effect of the Lunar New Year holiday… on their business as Chinese factories shutter. But the public health response to the virus this year effectively means extending the holiday. China’s industrial output could be running at a similarly low level for a much longer period.”

January 30 – Financial Times (Kathrin Hille, Mercedes Ruehl and Christian Shepherd): “The Wuhan coronavirus is wreaking havoc within the global technology supply chain, as many Chinese provinces extend the new year holiday in an effort to contain the spread of the deadly disease. Underlining the concerns for the tech industry, Taiwan’s Hon Hai Precision Industry, which is also known as Foxconn and makes the majority of the world’s iPhones, suffered its biggest share price fall in almost 20 years on Thursday.”

Markets celebrated this week’s stellar earnings reports from the technology heavyweights. Stock prices at record highs envisage nothing but booming earnings as far as the eye can see. That’s fine, but there is today major uncertainty with respect to global supply chains – technology and otherwise. And does Chinese consumer demand bounce right back as everyone seems to assume? Business investment?

I closely monitor China’s monthly Credit data. Bank loans to China’s Households rose 15.5% over the past year, 37% in two years and 139% in five. This data series doesn’t go back to the 2003 SARS outbreak. Yet Household borrowings surged almost 13-fold since 2007 to about $8.0 TN. The Chinese consumer not only has much more debt than ever before, she and he have unprecedented exposure to inflated apartment prices, securities markets and financial instruments more generally.

With expectations now incredibly inflated, there is maximum vulnerability these days to a rather precipitous reassessment. Even before this outbreak, the economy, apartment prices, Chinese finance and policymaking were all increasingly susceptible to a crisis of confidence. At this point, I’m skeptical Humpty Dumpty can be so simply restored. As a society, there exists all the essential elements for a period of troubling insecurity.

Chinese markets are to open Monday. We can assume the People’s Bank of China and the so-called “national team” will be playing tough defense. We’ll have to wait a couple weeks for the data, but it will be interesting to see the virus impact on Chinese Credit. Traditionally, January is by far the largest lending month of the year. Last January saw a remarkable $680 billion increase in “All-System” Aggregate Finance. I would expect much slower lending growth and problematic interruptions in the flow of finance, especially to heavily impacted cities and regions. This could prove a backbreaker for scores of struggling businesses (and banks?).

A few facts courtesy of Friday’s Bloomberg Businessweek article, “Coronavirus Is More Dangerous for the Global Economy Than SARS.” Looking back, SARS “knocked two full percentage points off China’s economic growth, which dipped from 11.1% in the first quarter of 2003 to 9.1% the following quarter. With the outbreak contained, growth recovered to 10% in the third quarter.” The “types of industries that were most affected by government-imposed bans on travel and other measures to contain the outbreak—such as retail, restaurants, entertainment, and tourism—accounted for 42% of gross domestic product. Since then, services industries’ share of GDP has risen to 54%.” “Back in 2003, China’s GDP was an insignificant 4% of the global total. That share now stands at 17%…”

“Virus May Drag China GDP to 4.5%…”, read a Friday Bloomberg headline. Other estimates have growth slowing to 5.0%.” Yet a full-fledged economic contraction seems a high probability. At least that’s what industrial commodities prices are suggesting. Copper dropped 6.2% this week and 9.8% for the “worst month since 2015.” Nickel fell 5.5% this week, Palladium 5.7%, Platinum 4.5%, Lead 7.2%, Tin 5.9%, Zinc 7.1% and Aluminum 3.6%. Crude (WTI) sank 4.2% this week, pushing the January decline to 15.4%. Ominously, the commodities self-off broadened this week. Coffee sank 6.8%, Wheat 3.4%, Soybeans 3.3%, Cotton 2.7% and Corn 1.5%.

There were ominous moves in global equities. Hong Kong’s China Financials Index sank 7.1%, boosting January losses to 10.4%. Taiwan’s TAIEX equities index fell 4.9%. South Korea’s KOSPI index sank 6.5%. The Jakarta Composite was down 4.9%. The Bangkok SET slumped 3.6%, and the Philippines PSE index dropped 5.5%. Germany’s DAX index fell 4.4%, and UK’s FTSE 100 dropped 4.0%. Brazil’s Bovespa index sank 3.9%.

From a global perspective, dire market signals continue to blare from sovereign safe haven bonds. Ten-year Treasury yields dropped another 10 bps this week to 1.51%, the low since September 4th. German bund yields fell 10 bps to negative 0.43%, and French 10-year yields were down 10 bps to negative 0.18%. Japanese JGB yields fell five bps to negative 0.07%. For the month, Treasury yields were down 41 bps and bund yields dropped 25 bps. In the realm of the wacky, Italian 10-year yields sank 30 bps this week (48bps for the month) to 0.94%.

Bond markets are increasingly anticipating a potent solution of antiviral central bank stimulus administered to neutralize the Novel Wuhan Coronavirus (2019- nCoV). Once eradicated, central bankers can move expeditiously to counteract CO2 and climate change. Untold QE will be available in the event of political or geopolitical instability. Formations of bazookas will be primed for any equities correction. Pundits reckon the Fed will be ready to respond in the event of a 5% market pullback. It’s good to have insurance against giving back any more than a fraction of last year’s huge gains. Not sure why a slug of monetary stimulus couldn’t do the trick for homelessness, placate Middle East strife and even bridge the divide between increasingly Balkanized societies and nations.

January 29 – Bloomberg (Rich Miller, Christopher Condon, and Matthew Boesler): “Federal Reserve Chairman Jerome Powell signaled that the central bank would pull out the stops to combat a global disinflationary downdraft, foreshadowing a potential shift toward an easier monetary policy over time. Speaking to reporters… after the Fed left its benchmark interest rate unchanged, Powell said he is intent on evading the downward spiral in inflation and inflation expectations that’s bedeviled other countries. ‘We have seen this dynamic play out in other economies around the world, and we are determined to avoid it here in the U.S.,’ he said.”

I vividly recall talk of economic depression in the aftermath of the 1987 stock market crash. Deflation was a major worry in the early nineties after the collapse of various late-eighties Bubbles (S&Ls, coastal real estate, junk bonds, M&A, etc.). Global policymakers were fretting deflationary forces after the 1995 Mexico collapse, SE Asia in ’97 and Russia/LTCM in 1998. The Fed was ready to resort to “helicopter money” and the “government printing press” to counteract the powerful forces of deflation after the collapse of the “tech” Bubble early in the new Millennium. And it’s now been 11 years of history’s most radical monetary stimulus to fight deflationary forces since the collapse of the last Bubble.

It all amounts to the greatest misdiagnosis in the history of central banking. The predominant risk has not been – and is not today – disinflation or deflation. Bubbles remain the overriding risk – and further inflation only intensifies historic Bubble risk. To be sure, foolhardy policy measures that work to neutralize Bubble deflation only ensure larger and more threatening Bubbles. Last year’s Monetary Fiasco unleashed precarious “blow-off” speculative excess – stocks, bonds, corporate Credit and structured finance.

The entire world inflated into the proverbial Bubble in Search of a Pin. At the epicenter of the global Bubble, trouble in China has been headlining my list of potential catalysts. The coronavirus outbreak poses a clear and present danger of pushing China into a dangerous predicament. The most alarming aspect of all this: few contemplate China as a catalyst because virtually everyone remains oblivious to Global Bubble Risk. How about those fantastic earnings from Apple, Tesla, Microsoft and Amazon…

Original Post 1 February 2020

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