Economic Crisis Overview
How the Crisis Began
Severe Acute Respiratory Syndrome- Related Coronavirus 2, Coronavirus for short, began in December 2019 in China and since then has brought the world to a standstill physically and economically. Moreover, because of this, the world, for the first time since World War 2, feels spiritually united, though physically distant, to fight a common enemy, but it did not start that way.
At the start of the pandemic, China refused the assistance of the Disease Control and Prevention Organization (C.D.C.). The nation believed it could contain the disease on its own. This decision prevented the world from understanding the situation until it had reached its shores, which China promised it would not.
The lack of information about the severity of the Virus caused a contrasting spectrum of approaches by different governments on combating the disease since details about its effects on the human body and how easily it could spread were unknown, as well as the indirect impact on the economy. On one end, Italy chooses a flexible, decentralized approach, which gave autonomy for local officials to devise their plans to combat the Virus. The other, South Korea’s Federal Government, took extreme measures on preventing the Virus from entering its borders from the start. With these two contrasting models, the world finally gathered and distributed information on how to combat the Virus and the lessons learned from mistakes due to underreaction from Italy.
Impact on the Markets and the Global Economy
The Coronavirus did do something relatively positive; it exposed the fluff of the record-long expansion of the Global Economy. Before the spread of the Coronavirus, the United States was experiencing what appeared to be an economic rise to the heavens, literally. Companies were taking advantage of the low-interest record rates by using debt to fund their assets, which made them appear as profitable to investors; this created an upward spiraling, positive echo effect that sent stock prices soaring. However, like all artificial highs, there is a catch, and the devil must be paid his due.
“On the eve of the crisis, one-quarter of the country’s largest companies had more cash going out than coming in,” according to Goldman Sachs. Investors completely understood that this economic boom was being built upon sand, and all it will take is just one push from a crisis to topple it all down. That initial push was felt within the supply chains, from the origin of the crisis, China.
Impact on Both the Supply of Goods and Overall Customer Demand
Before the Coronavirus and the breakdown of the supply chain, the United States and China were amid a trade war. The United States was imposing tariffs on the world’s manufacturing hub. Thus, causing companies to find new, more expensive, alternatives to build their goods or accept the extra cost of producing China. However, the trade war’s impact did not reflect itself in the stock market, as it was left ignored by investors to catch the high that is a record-breaking expansion.
Then reality became apparent as business activity and transportation were restricted in China; this prevented suppliers and exporters from fulfilling contractual obligations. Dun and Bradstreet have estimated that 90% of businesses in China have been affected by these restrictions. It is not just manufacturing goods, but also the production of raw materials has been grounded at a slow pace. The world’s supply chain is following suit. Thus, this problem now grows into other businesses which rely on moving goods and individuals from one location to another: Oil
Oil prices were low and dropping before the crisis because the production of it outweighed the demand. Then when suppliers were unable to meet contractual obligations due to restrictions, there were fewer goods to be shipped. Thus, lower demand for oil, which causes oil prices to drop even sharper; this created a negative downward spiral for the price of oil. As production continues to halt, workers were being laid off. These former workers are then confined to their homes due to quarantine, which meant they could only leave for necessities only, thus used and bought fewer gallons of oil; this, in turn, lowers the demand for oil.
The Potential Threat to the U.S. Economy and Stock Market, ETFs Questioned
The Virus has revealed the U.S. Economy’s real strengths, raw weaknesses, and abilities to adapt to this new, hostile environment. Its strength is in Silicon Valley, companies that rely heavily on software development and cloud computing; these companies allow their employees to telecommute from the safety of their homes; this means their workforce is left mostly unaffected. However, their stock prices are still susceptible to the volatility of the stock market due to ETFs. Which I believe be questioned after earning season has passed:
ETFs is an acronym for Exchange-Traded Funds; it is a security that comprises a collection of securities. ETF rise and drops depending on the index which they follow, which means winners also fall and rise with losers. The use of ETFs has grown much over the past years, which makes the beta of all companies inch closer to One; this means, even if a company is outperforming its peers by an overwhelming amount, it is still susceptible to fall if it is peers also fall dramatically; this is frustrating for investors who focus on a few companies and encourages them to invest in ETFs.
However, I believe we will see a higher level of volatility in prices for ETFs, not just due to the Coronavirus, but to investors reallocating their money into the individual companies who are succeeding amongst the chaos. As this reallocation happens, we will begin to see a separation of betas between the winners and losers.
How are Major Central Banks Stabilizing their Economies?
The Federal Reserve (F.E.D.) is limited to what they are can with stabilizing the economy. Before the crisis, the interest rates were already low. Furthermore, as the crisis ensued, it forced the F.E.D. to do something unprecedented, cutting interest rates to near 0 percent.
They have also increased the Treasury securities by at least $500 billion, and its holdings of mortgage-backed securities by $200 billion. Lend 1.5 trillion to banks and financial institutions and increase purchases of U.S. Treasury securities
The E.C.B., the European Central Bank, President Christine Lagarde, said that the bank was “ready to take appropriate and targeted measures” to deal with the economic turmoil caused by the Virus, and they have done just that. The central bank launched an $820 billion coronavirus package. It is an asset purchase program called Pandemic Emergency Purchase Program (PEPP). Investors are responding positively, as the yield drops as much as 1.542%. Bond prices move inversely to stocks.
The package also includes Greek securities, which has not been included in the central bank’s last asset purchase program (because of their credibility due to Greece’s default in the past).
The E.C.B., unlike the F.E.D., did not cut interest rates to boost economic activity. Instead, they are lending and expanding its asset purchase program by 120 billion euros; this means that borrowing from the E.C.B. is much cheaper, by making their interest rates to -0.75%; this is intended to encourage banks to borrow from them, so they, in turn, can lend to businesses and individuals; with negative interest rates, the E.C.B. is now paying banks to borrow.
BOJ, The Bank of Japan, has taken a direct approach to stabilize its economy by increasing commercial paper (C.P.) & corporate bond buying. The total amount accumulated for C.P. securities is $ 186 Billion. In the global market, this number may appear small or average; however, Japan is a small market for these instruments. So it had to extend the maturity of bonds from three to five. It also increases the maximum amount of Commercial paper and corporate bonds from 25% to 30% for corporate bonds and 50% for commercial paper. The Bank of Japan also pledges to buy unlimited amounts of government bonds to achieve its 0% long- term interest rate target.
To help corporate funding, the Bank of Japan as “decide to pay financial institutions for borrowing money from the central bank.” They achieve this by providing loans that have zero interest rates for up to a year. They have also accepted a broader range of assets to be used as Collateral
How are the U.S.A. and China stabilizing their Economies
The United States has passed and launched a $ 2 trillion emergency relief bill to expand unemployment insurance by providing $1,200 stimulus checks to most Americans and a lifeline for businesses, large and small; this is the most massive stimulus package in U.S. history. Most of the package comes in the form of “transfer payments” rather than direct payments from the Federal Government. The previous stimulus package, the Recovery Act of 2009, was under $900 billion; this will be paid with taxation, which will be spread over everyone, and for multiple generations.
The goal for these stimulus checks is to give individuals the ability to purchase necessary items as well as protect private credit markets “to keep money flowing between borrowers and lenders.” All of this in hopes to prevent a Depression, though there is no guarantee that it can avoid a recession; essentially, a recession is a best-case scenario.
China is stabilizing its economy by flooding the financial system with money. Moreover, in recent times, customers have now increased the demand for goods, which China is the manufacturing hub of the world, has profited from it. However, the question then arises, how willing is the country to spend to keep their economy going.
The way they are distributing money is through loans. This strategy helped him during the 2008 Global Financial Crisis with the hangover of the accumulated debt for years afterward. The reason why this helps is that borrowers had confidence that the growth in the economy will pay their debts for them.
The crisis will last long after the Virus has been put to bed into the history books. The consequences of using global debt to fund global stimulus packages will ring across the checkbooks for generations to come. Expect taxes in the United States to be high for the next decade.
However, this crisis has raised many questions in the fundamental, individual level: What does happiness mean?
Before the crisis, consumer spending and the increased social media usage have thrown family values out the window, made it acceptable to bypass social interactions for instant gratification. The crisis has ground the world to a halt and made everyone look in the mirror.
I can speak for personal experience, but this may be the most time I spent with my family outside of vacation. I really got to know who they are as a person, and because of that, I learned who I was. Calling and speaking to friends over the phone felt meaningful and appreciated.
Because of this, I believe people will rethink how they spend, instead of purchasing the newest iPhone every year, they will buy a plane ticket to see their mom and dad twice a year. The money will be allocated to items that matter and spent wisely. Luxury goods will have to adapt to this new, modern consumer by lowering their prices and making sure their products actually add value to their customer’s life than just be a status symbol.
My conclusion is that his Virus may be the wake-up call for the world’s youth to realize that calling mom means a lot more than scrolling through Instagram.
With Love and Sincerity,
Jose Michael Rubio