The longer Beijing enforces curbs on work and travel, the greater the global economic shock
The workshop of the world is closed. China is on a total-war footing. The Communist Party has evoked the ‘spirit of 1937’ and mobilized all the instruments of its totalitarian surveillance system to fight both the Coronavirus, and the truth. Make GDP forecasts if you dare.
As of this week two-thirds of the Chinese economy remains shut. Over 80pc of its manufacturing industry is closed, rising to 90pc for exporters.
The Chinese economy is 17pc of the world economy and deeply-integrated into international supply chains. It was just 4.5pc of world GDP during the SARS epidemic 2003, which some like to use as a reassuring template. You cannot shut down China for long these days without shutting down the world.
Today’s investor euphoria at reports of two new wonder drugs from Zhejiang University show how badly unhinged the market has become. This is not the way that medical science advances. Nor could these anti-virals possibly be ready, in time and at scale, to avert serious economic upheaval.
The open question is whether the coronavirus shock is enough to abort the fragile economic recovery underway since last Summer’s near miss, when frightened central bankers in the US, Europe, and 47 other jurisdictions cut rates in a drastic monetary U-turn.
Personally, I think the glacial SARS episode tells us little about the fast-spreading Wuhan virus. The 2019-nCoV variant is more akin to the Spanish Flu pandemic of 1918. It appears to be tracking the 1918 death rate at around 2.3pc (20 times normal winter flu) to the extent that we can believe any figures. There is some evidence that it is nearer 4.9pc in Wuhan.
The difference is that Spanish Flu felled the young, because their immune systems went into overdrive: this virus carries away the old.
There is no global economic safety margin. Both the US Federal Reserve and the European Central Bank have already relaunched quantitative easing, a bizarre thing to do if the US economy is really doing as well as Donald Trump claimed in his State of the Union address. Clearly US strength is a late-cycle illusion. Exhaustion has been masked by both by a blast of monetary stimulus and a fiscal deficit near 5pc of GDP.
The scale of disruption in China is already staggering. Hyundai, Number Five in global car sales, has been forced to close all its factories at home in Korea for lack of key components. Volkswagen, Toyota, General Motors, and Tesla have all downed tools at their Chinese plants, as has Apple’s iPhone supplier Foxconn.
Crude prices have dropped 20pc since early January, that long-ago moment when eight Wuhan doctors were already trying to alert the world to the virus, only to be arrested for “spreading rumours”.
This is the biggest shock to oil markets since the Lehman crisis. The collapse in Chinese transport and refinery demand has cut imports by three million barrels a day. Some say four million. This is twice the UK’s North Sea oil output. An embattled OPEC is having to talk about yet further output cuts, a horrible surprise as the perpetual petro-drought grinds on into its sixth year.
“It’s now clear that coronavirus is a serious event risk to the entire world and that financial conditions are tightening very quickly,” said Edward Harrison from Credit Writedowns.
The channel of financial contagion runs from the epidemic through the oil price to a “bear market rout” in the broader energy sector, and from there to overstretched US junk bonds. “High yield is where the rubber hits the road,” he said.
The coronavirus is the sort of Black Swan catalyst that the US Treasury’s Office of Financial Research (OFR) frets about. Its latest stability report said corporate bonds are an accident waiting for such a trigger. The ratio of junk bonds with debt-to-earnings ratios above six has reached 30pc, above the pre-Lehman peak.
The number of investment-grade securities rated BBB or lower has risen fivefold since 2008, many perched just above junk. If fear takes hold there is likely to be a cascade of downgrades and ‘fallen angels’, setting off a fire-sale by bond funds.
Commodity markets have taken the crisis on the chin because they are instant barometers of actual demand. Equity markets are instead shrugging off the Wuhan virus as media noise, betting that China’s factories will reopen on February 14 or thereabouts as Beijing brings the epidemic under control.
This is a brave assumption and I can only marvel at analysts suggesting that the infection rate may be tailing off based on each day’s official data. Are they aware of the astonishing accounts of Kafkaesque reality in Wuhan, Huanggang, and soon no doubt the 35m-strong megalopolis of Chongqing, where Britain has just closed its consulate?
Are they reading dispatches by Caixin or the South China Morning Post revealing a desperate shortage of testing kits and tales of the walking afflicted (transport has been shut down) queuing for hours at hospitals, only to be turned away and sent home to die undiagnosed.
These glimpses of truth are about to vanish. The propaganda police have ordered those within their direct reach to conduct an “editorial review”. Stories are being censored aggressively. Outsiders will be silenced in subtler ways.
The coronavirus numbers are patently fiction. Far more have died than the official tally of 493. A Lancet study last week by the University of Hong Kong estimated that the Chinese authorities have understated the epidemic tenfold. This was based on a spread rate of 2.68 per case and a doubling in total numbers every 6.4 days, matched with known travel movements within China and globally since the outbreak.
It calculated even then that the true figure for Wuhan was likely to be 76,000, and that Chongqing, Changsha, Nanchang, are already riddled with the disease. “Independent self-sustaining outbreaks in major cities globally could become inevitable,” it said.
Views differ but it is striking how many global experts – when not under political pressure – say it may already be too late to stop the spread. “It’s very, very transmissible, and it almost certainly is going to be a pandemic,” said Anthony Fauci, head of the US National Institute of Allergy and Infectious Disease.
It is the same warning from an “increasingly alarmed” Peter Piot, head of the London School of Hygiene and Tropical Medicine. The danger is that it will become endemic and circulate everywhere like flu, a manageable headwind for rich countries with good health care but a Sword of Damocles having over Africa or South Asia.
There is an inherent contradiction in the market’s nonchalance. Yes, it is possible that China’s 50-million lockdown and use of extreme surveillance and coercive power will accelerate the process of “contact tracking”, catching enough of those infected before they can spread it further. Such a hi-tech totalitarian response to an epidemic has never been tried before.
But the more thoroughly China enforces this, the greater the global economic shock is likely to be. How can industrial plants really be reopened next week? Yet if it takes another month, it becomes progressively harder to contain the international economic damage, and raises the risk of a Minsky Moment within China’s own hyper-leveraged system keeps rising.
We are in treacherous waters. The People’s Bank can no longer flick its fingers and ignite instant growth. Debt saturation and weak credit demand have furred up the monetary transmission channels. Extreme rate cuts and ‘QE with Chinese characteristics’ would threaten to set of a yuan slide and ultimately a repeat of the 2015 currency crisis.
For now global markets remain in Pavlovian mode. There will always be more Chinese stimulus. Uncle Xi will always look after everybody. Close China-watchers – and some very sharp scientists – suspect that this latest flurry of optimism is just a lull before the thunderstorm.