******************** POSTING RULES & NOTES ********************
#1 YOU MUST clip all extraneous text when replying to a message.
#2 This mail-list, like most, is publicly & permanently archived.
#3 Subscribe and post under an alias if #2 is a concern.
*****************************************************************
NY Times Op-Ed, March 16, 2020
This Is How the Coronavirus Will Destroy the Economy
By Ruchir Sharma
Mr. Sharma is an investor and a contributing opinion writer.
Though the Federal Reserve moved over the weekend to slash rates and buy
treasuries, markets around the world fell on Monday anyway. The
coronavirus threatens to set off financial contagion in a world economy
with very different vulnerabilities than on the eve of the global
financial crisis, 12 years ago.
In key ways the world is now as or more deeply in debt as it was when
the last big crisis hit. But the largest and most risky pools of debt
have shifted — from households and banks in the United States, which
were restrained by regulators after the crisis, to corporations all over
the world.
As businesses deal with the prospect of a sudden stop in their cash
flows, the most exposed are a relatively new generation of companies
that already struggle to pay their loans. This class includes the
“zombies”— companies that earn too little even to make interest payments
on their debt, and survive only by issuing new debt.
The dystopian reality of deserted airports, empty trains and thinly
occupied restaurants is already badly hurting economic activity. The
longer the pandemic lasts, the greater the risk that the sharp downturn
morphs into a financial crisis with zombie companies starting a chain of
defaults just like subprime mortgages did in 2008.
Over the last century, recessions have almost always been started by a
sustained period of higher interest rates. Never a virus: The damage
such contagions inflicted on the world economy typically lasted no more
than three months. Now this once-in-a-century pandemic is hitting a
world economy saddled with record levels of debt.
Central banks around the world are waking up to the prospect that the
cash crunch can beget a financial crisis, as in 2008. That’s why the
Federal Reserve took aggressive easing measures on Sunday that were
straight out of the 2008 crisis playbook. While it is unclear whether
the actions of the Fed will be enough to prevent the markets from
panicking further, it’s worth asking: Why does the financial system feel
so vulnerable again?
Around 1980, the world’s debts started rising fast as interest rates
began falling and financial deregulation made it easier to lend. Debt
tripled to a historic peak of more than three times the size of the
global economy on the eve of 2008 crisis. Debt fell that year, but
record low interest rates soon fueled a new run of borrowing.
The easy money policies pursued by the Federal Reserve, and matched by
central banks around the world, were designed to keep economies growing
and to stimulate recovery from the crisis. Instead, much of that money
went into the financial economy, including stocks, bonds and cheap
credit to unprofitable companies.
As the economic expansion continued, year after year, lenders grew
increasingly lax, extending cheap loans to companies with questionable
finances. Today the global debt burden is again at an all-time high.
The level of debt in America’s corporate sector amounts to 75 percent of
the country’s gross domestic product, breaking the previous record set
in 2008. Among large American companies, debt burdens are precariously
high in the auto, hospitality and transportation sectors — industries
taking a direct hit from the coronavirus.
Hidden within the $16 trillion corporate debt market are many potential
troublemakers, including the zombies. They are the natural spawn of a
long period of record low interest rates, which has sent investors on a
restless hunt for debt products that offer higher reward, with higher
risk. Zombies now account for 16 percent of all the publicly traded
companies in the United States, and more than 10 percent in Europe,
according to the Bank for International Settlements, the bank for
central banks. A look at the data reveals that zombies are especially
prevalent in commodity industries like mining, coal and oil, which may
spell upheavals to come for the shale oil industry, now a critical
driver of the American economy.
Zombies are not the only potential source of trouble. To avoid
regulations imposed on public companies since 2008, many have gone
private in deals that typically saddle the company with huge debts. The
average American company owned by a private equity firm has debts equal
to six times its annual earnings, a level twice what ratings agencies
consider “junk.”
Signs of debt stress are now multiplying in industries impacted by the
coronavirus, including transportation and leisure, auto and, perhaps
worst of all, oil. Slammed on one side by fear that the coronavirus will
collapse demand, and on the other by fears of a supply glut, oil prices
have fallen to below $35 a barrel — far too low for many oil companies
to meet their debt and interest payments.
Though investors always demand higher returns to buy bonds issued by
financially shaky companies, the premium they demand on U.S. junk debt
has nearly doubled since mid-February. By last week the premium they
demand on the junk debt of oil companies was nearing levels seen in a
recession.
Though the world has yet to see a virus-induced recession, this is now a
rare pandemic. The direct effect on economic activity will be magnified
not only by its impact on balky debtors, but also by the impact of
failing companies on the bloated financial markets.
When markets fall, millions of investors feel less wealthy and cut back
on spending. The economy slows. The bigger markets get, relative to the
economy, the larger this negative “wealth effect.” And thanks again to
seemingly endless promises of easy money, markets have never been
bigger. Since 1980 the global financial markets (mainly stocks and
bonds) have quadrupled to four times the size of the global economy,
above the previous record highs set in 2008.
On Wall Street, bulls still hold out hope that the worst can pass
quickly and point to the encouraging developments in China. The first
cases were reported there on Dec. 31, and the rate of growth in new
cases peaked on Feb. 13, just seven weeks later. After early losses,
China’s stock market bounced back and the economy seemed to do the same.
But the latest data, released today on retail sales and fixed
investment, suggest the Chinese economy is set to contract this quarter.
While China is no longer center stage, as the virus spreads worldwide
there are renewed fears that the crisis could circle back to its shores
by hurting demand for exports. Over the last decade China’s corporate
debt swelled fourfold to over $20 trillion — the biggest binge in the
world. The International Monetary Fund estimates that one-tenth of this
debt is in zombie firms, which rely on government-directed lending to
stay alive.
In other parts of the world, including the United States, calls are
growing for policymakers to offer similar state support to the fragile
corporate sector. No matter what the policymakers do, the outcome is now
up to the coronavirus, and how soon its spread starts to slow.
The longer the coronavirus continues to spread at its current pace, the
more likely it is that zombies begin to die, further depressing the
markets — and increasing the risk of wider financial contagion.
Ruchir Sharma is the chief global strategist at Morgan Stanley
Investment Management, author of the forthcoming book, “The Ten Rules of
Successful Nations,” and a contributing opinion writer. This essay
reflects his opinions alone.
_________________________________________________________
Full posting guidelines at: http://www.marxmail.org/sub.htm
Set your options at:
https://lists.csbs.utah.edu/options/marxism/archive%40mail-archive.com
