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Commentary :: International
Economics in the Times of the Coronavirus
31 Mar 2020
Most people’s thinking is determined by the development of the Covid-19 crisis, the return of “the hour of executive power” (Gerhard A. Ritter), i.e. state of exception legislation, and the fears which it evokes as well as the economic measures which appear to be in response to the health crisis.
Infected world economy - fight against the corona economic crisis
by Rudolf Hickel

[This article published on 3/3/2020 is translated from the German on the Internet, Infizierte Weltwirtschaft – Kampf gegen die Corona-Wirtschaftskrise - Memo-Gruppe.]

The coronavirus, which is transported via humans, has long since infected the global economy. In China, production came to a massive standstill, first in the centers of industrial production, but also in the production of medicines for the world. Important supply chains in the closely interlocked international divisions of labor have been interrupted. To the extent that the pathogen spreads to other countries, this is followed by interruptions in production and a slump in profits and income. The longer this infection spreads worldwide and no remedy is found, a global economic crisis is inevitable. Similar to the financial market crisis from 2008 onward, the economic decline is now being accelerated by fears and increasing panic.

Curse of globalization?

The new viral scourge suddenly disproves the ideology of globalization, which only creates wealth. It was primarily labor cost advantages that led to short-sighted relocations of production not only to China's new centers. They generate high crisis costs through interrupted supply chains. Globalization suddenly turns out to be a dependency and then also on production locations in only a few places in the world. Especially bitter for the corona pandemic, the medicine that is now urgently needed and only produced in a few countries like China is not available. These recent experiences force us to discuss the extremely fragile international division of labor, often with only a few local production sites.

Whether the fever of the globalized world economy will lead to a deep crisis is only a little uncertain. In any case, a globally coordinated, ideology-free policy is called for. For this, too, is becoming apparent with the corona plague: In the face of the rapid globalization in the transmission of the pathogen and the ensuing economic crisis of the worldwide supply chains, there is a lack of a globalized, internationally binding policy. It is therefore all the more important now that all states also use the findings of the World Health Organization and take decisive countermeasures. The EU must work for a communitarized policy of its member states against the medical and economic crisis.

Even as one of the previous winners of globalization, Germany is to be advised to take up the fight without ideological blinkers.

Stopping the danger of infection

First of all, it is a matter of limiting the further spread of this virus. This includes the many control and preventive measures. Personal restrictions through quarantine and hospitalization not only serve the person affected, but also benefit the environment and, ultimately, society as a whole because of the avoided risk of infection. Above all, however, the clinics, doctors' practices and the many other medical facilities must be financially secured in an unconventional way. Many clinics have already acted responsibly without financial security. Now the facilities of quarantine stations must be publicly financed without delay. This also includes the reduction of the staff shortages in the health system, which have long been complained about. The staff in the clinics who are at risk of infection deserve special help. In principle, medical experience with this virus also shows that a nationwide range of hospitals, especially with publicly responsible and non-profit providers, must be maintained against the ideology of the "bed overhang".

Evidence of the macroeconomic crisis

Beyond the medical containment of this corona plague, the economic crisis it has triggered must be combated. The omens of an otherwise expected general economic crisis extending into the banking system are already visible. In plant and mechanical engineering, production in Germany is stagnating due to massive supply bottlenecks. The automotive industry is expecting a drop in sales that will be difficult to absorb. Medical technology groups such as Fresenius complain about the interruption of supply chains to hospitals. Especially in the fight against corona viruses, important medical products are no longer available through pharmacies, also because of supply bottlenecks from China. Containers are stockpiled in the ports. Shipping companies are complaining about the decline in commercial shipping. Logistics companies as well as airlines are affected. Massive slumps in tourism (travel agencies, hotels) will continue to increase. Major sporting and other events and trade fairs will also be cancelled with losses for the small providers in the network. Finally, panicky hamster purchases will empty the shelves in retail outlets.

These are all evidence of an overall economic crisis with production slumps, losses of profits and labor income, job cuts but also declining tax revenues for the state. At the same time, this viral infection is hitting the German economy in an already severe phase of weakness towards recession. The loss of production and labor is now being followed by losses in overall economic demand. The financial markets are not spared the burden of the real economy either. Many DAX companies that are directly or indirectly affected have to accept price losses. The carelessness, indeed the widespread illusion, of the sustained price gains on the stock markets threatens to turn into panic. In addition, banks are confronted with a growing number of loans from crisis-affected companies that can no longer be serviced. The danger of a crash driven by the financial markets should not be underestimated.

Unconventional use of short-time work compensation

For this reason, measures to publicly finance the costs of corona infection in particular need to be bundled and concentrated to ward off an accelerating crisis dynamic. At the heart of this are the bridges that need to be built to restore normality.

The experience gained in overcoming the financial market crisis in 2008/2009 must first and foremost be used to make provisions in employment policy. In order to bridge the production slump, unconventional and generous short-time work must be financially secured. Since "extraordinary circumstances" exist, 24 months of short-time work compensation (67% of net remuneration due to loss of production for employees with children) should be promised to the Federal Employment Agency to increase planning certainty.

The Anti-Corona Program (ACP)

At the center of state financial policy is the demand for the federally oriented federal special investment fund "Anti-Corona Program (ACP)". According to the Federal Ministry of Finance, 50 billion euros could be mobilized as an initial investment.

From this amount, it would have to be financed:

Payments to the health system to cover additional costs such as quarantine stations, including additional staffing requirements;
assumption of the additional expenses for short-time work compensation to the Federal Labor Office;
bridging subsidies for companies that are particularly affected;
emergency loans to companies and grants for debt service;
To strengthen overall economic demand, bringing forward the "Future Investment Program", which is due anyway, with the focus on ecological restructuring.

Debt brake no longer in force

How should the costs of combating the medical and economic consequences of the corona crisis be financed? In Hong Kong, a variant of "helicopter money" is being used to strengthen private households. Although not distributed by helicopters over the country, everyone in the Special Administrative Region receives a one-off payment of 10,000 Hong Kong dollars (approx. 1,180 euros) from the municipality. Certainly, the unconventional money blessing has short-term advantages. But this policy is not medium-term and sustainable. That is why it is proposed to finance the "anti-corona program": in addition to the use of residual funds in the federal budget, financing is provided by borrowing on the financial markets. In this way, surplus money in the economy is skimmed off and used to finance the health system and sustainable infrastructure investments. Before this proposal is immediately discriminated against again with the debt brake/black zero, it is worth taking a look at Article 115 of the Basic Law.

There, exceptions from the upper limit (currently 12 billion euros) are provided for the federal government's debt limitation: In the article 115 GG it means "... In the case of natural disasters or unusual emergency situations, which escape the control of the state and impair the national financial situation substantially, these credit ceilings can be exceeded on the basis a resolution of the majority of the members of the Bundestag. The resolution must be accompanied by a repayment plan."

Fiscal policy in Germany has a leading role to play in the fight against the corona crash. This is because the ECB's monetary policy with its current low interest rate policy offers little scope for a successful tightening of the expansive monetary policy with low, zero and minus interest rates.

The Bio-Economic Pandemic and the Western Working Classes
The Covid-19 Shock Meets an Impending Economic Recession
As of March 2020, the world is back to the future. The global financial crisis of 2007-08, which escalated into a global financial meltdown in September 2008, was supposed to be the big bang crisis, a once in a lifetime event. And yet, here we are again.

The Russia-Saudi Arabia oil dispute of early March 2020, which has led to a freefall in the price of crude oil and was directed at the US fracking industry, as well as the economic shocks resulting from the globalization of the Coronavirus seem to have caused a new global recession. This has been declared by numerous mainstream economists like Harvard’s Kenneth Rogoff and Pankaj Mishra who are convinced that the world has already entered a new global economic crisis. A few days later central bankers like Germany’s Bundesbank chairman Jens Weidmann announced his expectation that a recession was “probably inevitable by now.”

Most people’s thinking is determined by the development of the Covid-19 crisis, the return of “the hour of executive power” (Gerhard A. Ritter), i.e. state of exception legislation, and the fears which it evokes as well as the economic measures which appear to be in response to the health crisis. By disrupting international supply chains and severely harming a highly vulnerable just-in-time production global economy, Covid-19 clearly accelerated the transition into recession; and yet, this recession was already upon us by the end of last year.
Quelle: Ingar Solty auf SP


We are only in phase 2 of a four-step crisis - in the end it will be all about everything

Coronavirus - Stock exchanges

by Daniel Stelter

[This article published on 3/26/2020 is translated from the German on the Internet, Wir sind erst in Phase 2 einer vierstufigen Krise – am Ende wird es um alles gehen.]

Wir sind erst in Phase 2 einer vierstufigen Krise – am Ende wird es um a...

FOCUS Online

Analysen zeigen, dass sich die Corona-Krise in vier Phasen unterteilen lässt. Momentan sind wir gerade mal in Ph...

Analyses show that the corona crisis can be divided into four phases. At the moment we are only in phase two, it will only go further downhill. And in the end the system question arises.

Central banks and states are fighting the crisis with massive programs. But is the worst already over? Looking at the events of recent weeks, the results of the analysis are sobering: We are only in phase 2 of a four-step crisis. The corona epidemic and the ensuing current financial crisis are followed by a deflationary shock for the real economy, and in the end the question is whether our monetary and economic system really still functions.

Phase 1: The epidemic that did not have to become a crisis

We first had an outbreak of the novel virus in China, and the authorities there took action against the virus with a consequence that was previously unimaginable for Western societies, and appear to have been successful: The infections are now decreasing. Of course, the virus has not been defeated in China either; it will remain, infect the population and accompany China for years. But the authorities have gained time. We know that it is above all a question of stretching the number of seriously ill people over as long a period as possible, if we do not want to increase the number of deaths by collapsing the health system.

Dr. Daniel Stelter (Twitter: @thinkBTO) is the founder of the discussion forum "Beyond the Obvious", which specializes in strategy and macroeconomics, and a management consultant. Previously, Stelter was with the Boston Consulting Group (BCG) from 1990 to 2013, most recently as Senior Partner, Managing Director and member of the BCG Executive Committee. His current book is "The Fairy Tale of the Rich Country - How Politics Ruins Us".

In the Western world at that time, political leaders were deeply relaxed. China is far away and what do we know that has escaped from a local poultry market? Carnival must be celebrated and football matches must take place.

Then the virus suddenly appeared in Italy. Here too, prejudices were quickly formulated. The Italians were asleep, they are very old anyway and the health system is not as good as ours. Now the virus is everywhere.

Donald Trump's catastrophic crisis management

It's not really comforting that things are worse in the USA. The Western world is about to make a fool of itself to the bone in the fight against a health crisis of historic proportions. Trump dissolved the White House's staff of pandemic experts shortly after taking office. For a long time, he played down the risks posed by the virus. Test kits were not available for days in the world's most expensive health system, and the number of undetected infections in the USA is correspondingly high. Only after weeks of delay did Trump declare a national emergency, and he is likely to get the credit for his poor crisis management.

China's neighboring countries are showing how it works. Taiwan, Vietnam, Hong Kong and Singapore have managed to keep the number of illnesses low right at the beginning of the epidemic by taking consistent measures. Although these countries border directly on China, the number of infected people is significantly lower than in Europe, both in absolute terms and relative to the population. Even South Korea, particularly affected by the epidemic - partly due to a mass wedding - proves how well an epidemic can be brought under control. The death rate is significantly lower than in other countries.

This success of the Asians is no coincidence. They have had the experience of SARS and have drawn conclusions from it. Our politicians, on the other hand, do not think it is necessary to learn from others, but they absolutely must allow us to have the experience. This led to Phase 1 of the virus crisis.

Phase 2: The financial crisis that was just waiting for the trigger

Phase 2, the financial crisis, is now beginning. In recent weeks, we have experienced breathtaking slumps on the stock markets. Observers are rubbing their eyes and wondering why the virus is having such a devastating effect on the stock markets. The virus has undoubtedly had economic consequences - but losses in value of 30 to 40 percent?
I have repeatedly explained here why, in the years since the financial crisis, our financial system has not become safer, as politicians claim, but on the contrary has become increasingly insecure. I have also always warned of the catastrophic consequences if there were to be a collapse. What would trigger it and when that would be the case, even I could not say. But I knew that when it started, it would be difficult to find a hold. Hence the purchase of the "Armageddon Putt".

The following factors come together in this financial crisis:

- Leverage: This is a crucial factor in understanding what is happening in the markets (those who know about leverage can jump straight to the next bullet point). Let's assume you could buy a share at 100 euros that pays a secure dividend of ten euros per year. (Yes, unthinkable in this day and age, but we'll get to that in a moment) If you only use equity capital for the purchase, you'll achieve a return of ten percent.

It would be more attractive to borrow 100 euros from the bank and buy two shares at once. If the bank is satisfied with five percent interest, five euros go to the bank and 15 euros remain with you. Makes 15 percent yield. In practice the bank might be more generous and be content with only 20 per cent own capital funds. They can borrow thus to your 100 euro still 400 euro of the bank and buy five shares. From the 50 euro dividend then 20 euro went to the bank (five per cent on 400) and you remained 30 euro. A net yield of thirty per cent on the own capital funds used. Now also others notice, what a good business that is and are content with net yields under 30 per cent, pay thus more for the share. If the share price rises to 140 euros, you have not only achieved a nice price gain, but also considerably more equity. Your "margin" available for lending increases to 300 euros (100 plus 200 price gains).

It is true that the dividend yield has fallen from ten to only seven percent. However, it is still above the bank's interest rate. You borrow another 840 euros and buy more. Then you have eleven shares worth 1540 euros and debts of 1240 euros. The return on your equity of 300 euros falls to 16 percent, but the total surplus (dividend minus interest) grows from 30 to 48 euros. To sum up: It is worth taking on more debt as long as the dividend yield is above the bank's interest rate. This is known as the leverage effect. However, this only works as long as the value of the securities increases and the lender does not demand a margin call on the equity. If no money can then be added, the securities must be sold.

- Exuberant debt: Leverage, as shown, is a lot of fun on the way up. Add to this the impression that the central banks always bail you out when things get tight and make money available cheaply, and you take even greater risks. This is exactly what led to the financial crisis and this is exactly what we have been promoting over the last ten years. Leverage is taking place at all levels: Companies borrow cheap money to buy back their own shares or take over competitors. The effect is that expensive equity capital is replaced by cheap borrowed capital, resulting in rising profits. If shares are bought back, earnings per share increase even faster due to the declining number of shares. The stock market is happy and managers receive higher bonuses.

- Investors are forced into risk: But that's not all: In view of the low interest rates, investors are forced to take more risks in order to improve their performance. This then leads them to buy risky corporate bonds at ever higher prices, thus driving down the interest rate differential ("spread") to government bonds. As a result, companies incur even more debt - and this at the "optimum point", namely in the area of BBB paper, which investors such as pension funds are just allowed to buy. In both Europe and the USA, this segment has literally exploded in recent years.

Another consequence is that investors are also beginning to work with leverage. They buy corporate bonds on credit, because they in turn increase the return on their equity. Meanwhile, the rating agencies are turning a blind eye to the ratings, as many companies would otherwise be in dire straits - General Electric is a well-known example of this.

So we have leverage high 3: at the level of the companies, at the level of the investors and, building up each other, again at both levels.
- Lure the private ones into the trap: Part of the game is to get the private investors, who face the same challenges as the institutional investors, into the game. To this end, ETFs, which are practically "risk-free" because they can be traded daily, were propagated. These would not only be cost-effective, but could also be sold at any time. What was not betrayed: Especially with funds that invest in bonds, it is not possible in practice or only at large discounts. After all, the market is not as liquid as was often said. In the event of panic, however, this reinforces the downward trend.

- Wrong regulation: As in the financial crisis, regulation is wrong. Instead of getting to the root of the problem - the high level of debt - the symptoms were tinkered with. Today, banks can no longer act as market makers and no longer hold their own books. What should make the banks more secure, makes the system more insecure, because there are no more buyers if the worst comes to the worst. This accelerates the panic.

The leverage monster is further fattened by the central banks

This has all been known for a long time. Everyone could see how another round of securities purchases by the central banks - supposedly to combat deflation - fattened the leverage monster. The professionals knew that regulation was narrowing the exit from the market. They all danced to the motto that it will be all right, because the central banks always come when things get dicey. Asset prices continued to rise and leverage was tightened.

Surfing tip: Curfing tip: Curfing, jogging, going for a walk - what else is allowed?

Now the leverage game turns

But now we have another trigger. A virus that strikes both the demand and the supply side. And we are dealing with central banks that have already burned their ammunition in recent years in an effort to suppress the financial crisis, which has by no means been overcome.

This is what leads to the crash. The leverage game turns:

Companies with high levels of debt suddenly find that their cash flow is declining. This has a disproportionate impact on profits and jeopardizes the ability to service debt. The rating wobbles. No wonder that companies with high debt levels have fallen the most.
The bondholders of these companies are getting nervous and want to sell. At the same time, they notice that the liquidity in the market is not as expected. The pressure to sell is increasing. Bond funds are falling.
Stock market participants realize that profit expectations - which were already exaggerated - cannot be sustained. Above all, they are afraid that others might sell before them. Prices are beginning to fall.
Everyone who bought on credit is getting nervous. Because as soon as the rate of price increase of the purchased good falls below the financing costs, we are in the crash zone. This also explains why crashes can occur even with zero and negative interest rates.
The selling wave begins and intensifies more and more. Margin calls are on the rise, it's all about liquidity. That's why in the end everything falls, even gold and sometimes even government bonds. It is the de-leveraging at top speed and the bon mot: If you want to panic, panic first!

This is the phase we are in. Is it over yet? Quite possibly, but it is far from time for a return to the Dax above 13,000 points. Phase 2 continues.

Phase 3: The real economy, which cannot cope with a deflationary shock

While phase 2 is developing, phase 3 is beginning and the virus would undoubtedly have had an impact on the real economy. But these would have been manageable if Western politicians had acted like Singapore, Taiwan and Vietnam. And if the chaos had not hit a financial world that - fired by the cheap money of the central banks (which thus concealed the failure of politics to solve basic problems such as dysfunctional euros and an over-indebted world) - drove leverage to extremes. The financial crisis is now being followed by the economic crisis.

As in the financial crisis, we are dealing with a deflationary shock. Falling asset prices are leading to a state of over-indebtedness among more and more economic players due to the high level of debt. A wave of bankruptcies with devastating effects would inevitably be the consequence, which, as we can study in the Great Depression of the 1930s, is something we can study. Irving Fisher, a professor at Yale, described the process in his "Debt Deflation Theory of Great Depressions". A description that applies to every process of de-leveraging, including the one that lies ahead if policy makers do not intervene boldly.

The process by no means only affects the evil speculators. It affects everyone who has to work with credit and thus the entire economy: restaurants, hotels, craftsmen, industrial companies. All of them have financial obligations which they very quickly cannot meet if they have no income: Rent, interest, principal, wages, taxes, social security contributions. Everything has to be paid for, even when no customers come.

This makes the slump on the financial markets a real problem and it intensifies when the market participants have doubts that politicians will still succeed in preventing this depression. And these doubts are justified:

Do the politicians understand? In the ZDF's "Heute-Nachrichten" news programme, Green Party boss Habeck suggested that hotel and restaurant owners should use the time to replace their old oil heating systems with ecological technologies. He did not explain why companies that have no liquidity to meet their current obligations should spend money they do not have on an investment that does not pay off. Fortunately, the government seems to be realizing that more action is needed. The federal government's "what-ever-it-takes" program announced on Friday is better in that respect, but it can only limit damage, not prevent it.
This is mainly due to the global situation. While in 2009 there was still a global consensus on cooperation, today it is to be feared that this no longer exists. Especially in the USA. This increases the risk of too few or wrong measures.
Do the central banks understand? One could hope so, yes. For example, Mrs Lagarde is said to have drawn parallels to the financial crisis in the video conference with the EU heads of government. This suggests that she and the others are familiar with the dynamics of leverage and de-leveraging, but it does not explain why central banks have fired the game over the last ten years. Because they cannot talk their way out of it now with ignorance.
Can the central banks still make a difference? Central banks have expanded their balance sheets by $14,000 billion since the financial crisis. They have pushed interest rates towards zero - or below zero in Japan and the eurozone - and they have thrown more and more rescue packages at banks that are actually insolvent. All ostensibly to fight deflation, in reality to avoid the de-leveraging that has been necessary since the financial crisis. This means that the central banks have reached the end of their normal possibilities. This is what was behind the ECB's decision yesterday. This is also behind the disappointing reaction on Wall Street to the Fed's measures. The end of the belief in the omnipotence of the central banks has begun. In the years to come, these institutions will be put to the test, as they have played a major role in the bubbles and crises of the last 30 years.

Irving Fisher already explained 90 years ago how to stop a deflationary de-leveraging crisis: you have to drive up asset prices, you have to provide liquidity, you have to restore the basis on which loans were granted. Clearly, the higher the debt, the harder that is to do.

Since the central banks can no longer do their trick, there is growing concern that the economy will continue to decline for longer and deeper. The longer phase 2 lasts, the greater the likelihood of a longer phase 3 - which in turn prolongs phase 2.

The answer will lie in coordinated monetary and fiscal policy: government economic stimulus programs financed directly by the central banks. Helicopter money, Modern Monetary Theory (MMT), Green Deal - we will get it all.

Two questions are relevant here: How long will it take to implement such measures and in which region of the world first? I bet on the US (China is certainly already doing this) and I think that the eurozone will take the longest. But even if: Phase 3 may be shortened. We can no longer prevent it.

Phase 4: The system question becomes obvious

It has been fermenting for a long time in the societies of the West. Since the financial crisis at the latest, it has become clear that the monetary system has become increasingly out of control due to the misguided incentives of the central banks and certainly in the interest of politicians. In essence, the following problems can be diagnosed:

The financial sector's share of economic output is increasing.
increasing zombification of the real economy
declining productivity advances
stagnating real incomes
increasing inequality of wealth distribution

The answers to these problems are not easy to find politically: it is a question of turning away from the drug of cheap money, real reforms to increase productivity and a reduction of the far too high debt. In Europe, the construct of the euro is added to this: instead of convergence, it leads to increasing divergence of economies.

The second financial crisis in ten years and the euro crisis, which is about to openly re-emerge after less than eight years, show citizens that politics is not doing its job. The inadequate response to the epidemic, i.e. the failure to defend the health of citizens, adds to this and will further weaken confidence in the political elites. Polarization and radicalization will increase. Meanwhile, the emerging nations of Asia are demonstrating how to do it: managed economies, strong states, stable financial systems.

The question of the system is on the table and the West is not doing well.

Outlook: Phases one through three will be with us this year. Let us hope that we succeed in making them as short and painless as (still) possible. Phase 4 is gaining momentum and presents us all with the bill for the denial and procrastination of fundamental problems in recent decades. There will be no "business-as-usual."
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