The economic fallout from the coronavirus pandemic is accumulating rapidly, much like the overflowing garbage on the streets of Los Angeles. Supply chains are disrupted, factories in China are shuttered, iPhone production has stalled, and there are significant shortages of products manufactured in China. With these trends, we can only expect conditions to worsen before they improve.
The financial consequences will be dire. As China’s economy stagnates, with first-quarter GDP growth projected to hover around zero, the global economy—including that of the U.S.—will face significant disruptions. This raises a critical question: what happens if many of our low-cost, Made-in-China goods go on an indefinite hiatus?
Truthfully, the global economy is overdue for a synchronized downturn, and the coronavirus may just be the catalyst. This inevitability would have manifested itself eventually, with or without the pandemic.
Nevertheless, the panic induced by a rapidly spreading virus can amplify anxiety. A typical recession and bear market evoke concern, but when combined with a hyper-contagious virus, they can provoke widespread irrational behavior.
Currently, despite a slight market dip yesterday, major U.S. stock market indexes are nearing record highs. This resilience can be attributed to investors’ expectations of continued Federal Reserve intervention. However, that’s not the only facet worth noting.
The yield on the 10-Year Treasury note has dropped to 1.50 percent, nearing the lower threshold of the federal funds rate, currently set between 1.5 and 1.75 percent. Essentially, Treasury investors have already hinted at the Fed’s next move. Similarly, gold prices have surged past $1,620 per ounce, further signaling market anticipations.
But what’s truly unfolding? And is it time to sound the alarm?
Should You Panic, Yet?
The answer largely depends on whether you are a borrower or a lender, so some context is essential.
In a fair financial agreement, both parties benefit: the lender receives reliable payments, while the borrower invests the funds into projects expected to yield returns greater than the loan. However, when the borrower fails to abide by the terms, situations can deteriorate quickly. This may lead the borrower to seek bankruptcy protection or force the lender to seize collateral.
During periods of economic growth, bad loans can be absorbed without much consequence. However, as the growth period extends, complacency often sets in, leading to increased debt levels and a reduced perception of risk.
At the peak of the credit cycle, market capacity has outstripped demand. Businesses and consumers, overconfident in the strength of ongoing growth, ignore their escalating mistakes. Ultimately, the cycle ends at the most inopportune moment.
The financial system becomes increasingly fragile, and any minor event can precipitate a crisis.
“Neither a borrower nor a lender be,” Polonius advises in Shakespeare’s Hamlet. If we must choose, being a lender is often more advantageous, but this isn’t always the case. In scenarios following a widespread credit expansion, both borrowers and lenders face dire consequences.
China’s Debts are Coming Due at the Worst Possible Time
Credit-fueled boom-bust cycles can be devastating, compounded by central bank policies aimed at moderating the business cycle. Instead of smoothing out peaks and valleys, stimulative fiscal and monetary strategies tend to magnify these fluctuations.
It’s almost uncanny how the genesis of the coronavirus outbreak has coincided with China at this critical juncture.
A particularly reckless example of destructive stimulus in the past decade is China’s enormous concrete production. The influx of credit to spur construction has driven the country into a frenzy, resulting in a staggering amount of concrete spread across vast landscapes.
To illustrate, China utilized 6.6 gigatons of cement between 2011 and 2014 alone—an unfathomably large amount. For context, the U.S. consumed only 4.5 gigatons over the past century.
What motivated an entire nation to act so recklessly? Unsurprisingly, misguided stimulus policies led to widespread malinvestment and an overextended capacity that may never realign with real economic demands.
Over the past ten years, China has taken on substantial debt to support unprecedented infrastructure development. Roads, bridges, airports, and entire ghost cities were constructed in a spectacular yet potentially catastrophic boom. The impending debt reckoning is approaching at a particularly inopportune time:
“More than 2 trillion yuan ($283 billion) of local-government notes will mature in 2020, according to Bloomberg-compiled data — a record and 58 percent more than [2019] level.”
How will local governments manage repayments as their economies remain under lockdown due to the coronavirus? Unfortunately, it seems that neither borrowers nor lenders will find a favorable resolution.
Sincerely,
MN Gordon
for Economic Prism
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