Wednesday 12 May, 2020 by Stephen Pope

COVID is coming

My first genuine encounter with the impact of Coronavirus or COVID-19 was on Tuesday, January 28. I was working at the U.S. investment bank, Morgan Stanley, delivering a workshop on the subject of “LIBOR Transition"

During a coffee break I overheard a bank executive discussing with a colleague the steps that were being taken to rearrange meetings with Chinese manufacturers in the city of Wuhan. At the time I must admit, such was my focus on my own daily agenda, it did not truly register with me that the world stood on the cusp of an economic calamity.

That was the last time I visited London, as another engagement with JP Morgan Chase in Canary Wharf scheduled for March 12 was cancelled given the precautions the bank was taking ahead of the government lockdown. The happy memory of making a family visit to the Tutankhamun exhibition at the Saatchi Gallery on January 2 seems a long time ago. Certainly, it was “BSD”: before social distancing!

An impiety for established theory

Ever since my graduation from Warwick in 1982, economics has featured heavily in my career. So, naturally during the lockdown I have actively considered how the U.K., European and indeed the global economy is being affected in the biggest shock since the global financial crisis (GFC) of 2007/8 and maybe the greatest economic dislocation since WWII.

The impact has seen many businesses having to close, hopefully temporarily, and governments around the world taking drastic action to flatten the curve of contagion to protect health services and save lives.

I have been running my own research and advisory firm, Spotlight Group, for 10-years. As I approached writing a first paper about this crisis, I looked back to first principles by considering a simple aggregate demand and supply model. Such has been the extent of globalisation that as China acted to close Wuhan so global supply chains were squeezed, causing a decline in aggregate supply, i.e. the curve moved to the left.

Had there been no change in aggregate demand, prices would have risen. That was not the case, for almost all nations (bar Sweden) have closed much of their economies. The result has been consumers and corporations curtailing consumption and investment plans. Yes, governments have radically increased state expenditure, however, much of this has gone into support programmes to guarantee loans and wages.

Even if there were huge increases in expenditure on “shovel ready” infrastructure programmes, the need for social distancing and the bottlenecks in the supply chain would prohibit such activities being efficiently undertaken.

One aspect of trying to protect the economy is that when the markets needed the central banks to survive, they showed up and their actions bought time in an era of doubt.

Please stay safe and be optimistic. Where we are now, is not the final destination

What is certain, however, is that in parallel with the vast swathes of liquidity added by central banks, the nimble steps taken by governments mean that sovereign debt will rise dramatically. Even the Eurozone has scrapped the stability and growth pact by announcing the “Great Escape Clause”, allowing as much debt and state intervention as each member state needs.

So, we should ask the question, “Who owns this crisis?”. The answer is “We all do”. So instead of having parcels of debt owned by and owed to one another are we going to enter a period of debt relief for the developed and well as the developing world?

If it is possible for central banks to quantitatively create money, and indeed create “bad banks” in the GFC to hold the non-performing debt, why not create a “Coronavirus Portfolio” that could absorb the emergency debt issued to contain the pandemic and keep it away from the main balance sheet? Maybe the academic purist would shoot holes in this idea, but we live in chaotic times and as necessity is the mother of invention, weird is what we must do.

After all, the ECB is laying the ground to be able to acquire “junk rated paper”. If they do not, there is a severe risk that Italy, rated just one notch above junk with all ratings agencies, will default. Greece was just 1.5% of the Eurozone’s GDP… Italy accounts for 14.9%.

Microeconomics cannot be overlooked. We see many industries reeling in distress, e.g. travel and leisure is on the rocks as is retail, and manufacturing has fallen off a cliff. As travel is curtailed so oil demand has faded, just at a time when the Saudis and Russians were engaged in a bitter production war.

On April 15, The Wall Street Journal reported that the International Energy Agency (IEA) had forecast oil demand would fall by 9.3 million barrels per day during all of 2020, with April demand off by 29 million barrels each day, down to a level not seen since the mid-1980s.

Therefore, storage space, both onshore and offshore, has filled. With no demand and an extreme of excess supply, prices had to fall.

That said, I never recall in 1978/79 Peter Law or John Cable introducing a chart to show a commodity finding an equilibrium price below zero. Yet, on April 20, on the last day of full trading of the May 2020 contract for West Texas Intermediate, the contract settled at -USD37.50/barrel. Those who had oil had no need for it and nowhere to store it, so they were prepared to pay other market agents to take it off their hands. Smaller contracts have settled below zero before, but never the most liquid global contract.

That, along with negative bond yields, means a few chapters must be added to the textbooks for future use.

Working on the down low

We have all been advised to stay safe and stay at home. For many, the initial sense of enjoyment at being at home has turned to boredom. I, fortunately, am not in that group as I have been able to continue my work with Spotlight and other activities.

I also work as a visiting professor at the School of Business and Economics at the University of Maryland Global Campus (UMGC), delivering education to U.S. military and diplomatic personnel. We have an advantage in that many courses have already been delivered in a hybrid format, with students both in my lecture hall on a face to face basis and others, including on a remote military base, dialing in via Zoom.

Such is UMGC’s experience in the field of virtual education that in the U.S., team members have been assisting many of the prestigious Ivy League universities.

UMGC has migrated all classes to Zoom and so far, everything has worked out well. There are certain difficulties for science subjects where lab work is required, however, I believe my colleagues are finding a solution.

At the start of this essay I mentioned training. The good news is that rather than seeing all the banking clients abandon their education schedules, these are also being redesigned for virtual delivery.

Unlike lectures, where it is mostly one person speaking to impart knowledge, the training must have a high level of interactive exercises and open discussion. This can be achieved by using breakout rooms, and whilst not as good as the reality of the face to face delivery, a little imagination can breathe life into what might be an otherwise dull experience. One must lift tonal and emotional range and not inflict death by PowerPoint.

I know that when this is over, there will be a reckoning. Will the rest of the world demand financial compensation from China? I am sure that we will witness a degree of shortening the supply chain.

The process of globalisation was meant to reduce cost and boost the bottom line. This crisis has holed that concept below the water line and I can foresee certain “mission critical” operations being brought back home to protect the flow of inputs. Making a reasonable profit is better than no profit.

Political boundaries may merge even more, as post-COVID-19, I imagine society will demand that a greater share of national wealth is directed to what is arguably of greater import to the economy than finance - the health of the nation.

Please stay safe and be optimistic. Where we are now, is not the final destination.