Covid-19: Do we know what we are doing?

Morgan Housel, more often than not, makes us think. This post is no different (ht: Rohit Rajendran). How human minds work is fascinating. Not fully understood.

England is a fascinating example because of the relentless night bombings that took place during the Blitz. Sebastian Junger writes in his book Tribe:

Before the war, projections for psychiatric breakdown in England ran as high as four million people, but as the Blitz progressed, psychiatric hospitals around the country saw admissions go down. Emergency services in London reported an average of only two cases of “bomb neuroses” a week. Psychiatrists watched in puzzlement as long-standing patients saw their symptoms subside during the period of intense air raids.

Junger writes about the bomb shelters nearly all Londoners crowded into while their city above was decimated:

Conduct was so good in the shelters that volunteers never even had to summon the police to maintain order. If anything, the crowd policed themselves according to unwritten rules that made life bearable for complete strangers jammed shoulder to shoulder on floors that were at times awash in urine.

Of course, human minds can soar to greater heights and also plumb depths in crises. This is the other example: AIR INDIA staff not beng allowed to return to their homes in housing societies because they flew to Covid-19 hotspots and ferried Indians stranded there. This too is unsurprising.

Had to buy essentials and to attend to some chores on Monday. Stepped out after, quite a gap of spending time at home except for evening walks, in Singapore. In ‘Parkway Parade’ mall, it appeared to be business as usual on Monday morning. ‘Cold Storage’ Supermarket practised social distancing in the checkout queue. But, customers queueing up to enter the United Overseas Bank Branch were not doing that. 

Singapore announced further restrictions on Tuesday evening: shutting down bars and movie theatres and guidelines on how restaurants must seat customers. Religious congregations are closed. Some predictable surge in supermarket last night. Overall, the Singapore government management of the virus outbreak has come in for high praise and deservingly so.

That said, more and more voices are questioning the tightening of the social distancing measures across the world resulting in virtual shutdowns of societies and economies. The trade-off between health-lockdown and economic lockdown is coming into sharper relief.  

John Authers had alluded to a paper from the University of Bristol that models the inflection point at which the economic pains (including its impact on human health and life expectancy) begin to exceed the gains from the lockdowns that are currently in force in many parts of the world. The paper deals with the UK situation but the author points out its relevance for the rest of the world.

In a way, he provides the formal quantification for the questions posed by two economists and also by two professors of medicine. Writing for the New York Times, Paul Romer and Alan Garber question whether the US economy would die before the virus does. Specifically, they write:

Loan guarantees and direct cash transfers will stave off bankruptcy and default on debt, but these measures cannot restore the output that is lost when social distancing keeps people from producing goods and services.

To protect our way of life, we need to shift within a couple of months to a targeted approach that limits the spread of the virus but still lets most people go back to work and resume their daily activities….

If we keep up our current strategy of suppression based on indiscriminate social distance for 12 to 18 months, most of us will still be alive. It is our economy that will be dead. [Link]

Two professors of medicine at Stanford Medical School, writing for the Wall Street Journal, pose the same question in different words:

A universal quarantine may not be worth the costs it imposes on the economy, community and individual mental and physical health. We should undertake immediate steps to evaluate the empirical basis of the current lockdowns. [Link]

They are simply saying that the world does not know the true number of infected persons. All that it knows is the number of people dying. But, the first number is vastly understated, perhaps. Therefore, the true fatality rate must be much lower.

Actually, that point comes out in this article on the number of people infected and who died from the virus, aboard the Diamond Princess cruise ship: 

3700 passengers and crew aboard Diamond Princess; 800 infected; 46.5% were asymptomatic; 9 died [Link]

Confirmation comes from another source too:

Another team used data from the ship to estimate2 that the proportion of deaths among confirmed cases in China, the case fatality rate (CFR), was around 1.1% — much lower than the 3.8% estimated by the World Health Organization (WHO).

The WHO simply divided China’s total number of deaths by the total number of confirmed infections, says Timothy Russell, a mathematical epidemiologist at the London School of Hygiene and Tropical Medicine. That method does not take into account that only a fraction of infected people are actually tested, and so it makes the disease seem more deadly than it is, he says. [Link]

Michael Levitt, Nobel Laureate in Chemistry (2013) and Stanford biophysicist, also points to the evidence from the cruise ship Diamond Princess as indicating a not-so-scary picture. He is supposed to have correctly anticipated China’s total number of infections and the deaths. He makes one point about the media:

…he also blames the media for causing unnecessary panic by focusing on the relentless increase in the cumulative number of cases and spotlighting celebrities who contract the virus. By contrast, the flu has sickened 36 million Americans since September and killed an estimated 22,000, according to the CDC, but those deaths are largely unreported. [Link]

The Return of the Seventies

About two hours ago, the Federal Reserve Board (FRB) committed to buying unlimited amounts of US Treasury Securities and Mortgage Backed Securities.

More than that, the Federal Reserve is lending directly (almost) to businesses:

Establishment of two facilities to support credit to large employers – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.”

The PMCCF will allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic. This facility is open to investment grade companies and will provide bridge financing of four years. Borrowers may elect to defer interest and principal payments during the first six months of the loan, extendable at the Federal Reserve’s discretion, in order to have additional cash on hand that can be used to pay employees and suppliers. The Federal Reserve will finance a special purpose vehicle (SPV) to make loans from the PMCCF to companies. The Treasury, using the ESF, will make an equity investment in the SPV.

The SMCCF will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds. Treasury, using the ESF, will make an equity investment in the SPV established by the Federal Reserve for this facility.

Establishment of a third facility, the Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. The TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.

In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA.

This is unprecedented. The Central Bank is directly lending to the Main Street.

This took me to the piece that John Authers had written few days ago on the melting of the ‘Ice Age’, a concept proposed by Albert Edwards of SocGen.

There are two ways to interpret the calling of the ‘End of the Ice Age’ where Ice Age refers to low growth, deflation or very low inflation and low nominal bond yields.

End of Ice age and the arrival of helicopter money (see the Federal Reserve announcement above; it is almost there) which has been hastened by Covid-19 does not necessarily have to be an equity bull market. It could simply mean the end of the bull market in bonds.

In that case, we could have a return of the Seventies. Those were the years of stagflation. Bad bond returns and worse equity returns, in real (i.e., inflation adjusted) terms.

(1) Pl. see table below (Only USA):

Real Returns on US dollar instruments

Source: This is from the text book, ‘Macroeconomics’ by Dornbusch, Fischer and Startz.

(2) On Real S&P 500 Equity Returns:

(3) Nominal returns for S&P 500 are as follows and interesting:

Source: https://seekingalpha.com/article/2789035-s-and-p-500-index-returns-by-decade-since-1940 (accessed 23rd March 2020)

In the Seventies, nominal returns were positive mainly due to dividends and real returns were negative since the inflation rate averaged 7.2% per annum.

Now, American companies are not in the habit of paying dividends as the table above clearly shows. Therefore, nominal equity returns in the decade of 2020-2029/2030 could be low or negative and real returns even lower (more negative).

So, the end of Albert Edwards’ ‘Ice Age’ could hearld the end of the bond bull market rather than presage the continuation of the QE inspired bull market in stocks which had no fundametnal underpinning as David Rosenberg had pointed out.

So, quite why John Authers is ‘anxious’ (my impression, of course) to point to Albert Edwards as turning bullish towards equities or quite why Albert Edwards should be willing to let that impression prevail is not clear to me. Perhaps, it points to anxious personal hedging. It can be too lonely to be a bear in QE inspired world in which very few are willing to call the emperor out for his nudity.

It is worth keeping in mind that two wrongs cannot make a right.

Hard to better this clarity

Stretched asset prices matter more, because they pose the nearest and most substantial danger of a recession. Since the early 1980s, recessions in the West have all been driven by asset price busts, and not by the traditional fear of excessive wage increases leading to inflation. If this is true, monetary policy, and the regulation of capitalism more generally, need to be radically different. [Link]

William Rhodes, former CEO of Citibank wrote this in December 2019:

They are wrong in believing there will ever be a good time to curb financial excesses, as they fail to comprehend that delay now will make action in the future harder and costlier. [Link]

He was commenting on Chinese authorities. Is it true only of the Chinese g government?

This video provides you the ‘answer’.

So, these warnings and that of Gillian Tett in her most recent piece in FT, are likely wasted efforts. Pity.

The triumvirate of indexing

From John Authers:


LSE owns FTSE-Russell, one of the top three indexing groups (with MSCI and S&P Global) which have enjoyed enormous profits from the growth of passive investing. A new paper by Johannes Petry, Jan Fichtner and Eelke Heemskerk outlines how this Big Three has taken on enormous power over markets, with a role as the gatekeepers to equity capital now very similar to the role of ratings agencies in controlling access to credit. Chart below is from John Authers.

The paper that he links (see above) has this abstract:

Since the global financial crisis, there is a massive shift of assets towards index funds. Rather than picking stocks, index funds replicate stock indices such as the S&P 500. But where do these indices actually come from? This paper analyzes the politico-economic role of index providers, a small group of highly profitable firms including MSCI, S&P DJI, and FTSE Russell, and develops a research agenda from an IPE perspective. We argue that these index providers have become actors that exercise growing private authority as they steer investments through the indices they create and maintain.

While technical expertise is a precondition, their brand is the primary source of index provider authority, which is entrenched through network externalities. Rather than a purely technical exercise, constructing indices is inherently political. Which companies or countries are included into an index or excluded (i.e. receive investment in- or outflows) is based on criteria defined by index providers, thereby setting standards for corporate governance and investor access.

Hence, in this new age of passive asset management index providers are becoming gatekeepers that exert de facto regulatory power and thus may have important effects on corporate governance and the economic policies of countries. [Link]

We all know what has happened and is still happening with the ‘oligopoly’ in credit rating. This is one more. Oh, well….

Pillars of financialisation

In my column for Mint on Tuesday (my last column for the year), I wrote that two important and promising developments – although small – have happened recently. One is that the International Monetary Fund has a serious rethink on capital controls and its usefulness. It used to look down upon capital controls. No longer, it seems. See here.

Then, there was the OECD draft proposal on taxation of international companies. One hopes that the developed world would adopt it. It would vastly discourage companies from doing ‘taxation shopping’. I had written on it in a column for Mint.

The pillar that is still holding up financialisation (asset bubbles, executive compensation, stock buybacks, etc.) is central bank policy. The recourse to Quantitative Easing and Negative interest rates without any shred of evidence that it has been beneficial, on balance, is what continues to fan social, political and economic imbalances. The major central banks continue to embrace QE/Negative interest rates without any audit or honest appraisal of the costs and benefits. See this article and the second chart embedded.

In that sense, it is good that Swedish Riksbank, thanks to public pressure is turning its back on negative interest rates.

If 2020 sees a rethink on the part of major central banks, if they return to normalcy, the world can avert a bigger replay of 2008. Or, is it already too late?

USD above 7 CNY

This morning, as I type this, the USDCNY exchange rate is 7.0445. Bloomberg sends out a daily newsletter called ‘Bloomberg Opinion Today’. The remarkable convergence of the views stated therein tells me that reading all of them is a waste of time. For everything that happens, Donald Trump is to be blamed. Period. There are no shades of grey nor nuances. Whether Trump is being shrewd or smart or miscalculating or bumbling from one step to another or that he throws his rivals off-balance, these can be debated ad nauseam. We will not know until a good deal of time has passed. But, to provide no scope for alternative points of view speaks poorly of the platform.

America has labelled China a currency manipulator. Treasury department makes the call and it leads to some punitive actions. It is one of those unilateral measures that America takes, in many areas. Back in the early-2000s and even after 2008, Fed monetary policy stance could have been termed currency manipulation. In any case, China technically does not meet the criteria America has set out for currency manipulation and yet it was tagged. But, the punitive actions that have to follow have no sting because China does not have any US government contracts nor does it receive development funding. See this well-written news-story in Bloomberg.

George Magnus has a piece on it in Bloomberg. It says a lot but says nothing much that is new. The path of yuan from hereon will determine global currency arrangements. Possible. Methinks that the elections next year, the Federal Reserve policies and a possible bitter fight between an incumbent President fighting for re-election and the central bank in America will play a big role in the global confidence on the US dollar.

But, unfortunately for others and fortunately for America, there are many other factors that would play a big role in influencing the trajectory of the continued global role of the US dollar. All those factors underpin dollar’s strength because they undermine the claims of other currencies and countries to dethrone the US dollar.

For example, sample this comment from Magnus’ article:

A major Chinese investment bank recently suggested the industrial sector has lost about 5 million jobs in the last year, almost half of which are attributable to the trade war.  [Link]

Vladimir Putin who is widely hated by the mainstream English media has suddenly become quotable for them because Russia is coming good on its threat to diversify out of US dollar. Mildly interesting news but nothing more, for now.

Trump’s fights with the Federal Reserve on American monetary policy stance are more critical, as far as I am concerned, to the path and fate of the US dollar.

John Authers wrote, after the Federal Reserve Board Open Market Committee Meeting last week in which they cut the Federal Funds rate by 25 basis points, that Trump escalates the stakes in the trade war with China to force the hand of the Federal Reserve. I find the logic weird.

A far more reasonable proposition is that he wants monetary policy to help cushion the shock coming from his long-standing and long-running trade battle with China. He is anxious and he knows that market sentiment would sour as he escalates the fight with China. He wants the Federal Reserve on his side to cushion the impact on market sentiment.

Be that as it may, he is risking a big setback to global comfort with and confidence on the US dollar by haranguing the Chairperson of the Federal Reserve. Fed policy is already a slave to stock market gyrations. Trump’s tweets and angry comments are compounding the blows to the Fed’s already-battered credibility. That is the big threat to the US dollar. Not the path of China’s yuan.

If anything, China’s currency war games are a double-edged sword.

Yuan prospects

Read this in John Authers’ missive:

On the yuan, I found this point from Michael Howell of CrossBorder Capital very interesting:

The China currency is getting traction and could displace the USD in Asia (China’s stated aim). What is not well understood is that China still has an immature financial system which forces it to accumulate USD (from trade which is USD denominated) and manage them centrally via the State. Domestic institutions, unlike in the West, have predominantly Yuan liabilities and so cannot afford to take this forex risk. China initially used forex reserves to buy US Treasuries, but now invests via FDI, e.g. Belt and Road. This external infrastructure programme will help to establish the wider use of the Yuan across Asia and get China off the US dollar hook. Do not underestimate the value of this seigniorage for growth.

He could even back it up with an anecdote:

I attended the LSE launch of George’s book. There I met an ex-Central Bank Governor from Central Asia who shared my scepticism about George’s Yuan point. “I will show you,” she said and pulling out her iPhone she shared a photo of her at a formal signing ceremony for a several billion Yuan swap line with the Chinese Finance Minister. Proof she claimed that this underlying use of the Yuan is already the reality across Asia.  [Link]

Let me now do what my good friend Amol Agrawal of ‘Mostly Economics’ usually does.

H…mmm