Pandemic Crisis: Dangers and opportunities Lim Mah Hui and Michael Heng

It is widely known that the Chinese word for crisis consists of two characters – “wei ji”. Wei stands for danger and ji stands for opportunity.  Every crisis is pregnant with danger and risks but also with opportunities – for some to make money, for others to learn valuable lessons, and for society to reorient or restructure its priorities, institutions and even the system.

Once in a Century Crisis

The COVID-19 pandemic, could turn out to be the singular biggest crisis in a century – a one in a 100-year event. It is a health crisis which if not checked in its track would be the most serious since the Spanish Flu of 1918 that killed over 50 million people. Within a couple of months the number infected has reached almost 1 million with over 30,000 deaths.

This crisis has morphed into an economic and financial crisis due to globalization. Due to the high degree of economic, financial, and transportation integration, countries have become so interconnected and  interdependent that a break down or severe shock in one part reverberates through the whole system. That is why when COVID-19 hit China and forced a shut down in certain regions, it delivered a supply shock to the world economy.

Economists initially focused on the supply shock and hoped that when China recovers the impact on the world economy could be minimized and a recovery would be swift. However, with air travel so prevalent, the virus was transmitted worldwide within a matter of weeks. In February only a few countries were affected, today 193 out of 195 countries are affected.

While the epicentre of the COVID-19 is China, the aftershocks felt throughout the world are now more serious than the place where it originated. The West, in particular Europe and the United States, have become the next pandemic epicentre. Already the number of deaths in Italy and Spain, as at this point of writing, has more than double of that seen in China. Entire countries are in lock down. This is not a demand shock but a demand collapse, the likes of which we have not seen for over a hundred years. The repercussions are almost indeterminable. When businesses are closed, companies lose their revenue, workers are laid off, companies with interrupted cashflow slide into illiquidity and eventually bankruptcy, more workers get laid off, aggregate demand drops. The Federal Reserve Bank of St Louis predicted unemployment in the US could reach 32%, surpassing that of the 1929 Great Depression.

Impact of Monetary Policies – setting the stage for a crisis

Even though this economic crisis did not emanate from the financial sector, what happened in the financial sector over the last decade played an critical part in aggravating it.

Central banks in US, Europe and Japan have lowered interest rates to near zero hoping that this will encourage people to borrow, spend and invest. It is intended to reduce the debt burden, as the indebtedness of households and enterprises has been ratcheted up in recent years (see below). But the past few years have shown that this has little traction. It’s like pushing on a shoe string.  Worse still the credit and liquidity are not going to the right places. Individual households with little financial resources and small businesses are shunned by banks. Instead, banks lent to corporations and financial institutions. Corporations gouged on cheap money and world debt to GDP rose from 200% of world GDP to close to 300%.  Unfortunately much of this debt did not go to productive investment as investment as percentage of GDP remained stagnant. Instead it went to inflating financial asset prices and in financial engineering tricks such as share buyback.

Financial Gimmicks

When companies buy back their own shares, demand pushes up price, and the number of stocks in the open market is reduced by the amount bought. With a lower denominator and the same earnings, EPS (earnings per share) automatically is inflated. Stock price is based on EPS; the higher the EPS, the higher the stock price and the more the CEOs’ remuneration as they are rewarded based on share price performance. The average remuneration of CEOs in the US has risen 940% since 1978 while that of workers inched up 12%. CEOs made 287 times more than their average employees in 2018. It is reported that the top 10 US airline companies used 96% of their free cashflow for stock buyback pushing share prices to record high instead of paying down debt and strengthening their balance sheet at the good times. This practice is ubiquitous and not limited to the airline industry. The moral hazard is that having depleted their cash, airlines are now seeking $200 billion of bail out funds from government.  In 2019, corporations buying their own stocks constitute the dominant source of equity demand, more than households, mutual funds and exchange traded funds.

Causes of Crises

Irrespective of the causes of financial crises, of which there are many, the one constant condition is excessive debt. Companies and individuals borrowing in excess of their ability to generate the income to pay off debt. The huge amount of liquidity unleashed by central banks created this mountain of debt leading to  a big asset bubble. It is a dry powder keg waiting to explode.  For months economists debated what might trigger a financial crisis waiting to happen. Could it be the trade war between US and the rest of the world, the US-Iran standoff, the global pandemic, cyberwarfare, diversification of US treasuries. Few, if any, anticipated that a humble, invisible bug, the COVID-19, would be the agent to ignite the powder keg.

Significantly, all the major financial crises over the last few decades were not caused by consumer price or wage inflation which the central banks watched over like hawks. They were caused by financial asset inflation that is a direct result of loose monetary policies described above.  As usual, central banks kept their eyes on the wrong ball. Not only that, they encouraged such behaviour by their asymmetric policies: on the one hand, allowing asset prices to rise eschewing any state policy intervention, chanting the free market mantra; and on the other hand, intervening to bail out or prevent decline in asset prices on the way down.

Despite the measures taken after the Global Financial Crisis that strengthened the banking sector, other structural reforms did not occur. Banks’ balance sheet were significantly strengthened thanks to public bailout and stringent capital ratio requirements, but other parts of the financial system became more speculative, fragile and unregulated. Finance which caused the 2008 Global Financial Crisis was the big winner post the GFC as the structural fallout was not severe enough. Today the health and economic crisis threaten a major financial crisis again.

Where do we go from here?

I started this essay by stating that crises offers opportunities for us to do something different.  It can be for the better or for the worse. Major crises are moments when classes in society contest for power to restructure the economy, politics and society. The failure of President Hoover to deal with the devastations of the Great Depression led to the election of President Franklin Roosevelt (1933-38) who introduced major structural reforms in the economic, financial and political spheres. His ‘3 Rs policies’ were relief, recovery and reforms. He implemented large scale public works to mop up unemployment, introduced social security safety net which still exists today, tamed and regulated finance by separating investment banking from commercial banking via the Glass Steagall Act, and set up regulatory watchdogs for the stock market such as the U.S. Securities and Exchange Commission (SEC). They led to the eventual recovery of the economy and most significantly to a well regulated financial system that did not experience major financial crises for over 40 years. Government took on a bigger role in the economy.

The stagflation  crises of the 1970s, triggered by oil price hikes and countered by accommodative monetary and fiscal policies led to serious inflation  and the demise  of Keynesian policies.  Discretionary policy by governments had become discredited by the failure to produce growth while reducing unemployment. As a result   President Reagan and Prime Minister Margaret Thatcher resurrected neoliberal market ideology – the role of government was severely rolled back and private sector and the market took control. Liberalization, deregulation and privatization were the new mantra. Government’s role was limited to creating conditions for business to grow and to fix the problems when market failures and problems arise.

Financial Sector the Behemoth

The financial sector was the main beneficiary of these policies. Finance became deregulated, banks merged, and became too big to fail. The US financial sector close to double its size to account for 19% of GDP; but it took home 40% of total US corporate profits. Financial innovations exacerbated speculation, risk taking, volatility and fragility. Consequently major banking crises erupted approximately every ten years with almost clockwork precision – beginning with the US-Latin American banking crises in early 1980s, Asian Financial Crisis in 1998, Global Financial Crisis (GFC) in 2008 and the imminent financial crisis in 2020. Finance instead of serving the real economy became its master as these crises originated in the financial sector; the tail is wagging the dog. In each of these crises the financial players were bailed out at tax payers expense and became bigger.

Some Silver Lining to Dark Clouds

If there is any silver lining to this dark cloud, it is found in some of the unintended positive consequences of this crisis – carbon emission that is choking the world is down significantly, traffic congestion has lighten up, mountain of garbage generated has declined, communities have gotten together to help the more unfortunate, and nature is reclaiming its space. As one US celebrity who was infected said in his interview, it is nature’s way of hitting back at what humanity has done to it. We were supposed to be the guardian and trustee of this earth but we abused it. Deforestation and the destruction of natural habitat has reduced the space between humans and wild life opening more chances for new forms of virus and contamination. Epidemiologists have warned for decades the potential and dangers of new pandemics. This is the most serious but unfortunately it may not be the last.

This multiple crisis – health, economic, financial and environmental – is a wake-up call for humankind to rethink its hyper consumerist economy that it prides growth, and at that, one that benefits a tiny segment at the expense of the majority. It offer us the opportunity to restructure society to one that is more socially and economically equitable, more respectful of nature and our environment, and a saner balance between non-materialism and materialism. Since the 2008 Global Financial Crisis, there was a nascent effort to move away from the obsession with GDP growth as the measurement of a society’s welfare and wellbeing. The small nation of Bhutan spearheaded the alternative concept of Gross National Happiness. But these movements were muted and side lined. This crisis offers us the opportunity to bring it to the fore. Prime Minister Ardern of New Zealand recently said she would prioritise her people’s wellbeing over growth.

Karl Polanyi 70 years ago published the Great Transformation. His great contribution was that markets has existed for thousands of years before the rise of industrial capitalism in 18^th century. Markets where goods and services are exchanged to meet social needs have also be subordinated to social, political and cultural norms. But this arrangement was overturned when market was deified to become the only organizing principle in society. Markets in society became the market society.  This formed the basis of the neoliberal ideology that has dominated politicians and their policies the last 40 years.

This crisis lays bare the myth of the invincibility of the market. Market has broken down in a big way and the state is asked to step in to solve this crisis – from bail out of companies, to paying wages of workers, to cutting interest rates, soft  loans to small business guaranteed by the state etc.  President Trump invoked emergency authority and directed companies to produce vital health equipment needed to fight the epidemic. Once this is over, we should not be going back to business as usual.

Markets will continue to exist and play a part in the economy. But it must be subordinated to society, to be regulated by the state to serve a greater good. The new economy must prioritise people’s as well as nature’s wellbeing over profit making for a few.

*Dr. Lim Mah Hui, economist and former banker and Dr. Michael Heng, former professor in management science

(This article was originally published in the Edge Malaysia April 6, 2020)