Coronavirus contagion spawns climate of panic on share markets

Updated February 28, 2020 23:02:35

Video: Coronavirus fears send shares from records into freefall (ABC News)

Contagion. It's the word the world's top health authorities dare not utter. But it's the medical term that has transitioned to the finance world that now lurks in the thoughts of most senior central bankers and treasury officials across the globe.

The coronavirus COVID-19, once contained in China's industrial heartland, has now spread to Europe and the Middle East, spawning a climate of panic that threatens to undermine not just financial markets, but the global economy.

A week ago, Australian stocks were riding high, riding on the record-breaking coat-tails of Wall Street.

Delayed coronavirus reaction

Share markets have roared blithely higher as the coronavirus outbreak worsened in China, but that complacency appears to have been punctured in the biggest sell-off for two years, writes Ian Verrender.

In the space of just six brutal trading sessions, however, the mood has turned from serene optimism to abject fear.

Fear is a powerful and primitive human emotion and, when deployed en masse, a force more powerful and debilitating to financial markets than any other.

While COVID-19 may have been the catalyst for this week's dramatic turn of events, the real malaise underpinning the ructions on financial markets relate to just one thing — debt.

Global debt has exploded

Worldwide, debt has exploded since the global financial crisis. It was the debt crisis we solved by piling on vast quantities of extra debt.

Almost every country has some form of debt bubble.

In Australia, we hold world record levels of household debt. The US Federal Reserve holds more than $US4 trillion in debt securities that it used to pump up the global economy. Plus, this year, the Trump administration is likely to rack up a $US1 trillion budget deficit, adding to public debt.

Coronavirus not the only cause of falling Aussie dollar

Interest rates, trade tensions and the recent bushfires are other factors contributing to the fall of the Australian dollar.

China, the world's second biggest economy, has debt bubbles at government, central bank and corporate levels.

And let's just not talk about Japan, which has a government debt of around 260 per cent of GDP.

Then there is the vast accumulation of debt in developing nations, which the World Bank estimated at $US55 trillion in 2018.

"The size, speed and breadth of the latest debt wave should concern us all," World Bank group president David Malpass said in December.

The rationale for all this was to spur investment: for individuals and firms to borrow money to invest in new factories, in plant and equipment. It was supposed to create jobs, boost demand and fuel inflation and wages. The debt would then fade into obscurity.

Instead, it has mostly just inflated asset prices. Housing prices have gone nuts. Global stock markets have been soaring, scaling new heights even as the global economy has barely been stumbling along.

With so much debt issued at record-low interest rates, it has become almost impossible for policymakers to even consider raising interest rates in good times, for fear of creating a debt default avalanche.

That became obvious when, as the US economy began sputtering back to life in 2013, the Federal Reserve announced it would start to wean financial markets off stimulus. Wall Street had a conniption that spread across the globe.

It happened again in 2018 when, after raising interest rates on eight previous occasions, Wall Street took fright at the prospect of interest rates heading back to anywhere near normal levels.

Add in President Donald Trump's escalating trade war with China, and the US Fed was forced to reverse tack, cutting interest rates twice last year and restoring Wall Street's record-breaking decade-long bull run.

Debt the death of coronavirus-affected businesses

Even under ordinary circumstances, the outbreak of a major global health pandemic such as this would hit commerce and industry hard and rattle financial markets.

Coronavirus recession?

The economic fallout globally from the coronavirus will be far worse than SARS now that China is so critical to the global, and especially Australian, economy, writes Ian Verrender.

But, with so much debt, the impact will be magnified. Just as debt amplified the rises, it will exacerbate the falls. And with so much uncertainty around how long the virus will remain unchecked, the potential impact on industry and earnings is enormous.

China attempted to contain the outbreak, unsuccessfully as it turned out, by almost shutting down its economy.

The grim cost of those measures alone, yet to be fully tallied, will provide a serious shock to the global economy.

If those measures are replicated across Europe, the US and the developing world, there is a real and growing prospect of widespread corporate collapses, job losses and a broad economic slowdown, perhaps even a global recession.

The companies most at risk will be those labouring under massive debt. That's why Wall Street is shuddering, for traders now realise just how fragile the foundations of the current boom really are. The rush for the exits is turning into a stampede.

The problem for policymakers is two-fold. The first is to try to halt the current market slide, which has the power to undermine consumer and business confidence and spark an economic downturn on its own.

Then there is the near impossible task of inoculating the real economy from the virus if there is a mass shutdown of industry.

If history is any guide, the immediate solution will be interest rate cuts backed by radical measures, which could include money printing and possibly even cash handouts, as has just happened in Hong Kong.

Video: How coronavirus sparked a global emergency (Four Corners)

Topics: stockmarket, currency, markets, epidemics-and-pandemics, futures, money-and-monetary-policy, economic-trends, banking, australia

First posted February 28, 2020 14:25:19