The economics of COVID 19

Medical workers in protective suits at a coronavirus detection lab in Wuhan. Picture: AP

Up to Friday, markets have been treating the China coronavirus, COVID 19, as nothing more than a mild deflationary shock and were celebrating the prospect of further monetary policy loosening to offset it.

It’s been the classic bad news is good news thing, with markets focused not on the news itself but on the likely central banks’ reaction to it: these days markets are more concerned about liquidity and interest rates than anything else.

The clue to this has been the reversal of bond yields. The US 10-year yield was rising after the low of 1.46 per cent in September and almost reached 2 per cent on January 1, but since then has to returned to 1.46 per cent as bond prices have rallied strongly.

And in a world where two-thirds of stockmarket buying is done by algorithms, that has been enough to push markets back above the pre-coronavirus peaks … at least until the economic data out of China becomes bad enough to tip the algorithms into selling mode.

There were some signs of rising anxiety on Friday with a 1 per cent fall on Wall Street, but whether markets now go into full correction mode, or hold these levels and continue to regard it as nothing more than a mild deflationary shock will depend on how long China stays locked down and whether the epidemic becomes a pandemic and the lockdown spreads.

If Chinese factories start to re-open over the next couple of weeks then the deflationary hit may prove to be fairly mild and temporary – enough to keep global monetary policy loose without serious economic harm, in other words, all good. Last week President Xi Jinping was urging China to get back to work, so maybe that’s what will happen.

And when things get back on track, share prices may get a double boost as businesses everywhere rebuild inventories.

If, on the other hand, the Chinese economy stays in lockdown mode for more than the next few weeks, then it is hard to see how a spiral of bankruptcies and job losses does not kick in and the Chinese economy takes a very significant hit.

And if it turns into a global pandemic – and panic - then all bets may be off for investors.

Pandemic was defined for me last week in a conversation with Dr Rob Grenfell, director of biosecurity at CSIRO: it’s when “the disease is replicating inside other countries that are not the source of where the infection started”.

On Friday the director of the World Health Organisation, Dr Tedros Adhanom Ghebreyesus, said the window of opportunity to contain the virus is narrowing.

Clearly the WHO is getting worried about the number of cases outside China, such as in Iran, where officials apparently said it’s in “all Iran’s cities”. Italy has quarantined a dozen towns as the number of deaths there reached three and the number of cases topped 150..

Dr Grenfell explained how this virus differs from SARS and MERS: it’s because of the low mortality rate – if the virus doesn’t kill many of its hosts, it has more chance to spread.

“We saw SARS back in the early 2000s, it had a fatality rate between 10-25 per cent, that’s not very good for a virus because it means that if you kill your host it doesn’t spread it.

“MERS came through and it was even worse with up to about 40 per cent-plus fatality. That too is absolutely not tenable for it. This time it looks like it’s got a fatality rate somewhere between 1.5-2.5 per cent.”

Up to Sunday there had been 78,823 cases confirmed and 2462 deaths, which is a mortality rate of 3 per cent, still very low. But if the infection rate is high – say, 25 per cent of the population – that can still be many thousands of people dying.

But another important difference between this epidemic and SARS is the existence of social media this time around, and with it the way panic tends to spread faster than the virus itself.

Social media not only spreads wild rumours, it also produces extreme reactions from politicians and businesses. We live in an age of “virtue-signalling” and an obsession with health and safety, with the result, for example, that 31 airlines have stopped flying to China whereas during the SARS epidemic in 2003, none did.

On the other hand, the global pharmaceutical industry and medical authorities may have been too complacent after SARS and MERS, not putting enough resources fighting such viruses.

Dr Grenfell calls it a market failure. “It’s market failure in that we haven’t been doing the preparative work for an epidemic like this coronavirus that we could have, like we do for cancers or, for that matter, cardiovascular therapies.”

He told me that the low mortality rate and the 18 months or so that it will take to get a vaccine approved means that this virus is going to stay with us.

“It’ll be another winter virus for us, and it’ll be reality for us to live with from now and into the future.”

Longer term, the coronavirus and the reaction to it may be another reason – on top of the pressure from the United States – for Western companies to look for alternative production capacity and sources of supply. Expat staff and their families may be reluctant to go to China, and work stoppages will have to be factored into cost calculations.

Whether that is deflationary or inflationary depends where production is moved to, if it happens. Companies moved production to China in the first place to take advantage of lower labour costs, which was itself a massive deflationary shock that was given the name “globalisation”.

If production is shifted back to America, Europe and Australia, costs and prices will rise. But if it’s moved to Bangladesh or Africa, the reverse would apply.

Alan Kohler is Editor in Chief of InvestSMART.com.au