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Coronavirus: The biggest economic risk is not China

It’s the USA.
It may be seen as a major driver of economic activity, but a lot of what China relies on is demand from the US. Image: Shutterstock

The current period of economic growth in the USA is the country’s longest since the mid-1800s. The US economy has now been growing consistently for almost 10-and-a-half years.

However, while the length of this expansion is unmatched, its rate is less impressive.

“It is the weakest since records began,” notes the chief economist at Schroders, Keith Wade. “In this expansion, the average growth rate has only been 2%. That is a lot less than we’ve seen in previous expansions. Back in the 1960s, you had expansions of around 5% per annum.”

Source: Refinitiv Datastream, National Bureau of Economic Research, Schroders Economics Group

Partly, as Wade explains, this is because productivity growth since the great financial crisis has been disappointing. However, the main factor is that the US consumer has not been as influential as in the past.

Consumer weakness

“Consumer spending is always the main driver of economic activity,” says Wade. “It always makes up around 70% to 80% of growth.”

In this cycle, however, it has been far weaker than in any other expansion since the 1950s.

“It’s not difficult to explain why,” Wade says. “The great financial crisis saw a major change in consumer behaviour.

“Suddenly, people found that they couldn’t borrow, or didn’t want to borrow. They had overextended themselves.”

Household debt, which is an important factor feeding economic growth, has therefore actually declined sharply over this period, instead of going up as one would usually expect that it would.

“As a percentage of GDP, household debt has been falling for 10 years,” Wade points out. “We have never had a period where people have deleveraged for so long.”

A viral problem

This is a significant consideration when analysing the potential impact of the coronavirus Covid-19 on the world economy. As MSCI argued in a recent investment note:

“The global spread of Covid-19 is already affecting global growth.

“Disruptions in the global supply chain and decreased consumption affect companies’ earnings in the short term. Combined supply and demand shocks could lead to a severe short-term decrease in GDP growth.”

The focus of this impact has primarily been in China, which is where the virus originated. Figures on car sales in the country published this week, for instance, show an 80% decrease for February this year.

Other data also reflects the severe slowdown in economic activity in China. The following graphs illustrate how the usual rebound in activity that usually follows the Chinese New Year has almost been entirely absent in 2020.

Source: Wired, Amap, UBS, Schroders Economics Group

However, the impact is far from limited to the Chinese economy alone.

The UN Conference on Trade and Development (Unctad) published a special issue of its investment trends monitor on Sunday revealing that more than two thirds of the multinational businesses in its Top 100 have issued statements about the impact that coronavirus is having on their operations.

“Many are slowing down capital expenditures in affected areas,” Unctad notes. “In addition, lower profits – to date, 41 have issued profit alerts – will translate into lower reinvested earnings.”

The big concern

That illustrates the global impact that it is having. The ultimate question, however, is how much this will extend to the US consumer.

“If the US consumer is weak, the US economy is weak, and the global economy tends to be weak,” explains Wade. “Because we don’t have any other major drivers of economic activity. People often say that China is a major driver of economic activity, and it is in many sectors. But a lot of what China relies on is demand from the US. China itself doesn’t tend to drive a lot of overall activity.”

How significantly Covid-19 impacts US consumer spending is therefore going to be critical.

“We’ve often described the world economy as a bit of a wobbly bike,” Wade says. “It’s not actually moving very quickly, and if it hits a shock it’s likely to fall over.

“That is, in a way, how we are thinking about coronavirus,” he adds.

“We’ve had a big shock and a number of economies are going to roll over as a result of that. So there is this risk of global recession. If the coronavirus continues and it does spread to the US, then the world economy as a whole is really going to struggle.”

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Well, you said it- The Dodd-Frank act is more devastating to the economy than Covid-19. Economic growth is the result of credit expansion, and the banking regulations, that was enacted in 2010, restrict credit expansion.

Covid-19 is not so much of a problem, but people’s reaction towards it is. The economic crisis of 2008 could have been long forgotten, but the implementation of banking regulations extended and amplified economic problems and restricted growth. All the newly-printed money went into financial assets and not into the “real” economy. The enactment and eventual repeal of banking regulations are merely part of the larger economic super-cycle I suppose.

I’m not sure if you are being sarcastic here.

I’m not sure if you are being sarcastic here.

So you are positive about the banking regulations if I read you correctly? Banking regulations should be way more restrictive as far as I am concerned. We should have free banking and a 100% reserve banking system without a Central Bank.

My preference is not the topic of discussion here though. The article is about constrained consumer spending. Consumer spending is a function of lending. Therefore, banking regulations constrain consumer spending.

After 1933 we had Glass–Steagall legislation, which was repealed by Clinton. After 2008 we got Dodd-Frank, that is in the process of being repealed by Trump.

Excuse me.I think I’ve misread you. I agree that the repeal of Glass-Steagall has been a major contributor to the inflated valuations we have now. And Goldman wants to get rid of Dodd-Franks.
I also agree on your central bank opinion. It always amazes me that the same people who deride socialism and praise the free market are content with centrally planned money supply and interest rates that are manipulated by a committee of unelected bureaucrats.

Yes, thank you Oubok.

Central Banks are central planners of the economy. In the same way that GOSPLAN in the USSR failed to account for all the variables in a diverse economy, no Central Bank can ever have all the information to enable it to determine the most appropriate level of the money supply. Therefore, just like GOSPLAN, they would rather err on the side of caution by expanding the money supply before they have a contraction on their hands.

The appropriate allocation of scarce resources was the biggest problem for communist central planners. This is also the biggest problem for the current Central Planners of the monetary system. We experience a misallocation of capital, where financial assets are in an extended bull market while the real economy is in decline. This leads to constant boom and bust cycles. The seeds of economic contraction are sown by the Central Bank during the boom years.

In order to stimulate sustainable real growth on an international scale, we need a gold-standard with a 100% reserve ratio, free banking system, without Central Banks.

Until that happens, we should exploit the current system to the maximum.

Von mises quote about why we cannot have 100% reserve ratio.
“Issuing money-certificates is an expensive venture. The banknotes
must be printed, the token coins minted; a compIicated accounting
system for the deposits must be organized; the reserves must be kept
in safety; then there is the risk of being cheated by counterfeit banknotes and checks. Against all these expenses stands only the slight
chance that some of thc banknotes issued may be destroyed and the
still slighter chance that some depositors may forget their deposits.
Issuing money-certificates is a ruinous business if not connected with
issuing fiduciary media. In the early history of banking there were
banlis whose only operation consisted in issuing money-certificates.
But these banlis were indemnified by their clients for the costs incurred. “

Blokchain database… Fully digital, not expensive to run. Banks should not leverage their client’s money, it is not their money in the first place. If a lawyer plays the horses over the weekend with the trust’s money he will go to jail, why should banks be treated differently?

The US consumers are artificially bouyed by quantitve easing and that is not sustainable. The inflection point is when it does not make sense for the creditors to hold that much US bonds or cash.

Please note that we should all be heading off shore to diversify into this mess – wasn’t that the flavour of the last year or so that was punted to the average Joe?

Johan_V,
Absolutely if you had headed offshore on the 1st Jan 2020, $1 would have cost you R14, today a $ will cost you R16.30 you do the math my friend.

About the same what Wall Street lost since then.

pisces, the issue is Wall Street will come back and so will the dollar. You need to ask yourself will the Zar ever come back or will it carry on depreciating like it has for the past 15 years? Just let junk status, Land Expropriation without Compensation, and prescribed assets all kick in. Sprinkle a bit of a recession and Eskom on the top of that and you have a lovely mix.

You welcome to go long on the Zar and the JSE. I will keep my hard earned money as far away from the ANC’s grubby paws as and SA’s downwards spiral as possible.

Johan V absolutely and yes any day of the week, offshore is the place to be, look where the rand was on Jan the 1st and look where it is today. Unfortunately my comment has again been held for moderation.

Given the current conditions of economic contraction, it might be somewhat wiser to consider only a proportionate exposure and then also on a phasing-in basis rather to Euro-zone stocks, ETF’s or Unit Trusts and similarly also to some international emerging markets. Be careful for the U.S.A. A majority of the top 100 companies foresee a drop in profits and investment earnings (irrespective of COR-19). The Rand exchange rate is only one side of the coin. The other side is as always direct investment return.

France, I have been waiting patiently for this black swan event for a few years now and to get 2 in a month is unheard of magical for the want of a better word. My plan going forward is simple. I have a high exposure to the S&P 500 so there I will stay, I like American stocks, and the rest is in cash ($ to be exact). Now I will try my best to sit on my hands and wait patiently for this to play out. Sometimes sitting on your hands and ignoring the noise is the hardest thing to do.

Good article, Thank you. It holds a lot of very valid points but I’d like to point out some omissions that effect the perspective of the reader. As stated consumer spending makes up 70% of the US GDP print and if this is threatened by CoVid then the US economy is also at risk of recession, however figures coming out of the US this year have been remarkably strong, new jobs, average wage growth and unemployment levels. These all point to strong consumer purchasing power and if there is demand, it will be filled one way or another.

Additionally, the points made regarding the rate of growth being “less impressive” than the length of the current growth phase are somewhat misleading. The reason for the extended growth phase is because of the rate of growth, slow and sustainable rather than fast and sharp. If we look at Aus, they have been in a growth phase for 24 years, and much like the US their growth has been slow and sustained with low inflation and strong economic fundamentals.

For an economy the size of the US (largest in the world), who make up 15% of global GDP but 4% of global population and 6% of the worlds landmass, growth of 2% is remarkable.

Thank you for your articles, I find them really interesting.

I still think that the ANC beats Corona and China.

As a force for damage, yes indeed.

Yes, you’re absolutely right. ELearning ways also talks about this matter and said US is the main

Never has the saying “USA sneezes and the rest of the world gets influenza” been more literally true.

Having ground zero moronvirus in the White House amplifies the risk.

The difference is that the Bank is telling you that its lending your money out whereas the lawyer is probably not telling you he is borrowing the money to bet on horses. Secondly betting on horses carries a much higher risk then the bank lending out money (bank have rules to follow). Thirdly the bank is paying you some of the profit to you in the form of interest. If it could not lend the money out it would not pay you interest to compensate for your risk undertaken. You would have to pay the bank for watching your money.

End of comments.

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