Please note: this report reflects the assessment by Beijing’s leadership of the Federal Reserve and European Central Bank actions, potential US fiscal actions, risk points, and the impact of policy decisions and recent global events on global economies and markets. It is for informational purposes and does not and is not intended to represent the views of SGH Macro Advisors.
China’s Premier Li Keqiang presided over an emergency meeting of top officials last Saturday in Zhongnanhai to assess the impact of the COVID-19 pandemic on the global economy.
In attendance were the heads of the National Development and Reform Commission (NDRC), the Ministry of Finance, the People’s Bank of China, the Ministry of Commerce, the Ministry of Industry and Information Technology, plus the heads of two of the three the top regulatory agencies, the China Banking and Insurance Regulatory Commission (CBIRC), and the China Securities Regulatory Commission (CSRC).
At the invitation of Premier Li, the meeting was also attended by former Finance Ministers Xie Xuren and Lou Jiwei, as well as by former PBoC Governor Zhou Xiaochuan.
*** The meeting concluded that signs are increasing the COVID-19 pandemic will lead to a global recession. Furthermore, officials voiced concerns that the impact of COVID-19 on the global economy could be as bad as the Global Financial Crisis of 2008, and perhaps even worse and longer in duration. ***
*** The economic leadership in Beijing believes, however, that central banks and fiscal authorities should wait, or should have waited in some instances, until after the pandemic is brought under control before rolling out any large-scale stimulus measures. Any premature actions, in their assessment, will only get swallowed by the downdraft of negative news surrounding the pandemic. ***
*** Beijing believes the ECB decision to pump liquidity while holding off on even deeper rate cuts into negative territory was the right one. On the other hand, even while the meeting was held before the Fed decision on Sunday to cut rates straight to zero, and while the attendees expected such a move to be coming “at or before the March 17-18 meeting,” they expressed concern over such an aggressive cut in rates. Cutting rates to zero so quickly ran the risk, they felt, that it would send a signal to the world the Fed believes the US economy is facing a deep recession. ***
*** Without targeted and sustained fiscal stimulus, even with the Federal Reserve cutting rates to zero, attendees believed there is a high probability the 11-year bull market in stocks may end and turn into a bear market cycle. While the US banking system is, beyond question, healthier than it was in 2008, attendees expressed concerns that a healthy banking system could quickly turn vulnerable when the underlying economy is hit hard for a few months, and pointed to the rapid collapse of Lehman Brothers as a living example. ***
*** The meeting, from what we understand, stressed that Chinese financial institutions should therefore “continue to persistently reduce their holdings of US dollar assets.” ***
Stacking Today against 2008
As they compared the 2008 crash and recession to today, meeting attendees noted that the 2008 global financial crisis was primarily caused by deregulation in the financial industry that permitted banks to engage in “hedge fund type” trading in derivatives.
When the value of those derivatives crumbled, banks stopped lending to each other, creating the financial crisis that led to the Great Recession.
The current economic recession is of course caused by the COVID-19 pandemic, and as such, it not only impacts the global industrial chain, but hits directly at a host of industries including trade, transportation, education, sports, entertainment, catering, tourism…the list goes on. And this, they believe, will ultimately affect the banking sector and global financial markets in a significant way.
Stated more starkly, compared to the recession caused by the 2008 financial crisis, they are concerned that this economic recession is being brought about by severe depressions in the real economy, most acutely the service sector, that will lead to an overall contraction of the financial sector, where a large number of financial institutions that have poor asset quality could go bankrupt over the next few months.
Cavalry Should Come After, not Before Pandemic Abatement
And in what will surely be interpreted as a provocative assessment of the appropriate financial policy responses under this outlook, the economic leadership in Beijing believes no country should undertake massive economic stimulus until after the pandemic is brought under control.
Any announcement of economic stimulus measures, they believe, that is premature will only be offset by the continued spread of the pandemic. Global markets will remain highly volatile until the COVID-19 pandemic around the world, particularly in the US and Europe, is fully contained, and Beijing believes several countries are already likely to experience financial crises in the coming months.
Global trade is expected to enter negative growth this year, and the WTO forecast of 2.7% growth in global merchandise trade this year is simply impossible. China’s exports, for one, are likely to register negative growth.
Watching the ECB, Fed, and Capitol Hill
While markets may not have liked ECB President Christine Lagarde’s delivery, the Zhongnanhai meeting attendees all in all agreed with the decision by the ECB Governing Council to roll out a comprehensive package of monetary policy measures designed to ensure liquidity support during the COVID-19 crisis, while refraining from cutting interest rates deeper into negative territory. A deeper cut into negative territory, in their assessment, could have made liquidity maintenance for banks as well as companies even more expensive in the Eurozone.
Not surprisingly, they emphasized the need for all member states of the European Union to take targeted and timely actions to address the public health challenge and mitigate its economic impact. And for when the COVID-19 pandemic is brought under control, they hoped the EU would adopt a “fiscal first” policy to provide support for affected companies and employees.
The meeting also acknowledged that the administration of President Donald Trump would do its utmost to respond to the pandemic with aggressive fiscal policy, and by pressing for loose monetary policy. They expressed concerns these efforts could result in less than desired outcomes.
Beijing worries that the timing of the Federal Reserve’s March 3 intermeeting 50 basis point interest rate cut may have been hasty and conducted under enormous pressure from both President Trump and Wall Street.
Fully expecting on Saturday that the Fed would, by the March 17-18 meeting or sooner, cut rates by 100 basis points to zero, as they did the next day, Beijing officials furthermore worried that such a move could result in another replay of the March 3 intermeeting cut, in its execution this time sending an even stronger signal to the world that the US is, and not just may be, facing a recession.
Officials noted that the US banking system is considerably stronger than it was in 2008 but raised concerns that a few months of protracted economic weakness could turn than around quickly and urged Chinese financial institutions to “continue to persistently reduce their holdings of US dollar assets.”
As to an assessment of the fiscal debate raging in Washington, Beijing is concerned a payroll tax cut may not be the optimal policy tool for delivering the needed targeted relief to the US economy.
Their concern is it may prove to be a short-term measure, and one that could divert fiscal resources away from a focus on providing direct assistance to hard hit sectors and workers.
But with the US and global economies in full on crisis more, those distinctions may prove moot to a White House and Congress now looking to deliver the most aggressive fiscal package possible.