It’s the Corona Virus Stupid

The author of this Excellent piece is John Authers, Bloomberg
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It’s the Coronavirus, Stupid

After at least three months of furious debate over the rival merits of fighting the pandemic and keeping the economy alive, it looks ever more as though this was a false dichotomy. The disease needs to be beaten. Even if it is not as terrifying as some made it seem a few months ago, the economy cannot function on full throttle until the virus has been bottled
up and defeated.

Exhibit A) lies in a comparison of Denmark and Sweden, two very similar and very beautiful liberal Nordic countries, joined by the bridge from Copenhagen to Malmo, which took very different approaches to fighting the coronoavirus. Denmark opted for a strict lockdown, while Sweden was much more lenient, aiming to build “herd immunity.” So far, Dhaval Joshi, chief European investment strategist for BCA Research Inc. shows that the Swedish approach isn’t working. Looking at consumer confidence numbers, Swedes have taken an even greater hit to consumer confidence than Danes:

Meanwhile, Sweden has had far more infections (which might help to explain why confidence was so damaged): And Swedish deaths have run at a far higher rate than in Denmark: As for arguably the critical economic measure of unemployment, Denmark entered the pandemic with a lower rate, and has maintained its edge. Sweden’s hasn’t risen quite as much, but the country has still failed to gain any significant advantage from deciding not to lock down:

The virus has a naturally deadening effect on economic activity, as the Swedes have shown. But a lockdown, with all the disturbing issues of authority and incursions on individual liberty that it raises, does have the advantage that it can eliminate the behavior of a few “free-riders” or “super-spreaders” as they are now widely known. Pain is inevitable, and dealing with it is a collective action problem. Taking a direct approach to resolving that challenge, and opting for a lockdown, turns out to have inflicted far less economic damage, at least in a Scandinavian context.

Following on from the Nordic example, we now have some more examples coming in from the Sun Belt states of the U.S. Most tend to be politically conservative with Republican governors and have therefore — in the polarized U.S. political environment — opted to reopen earlier and with more enthusiasm than other states. The philosophy behind doing so was to boost the economy. But the evidence from a study by Deutsche Bank AG, using data from Johns Hopkins University, suggests that early reopenings have had exactly the opposite effect. This chart maps changes in consumer spending on the vertical axis against the rate of increase in Covid cases on the horizontal axis. The states with the fastest-rising Covid problem, led by Arizona, are seeing very slow growth in consumption.

The relationship isn’t strong, but there is plainly no economic advantage to an early reopening: When we do the same exercise for restaurants, possibly the sector most directly affected by Covid, the effect is more dramatic. Governors can make big political gestures and tell people they are free to go back to restaurants, but people won’t go if they are worried this will make them sick:

The bottom line is that the virus needs to be controlled, possibly by means short of a compulsory lockdown that infringes on civil and economic liberties, if economic damage is to be avoided. There are significant differences between the approaches taken by Sweden and the U.S. Sun Belt states, and they have different political ideas behind them. What they appear to have in common is that they were meant to avoid economic pain, and failed to do so.  A further corollary from this is that it is reasonable for investors to react negatively to news of viral spread, and to bid up economies where the virus appears to be under control. In the final analysis, that at present appears to mean the economies of the EU are better positioned to grow than the U.S.  

Good News, Bad News for Banks After the Great Crash of 1929 and the U.S. banking crisis that followed it, the issue of banking regulation was settled for two generations. The measures rolled out in the 1930s to buttress the banking system were largely in place until the 1990s. Within a decade of repeal came the crisis of 2008, followed by another effort at re-regulation.  This second effort at re-regulation hasn’t lasted quite so long. And on Thursday, the U.S. banking sector was buffeted by two separate announcements, both of which made drastic adjustments to the post-2008 settlement. First, a group of financial regulators announced that bank lobbyists had won a lot of what they wanted in peeling back the so-called Volcker Rule. Named for Paul Volcker, the great former chairman of the Federal Reserve who died last year, the rule was intended to stop any possibility that depositors’ funds were being used for proprietary trading by banks. It has since been whittled away, and the latest changes leave a “Volcker 2.0” that allows banks far more freedom. They can now invest in venture capital funds, and deploy money they had previously been required to use as a backstop for derivatives trades. After the close, however, came the news that the Fed, after the annual financial stress tests, had ruled that the biggest banks would be barred from paying dividends or buying back stock at least until the end of the third quarter. This is a sensible measure to ensure that they have a big enough capital buffer to deal with any fresh horrors from the coronavirus later in the year, and makes sense given that it is now accepted that the banks cannot be allowed to fail. Letting them pay out dividends to shareholders would effectively have been putting taxpayers’ money at risk. If this was good public policy, it was awful news for banks’ shareholders. (And it also raises the question of whether it was really prudent to make it easier to let banks take more risks with depositors’ funds once more via Volcker 2.0.)

This is how the shares of Wells Fargo & Co., JPMorgan Chase & Co. and Bank of America Corp., three of the biggest U.S. banks, fared through the day. What regulators giveth (in the morning), the Fed taketh away (after the close): If America’s attempt to re-regulate banks still appears to be in disarray, it has nothing on the problems afflicting the European Central Bank. Bloated European banks tended to be on the wrong end of many bad U.S. credit trades a decade ago, and they still haven’t recovered. For a brilliant and caustic attack on the ECB’s latest gambit, I recommend this piece by Charles Gave of Gavekal Economics, in which he asks for 10 billion euros, a small sliver of the 1.31 trillion euros that the ECB is currently offering to banks at a generous interest rate of -1%. He points out that this enables a virtually risk-free arbitrage to help bring down Italian borrowing rates, the current great threat to the EU, which would net him a profit of 1.75 billion euros for no risk after three years, after he had repaid the 10 billion euros to the European Central Bank. (He would spend some of these gains on a crate of champagne for Christine Lagarde as a thank you present).  This is somewhat of a flight of fancy, but he ends with a powerful point. I will quote it at length: Seriously, the ECB’s TLTRO program is the most blatant—and ridiculous—attempt I have seen in my life to save a banking system fatally injured by a stupid policy. None of last week’s €1.31trn will go into corporate loans. Every cent will go into funny-money strategies with one goal and one goal only: to reduce the spreads between Italian and German debt, and so lower the cost of capital for Italy. Put simply, the ECB is attempting to shore up the eurozone’s banks by subsidizing them to buy Italian bonds and sell German bonds. The objective, once again, is to save the euro. But although the banks may rebuild a part of their capital base with strategies like the one I have just described, they will lose a lot more on all the bad loans which are going to emerge in Southern Europe, especially after a summer without tourists. That €1.31trn may spin around in the financial markets with colossal velocity, but the small hotel in Rome will see none of it, as usual. And that will be a problem. Saving the banks while killing the economy will not go down well with European electorates, who for years now have had the distinct impression that, among the institutions of the European Union, banks are regarded as far more important than citizens. It’s as sure-fire a recipe as any I can think of for the resurgence of Euroskeptic populism.

This is very true. And if bank shareholders in the U.S. feel sore about their dividends, they might want to bear in mind that people in the U.S. similarly feel that the banks have been let off very lightly. Meanwhile, the performance of global bank shares this year makes clear that they still aren’t strong or dynamic enough to help lead the economy through its latest crisis:  

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