Worse than
Lehman
Coronavirus
Tightens Its Grip on the Economy
It is an
unprecedented crisis: The coronavirus pandemic is crippling entire economies,
while governments and central banks are deploying all means available to
prevent a systemic collapse. How long can we hold out?
24.03.2020,
14:30 Uhr
By Tim
Bartz, Markus Becker, Simon Hage, Martin Hesse, Alexader Jung, Armin Mahler,
Christian Reiermann and Marcel Rosenbach
A week ago
Saturday, the opening night celebration went late into the night at the new
restaurant Blaue Blume in Hamburg’s Altona district. There’s still a bottle of
champagne on one of the tables, evidence of the party. "It was
packed," says restaurateur Karin Wege. That was only 10 days ago, but it
already feels like a different era.
Wege and
her partner have run the Blaue Blume, a restaurant for home-style potatoes and
beer, for 17 years. Six months ago, they lost their lease, but they lucked out
when they found a new location around the corner, a prewar building with arched
windows and exposed brick walls. "The location is a gift from God,” says
Wege, but the opening couldn’t have come at a worse time. Wege stands directly
behind the tap and looks fatigued as she gazes out into the empty room.
Weeks?
Months?
Severe
restrictions have been in place at eateries across Germany since last
Wednesday. And as of the weekend, no guests were allowed inside restaurants --
with takeaway now being the only option. It’s a blow for the business, a disaster
for the restaurateur and her 10 employees. She slaved away for months
organizing the move, sanding down wooden tables, having a new kitchen
installed, and now this? Wege says she’s invested an incredible amount in the
business. Now the bills from all the carpenters and craftsmen are coming due,
but revenues have dried up.
How long
will she be able to hang on? Weeks? Months? The restaurateur doesn’t want to
think about it. She’d rather fight. "Closing isn’t an option,” she says
almost defiantly.
Weeks?
Months? These are the questions everyone is asking now: Business owners and
normal folks, but also governments and central banks. How long will it take to
stop the corona pandemic? And how long can the economy survive a forced
shutdown like this?
No one can
answer that question. Health comes first and the economy is secondary right
now. But the consequences are devastating and the economic forecasts are
growing grimmer by the day. The stock markets are in a state of panic and the
share price gains that took many years to achieve have disappeared within a
matter of just weeks. There has never been such a short amount of time.
This crisis
is unprecedented, and that’s what makes it so dangerous. It’s hitting every
country, industry and company.
"This
is the biggest crisis we have had in the postwar era,” says Hans-Werner Sinn,
the longtime president of the Munich-based economic think tank Ifo. "This
even overshadows the Lehman crisis."
Global
Recession or Prolonged Depression?
The corona
shock is striking an economy that was already weak before the pandemic and a
financial system that has never really recovered from the consequences of the
2008 financial crisis. If companies aren’t given prompt assistance, we could be
facing a domino effect that takes everything down. Banks could face possible
collapse and members of the eurozone would need to be bailed out again. Then
the inevitable global recession that we are certain to face could potentially
turn into a prolonged depression like the one that followed the Wall Street
crash in 1929.
The
reactions from central banks and governments around the world are indicative of
how dramatic the situation is. Some are flooding the markets with money. Others
are passing rescue bills on an unprecedented scale. Whatever it takes. The
mantra adopted by Mario Draghi during the last crisis when he was president of
the European Central Bank to save the common currency has now been taken up by
governments around the world, including Berlin.
What
companies need mostly right now is cash. Entire industries have been put into
an artificial coma to combat the spread of the coronavirus. If the economy
isn’t provided with the capital it needs right now, it will suffer from
irreparable damage once the shutdown is over. And then what?
Tom
Neukirchen has already switched his company Fundgiver into "emergency
operations,” as he puts it. He had originally planned to travel to Berlin for a
two-day workshop this week and then to Würzburg for a training session.
Neukirchen has spent the past 20 years advising organizations on how to
effectively raise funds.
An Economic
Pandemic
His
appointments have been cancelled, orders have dried up and he has served notice
that he will lay off his employees on June 1. He says he has experienced
financial crises before as a business owner, but this time a much longer and
more serious order drought has begun to take shape. "Many others are in
the same position," he says. "The government should also pay more
attention to the economic effects when making decisions, otherwise the viral
pandemic will soon be followed by an economic one with millions of
unemployed."
In addition
to BMW, Opel and Daimler, Volkswagen has also announced it will close its
plants in Europe for at least two to three weeks. The world's largest car
manufacturer, which only recently announced a record profit, is now preparing
for a deep crisis. Indeed, the German economy’s most important growth engine,
the automotive industry, is on hiatus for the time being.
"In
many European markets, business has practically come to a halt,” states a
letter from the VW management board and its works council to employees.
"Demand is declining noticeably.” In order to save jobs, however,
manufacturing has to be restarted at some point. The letter states that
Volkswagen is a strong company, "but even we can’t carry this burden for
too long.” The company is now planning to implement the German government’s
short-time work relief package in order to mitigate the consequences of the
suspension of production. The government subsidy, which can last for up to a
year, offsets the labor costs and social insurance benefits for employees who
might otherwise be laid off.
The automobile industry, the core of the German economy, has been particularly hard-hit by the coronavirus. Volkswagen and other major carmakers have announced temporary factory closures in response to the crisis.
"The
most important goal in the coming months is to avoid bankruptcies,” says one
high-ranking automobile industry executive. He says that once carmakers restart
production, supply chains and sales channels also need to be able to function
immediately. It’s also important to ensure that the supply of parts from Europe
to other regions of the world, such as China, where production is already
underway again, is secured.
But even if
suppliers, manufacturers and dealers are able to resume their work soon, no one
can know for sure today when people will start buying cars again. There is
already talk in the industry of a worldwide "demand shock,” which is
likely to result in losses for manufacturers, some of which will be
considerable.
Whether
it’s small business owners like Neukirchen or a major global corporation like
Volkswagen, and with it the entire automobile and supplier industry, the crisis
has affected the entire spectrum of the German economy. The situation doesn’t
look any better in other countries, either.
Profiting
from the Crisis
Ironically,
times of crisis like this are good for people like Boaz Weinstein. When the
economy staggers, he’s never far from the scene. As a star trader at Deutsche
Bank, he and his team gambled away $1.8 billion during the financial crisis. He
had to leave the company and he then founded the hedge fund Saba. Since then,
he has sought to profit from crises by speculating through credit default swaps
(CDS) that companies will go bankrupt. Business had been pretty mediocre and
the numbers of bankruptcies low in recent boom years.
But
business is picking up now. At the start of the coronavirus, he began buying
CDS so he could profit when tourism companies like Royal Caribbean Cruises or
United Airlines ran into trouble. Since the beginning of the year, the value of
his fund has risen by 67 percent.
Weinstein’s
happiness is the misery of others. In New York, London, Frankfurt and Tokyo,
indeed all around the world, investors are unloading all sorts of asset classes
to retain their liquidity. Share prices are plummeting, securities in emerging
markets are collapsing, and gold, silver and even U.S. government bonds are in
such turmoil that the Federal Reserve had to intervene to prevent the market
from freezing. "The only safe haven right now is cash,” says Jochen
Felsenheimer, founder of the Munich-based hedge fund Xaia.
The
situation is threatening to spiral out of control. Central bankers and
politicians are still trying to calm people, saying that a financial crisis
like the one in 2008 with bank collapses and nationalizations isn’t
foreseeable. And what else could they say without shaking up the markets?
The
greatest danger for the banks comes from companies that are no longer able to
service their loans. And there are many signs that this threat is real --
exploding CDS prices, for example. Or the prices of corporate bonds, which seem
to be falling into a bottomless pit. Thanks to the almost 10-year upturn in the
global economy, even the "junk bonds” for companies considered shaky were
finding buyers for years without any problems.
Low
interest rates allowed companies to go deep into debt, which fueled growth that
was largely built on borrowed money. That is now coming back to haunt us.
And it’s
not only a question of bank loans. In recent years, many companies, especially
in the United States, have increasingly been issuing bonds to buy back a huge
amount of their own shares using borrowed money. The aim was to drive up share
prices, but also executives’ bonuses. Some of these companies may now have to
be bailed out using taxpayer money.
"Encouraged
by the ultra-easy monetary policies of central banks, the global debt bubble
has continued to grow in recent years," says William White, former chief
economist of the Bank for International Settlements and an oracle of the last
financial crisis. "The coronavirus appears to be the needle that will
burst that bubble."
As early as
autumn of 2019, even before the corona crisis, the International Monetary Fund
painted a gloomy picture of the market for corporate debt in larger economies.
It warned that in an economic crisis only half as bad as that of 2008/2009,
around 40 percent of interest and repayments could be lost - a figure of no
less than $19 trillion.
At the
time, it was just a calculation, but it has the potential to become a real
horror for the banks. The rating agency Standard & Poor’s expects that more
than 10 percent of bank loans to U.S. companies are likely to be defaulted on.
For Europe, the losses could end up in the upper single-digit percentage range.
That would mark a tripling of the normal rate and would also match the level
seen in the 2008 financial crisis. The fact that banks have been so willing to
issue loans in recent years is now coming back to haunt them.
The Hour of
the Central Banks
Once again,
this is the hour of the central banks. The European Central Bank (ECB), the Fed
in Washington and the Bank of England have all made clear that they will
continue to provide their commercial banks with free liquidity so that lending
doesn’t collapse.
The ECB
acted hesitantly at first, but made up ground last Thursday by announcing it
would buy another 750 billion euros worth of bonds from companies and countries
to prevent another euro crisis from flaring up. "Extraordinary times
require extraordinary action,” ECB President Christine Lagarde tweeted on
Wednesday. "We are determined to use the full potential of our tools,
within our mandate.”
In contrast
to the actions taken after the Lehman bankruptcy, however, the trillion-euro
announcements made by the central banks have so far provided only brief respite
on the markets. They can’t prevent a crash in stock prices on their own,
because this time it’s not a purely financial crisis – this time entire
industries are shutting down. And no matter how cheap the money is, no one
wants to invest in a completely uncertain future.
The central
banks are now firing their bazookas just to do something, but it’s possible
they won’t achieve much in the end. At the same time, there still hasn’t been a
credit crunch and the markets are functioning, even if they’re in a state of
free fall.
But that’s
the most positive thing that can be said right now. The central banks may have
created the perception of omnipotence during the Lehman crisis, but they appear
to be at a loss today. For the most part, the central banks have already
exhausted their firepower. Key interest rates worldwide are at or close to
zero, and there’s no more downward potential.
The Last
Line of Defense
The last
line of defense is governments. They will have to jump in as the lender of last
resort. And they seem very determined to take on this role, regardless of the
cost.
U.S.
President Donald Trump, who until recently didn’t even take the disease
seriously, is planning a $1 trillion aid package. It includes, among other
things, a form of wage subsidy and aid for vulnerable companies as well as
direct payments to the people. The talk is of every American getting a check
for $1,000.
In a
country where there is no universal unemployment insurance system, those kinds
of payments may well be useful for protecting those who are now suddenly left
without any income. The measure is being sold as "helicopter money,” but
it isn’t really, because the $1,000 would come from the government budget and
would not be money printed by the Fed.
The actual
concept of helicopter money goes back to the U.S. economist Milton Friedman,
who considered what it might look like if a central bank dropped cash from a
helicopter. It hasn’t been seriously considered in its pure form so far,
because critics argue that it would undermine confidence in the monetary
system.
But
programs aimed at stimulating consumption bypass the current problem anyway,
because they only make sense once the industries that have been put into an
artificial coma have been taken out of it. Only at that point can demand be
stimulated, because you first need supplies, with the companies producing and
restaurants and shops open again.
Right now,
though, nobody knows when that point will come. For the time being, governments
need to try to save as many companies as they can, to preserve as many jobs as
possible and to try to prevent a situation, to the degree possible, where
people are no longer able to pay their bills or rent.
That’s
actually the good news: Most countries have sufficient possibilities for
generating the sums of money necessary to do just that. In times of zero and
negative interest rates, government bonds sell like hotcakes, especially for a
country with an excellent credit rating like Germany. That’s why the German
government has been as relaxed about this issue as it has been. Over a week
ago, German Finance Minister Olaf Scholz and Economics Minister Peter Altmaier
presented a vast relief package for the economy, promising bridge loans for
companies quickly and with as little red tape as possible.
In addition
to the liquidity support, a bailout package for companies has also been
presented. On Monday, Scholz announced a 500-billion-euro bailout fund to
protect companies from bankruptcy by providing credit guarantees for their
liabilities or by actually injecting capital in what would amount to partial
nationalization. In the current situation, many companies need not only loans,
but also direct financial assistance to pay wages, rents or loan installments.
The model
for the measure is the Special Fund for Financial Market Stabilization
(Soffin), with which the government stepped in to save banks from financial
difficulties during the financial crisis 12 years ago. At the time, it had a
volume of 480 billion euros, the majority of that sum in the form of credit
guarantees. But it also had the ability to borrow on its own, if necessary.
That’s also likely to be part of the rescue package for the real economy.
Sources in the German government say that the structure proved itself during
the last crisis.
"Multiple
Organ Failure”
The
government programs cover virtually the entire economy. The German government
wants to revive Soffin in case the current crisis leads to a new situation
where credit institutions start to fail. Meanwhile, the government has
established up a lavishly endowed "solidarity fund” for self-employed
individuals who are no longer getting any work.
The finance
minister’s plans mark the final farewell from the German government's policy in
recent years of balanced budgets. The federal government will have to incur
enormous debts in order to slow the economic collapse. One senior government
official describes what is currently happening to the economy and society as
"multiple organ failure.”
Volker
Brühl, managing director of the Center for Financial Studies at Frankfurt's
Goethe University, sees the risk of a depression with deflationary tendencies
if the coronavirus continues to traumatize markets and the economy into the
second half of the year. Deflation would be an economic horror. If that
happened, there would be more supply than demand, prices would fall and the
economy would continue to shrink.
But that
scenario cannot be ruled out, especially if the economic coma lasts for months.
Should that happen, only the government could turn things around. It could
attempt to revive the economy with a gigantic stimulus package.
Finance
Minister Scholz would be willing to do so, and he has sufficient resources to
mobilize funds on an unprecedented scale. A volume of up to 5 percent of gross
domestic product is under discussion. In absolute figures, this would be around
180 billion euros.
According
to government experts, that sum could be increased almost at will. "Even
if we were to increase the national debt to 80 percent in a short period of
time, Germany would still get the best rating from the rating agencies,” says a
senior government official. "We've already been through all that."
The
government could borrow more than 700 billion euros in new loans before it
reaches that threshold, the source said. "We are thinking about orders of
magnitude that have never existed before," says a person working with
Scholz.
But outside
of Germany, what countries can even afford that? In Italy, which is suffering
the most from the corona pandemic, sovereign debt is already at 130 percent of
gross domestic product. And the risk premiums on Italian government bonds have
begun increasing on financial markets.
Before the
latest bailout package, the ECB made clear that it wouldn’t stand by and watch
as the creditworthiness of eurozone member states corrodes. But at some point,
even the ECB will reach the limits it has set for itself. At that point, an
actor will come into play that hasn’t had to intervene so far: the European
Stability Mechanism. It has 705 billion euros of share capital, of which 410
billion euros are currently available.
Coronavirus
Bonds?
That money
could be used to help Italy with emergency loans. But even this money would
have to be paid back at some point.
In that
sense, it’s little wonder that the old discussion about common bonds between
the eurozone countries, so-called euro bonds, has flared up again. Italian
Prime Minister Giuseppe Conte has raised the idea of special "coronavirus
bonds.” Germany and other Western and Northern European countries have so far
categorically rejected such communitized debts – and that is unlikely to
change. The EU should first use the tools it already has, says a diplomat from
a Western EU country. "And we believe that these tools will be
enough."
If interest
rates remain low, European countries could easily increase their debt burden by
10 percentage points, says Guntram Wolff, director of the influential Brussels
think tank Bruegel. If this were to lead to the economy returning to its
previous level more quickly after the end of the crisis, he says, then debt in
relation to economic power would probably not be any greater afterward than if
no action were taken now.
But that
economic power definitely wouldn’t be any greater than it is now. At the end of
the corona shock, the world will be even more indebted than before and the
system will be even more vulnerable. The crisis caused by this pandemic is
likely to last far longer than the outbreak itself.
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