by Brunello Rosa

30 March 2020

In our column of March 16th, titled “The World Is Likely To Be Radically Different After The Coronavirus Crisis” we mentioned that the Coronavirus is posing an existential threat to the survival of the EU. In this column, we want to further elaborate on this issue, following the EU Council meeting on March 26, in which the heads of state and governments failed to reach a deal for a common strategy to fight the crisis.

The underlying principle behind the EU integration process is the solidarity that member states should display towards one another on all matters of common interest, after centuries of inter-European conflict. For this reason, the first embryo of the EU was the European Coal and Steel Community, coal and steel representing the key ingredients for the economic recovery in the post-War period. Once solidarity ceases to exist, there is no reason for the Union to exist either. In spite of the initial, delusional hope that COVID-19 was an asymmetric shock to Italy rather than a generalized crisis across the region, and could therefore be addressed by the activation of article 122.2 of the EU Treaty (i.e. grants to the country “seriously threatened with severe difficulties caused by … exceptional circumstances beyond its control”), it is now clear that is a symmetric shock to every country of the EU. 

This means that the EU as a whole should react to it, with common instruments, rather than by simply adopting a coordinated approach of national policies by individual member states. Instead, so far national selfishness has prevailed, and countries have reacted by adopting a series of policies based on their individual circumstances. For example, at the fiscal level, Germany has announced a plan of EUR 550bn of fiscal easing (of which EUR 156 will be fresh expenditures), France a EUR 300bn plan, and Italy, given its more stringent budget constraints, only a first EUR 25bn plan followed by another EUR 25bn likely to be announced in April. Virtually all countries have re-instated national borders and suspended the Schengen agreement.

At the EU level, there has thus far been only a partial and temporary suspension of the Growth and Stability Pact (GSP) and an easing of the discipline regarding state aid to private-sector companies. Even the ECB was initially reluctant to engage in its mandatory spread-compression activities, until finally the EUR 750bn PEPP was launched, with the inclusion of Greece and the suspension of the issuer limits. But this is still too little compared to what the EU could and should do to face the existential crisis before it. 

With Brexit underway, and the UK initially threatening to deviate from the continental practices of social distancing to follow a chimeric and flawed herd immunity approach; with Schengen and the GSP suspended; with every country following its own approach to COVID, from para-military lockdowns (in Italy, for example) to minimal social distancing rules (e.g. in Sweden), the risk is that re-converging when the crisis is finished will become virtually impossible, as every country will find it more convenient to pursue its national strategies and interests. A country might, for example, bitterly and understandably decline to pursue European reintegration because it felt that it was neglected during the crisis.

Take Italy, for example. In 2011-12 Italy was brought to the verge of default because of the slow and flawed response (by moral hazard considerations) from the EU/EZ to the Greek crisis. Italy, which participated in the rescue packages for Greece, Ireland, Portugal and Spain, came under speculative attack because it was perceived as being part of the PIIGS grouping of economies. Only Draghi’s “whatever it takes” pledge and the consequent OMT avoided the disaster. In 2015, during the migrant crisis, Italy was then left alone facing the arrival of ships landing on the southern shores of Europe. In 2020, after the symmetric exogenous shock deriving from COVID, the implicit message from the EU was: “deal with it by yourself, we’ll be lenient on your fiscal position, ex-post.” It is not clear where solidarity is in all this, and we should not be surprised if, at the end of the crisis, the levels of EU-scepticism will be at historical highs. Other countries are in similar positions, and if the EU fails to rise to the historical task it is now facing, it might end up being the largest, institutional victim of Coronavirus. 

So, while Merkel and Von Der Leyen declared their opposition to Eurobonds/Coronabonds being used  to finance a pan-European recovery plan, the Eurogroup has been tasked with coming up with technical proposal on the feasibility of risk-sharing instruments. Hopefully, it will come up with some serious proposals in the next couple of weeks, and these approaches will be adopted by the EU Council. But other roads are possible, such as the possibility of activating ESM loans with virtually zero interest rates and null or very limited conditionality. That, in turn, could open up the possibility of using the OMT to fight unwarranted widening of sovereign yield spreads within the EZ. 

24 March 2020

Introduction: The Last Great Pandemic

It is a truism to note that no two historical events are ever exactly alike. But before we who advance the audacious theory that the past can and must be learned from fold up our tents and depart, dispirited, for home, Twain’s supposed quote is a reminder of how the past can still vitally serve us as a guide. 

The unfairly named Spanish flu of 1918-1920 (neutral Madrid’s reporters were some of the very few in the West accurately recording the effects of the virus amidst the crescendo of World War I, hence the name) infected an estimated 500 million people in the world, or then a whopping 27% of the global population. 

As is true for the coronavirus, death toll numbers are extremely suspect, but perhaps 40-50 million succumbed from the virus, with the fatality toll possibly being as high as 100 million. In the case of both the Spanish flu and the coronavirus, initial deaths came about primarily as the result of pneumonia and other bronchial maladies. 

To put this unfathomable number in perspective the Spanish flu killed around 675,000 Americans, more than died in the Revolution, the Civil War, World Wars I and II, and the Korean and Vietnam Wars put together. Whatever the exact tally, it is safe to say the Spanish flu ranks--just behind the 14thCentury Bubonic plague--as one of the deadliest pandemics in human history. 

Unlike our present plague in which the elderly are by far the greatest target, Spanish flu fatalities very oddly centred around those 20-40 years old, in the prime of life. 

Whereas we know the coronavirus started in Wuhan in Hubei province (despite the Chinese Communist Party’s reprehensible and pathetic propaganda diversionary tactics), the origins of the Spanish flu are murkier, with the chief suspects of origin being Kansas in the US or northern France during the carnage of the Great War. 

As is the case with the coronavirus, the transmission origins are not clear. Bats seem to play a major role in the animal-to-human transmission in the case of the coronavirus, while for the Spanish flu either birds or pigs are the likely culprit. 

Unlike the Spanish flu which killed remarkably swiftly, the coronavirus has two phases: first a mild viral phase, lasting for a week; for the majority of the people that is all that happens. 

However, in a significant minority of cases a second phase ensues—starting on about day five—which is triggered by a reaction of the body to the crisis. This, hauntingly, is very like the Spanish flu, where the great killer (beyond pneumonia) was deaths occurring when the body’s own immune system went into overdrive, or a cytokine storm. 

 It is clear that over these basic facts the two viruses follow specifically different, if similar, paths. However, for all their clear discrepancies, in fact, both pandemics do rhyme historically. In both cases, the ease and increase in international travel played a major part in their spread. For the Spanish flu, the vast movement of men around the world necessitated by World War I was a primary driver; for us the age of cheap travel and globalisation plays a very similar role.

What traditionally might have been localised epidemics instead become pandemics because of the transmission belt of the global superhighway. While today we doubtless have superior health care and technology to 1918, we also travel at many times the rate of the early twentieth century. During a pandemic such as now, these two immutable facts are racing against one another. 

Hauntingly, many other aspects of the two pandemics are precisely the same, from the use of surgical face masks, to the stockpiling of food, to the belated (and too often half-hearted) entreaties to avoid public gatherings. Tragically, in 1918 Philadelphia, despite Spanish flu warnings, a massive parade to sell war bonds went ahead throughout the city, with 200,000 souls turning out to support the troops. Just three days later, every single bed in the city’s 31 hospitals was filled with the sick and the dying, infected by the Spanish flu. By the end of the week, 4500 were dead. This is the damage a pandemic can do. We must either learn from the Spanish flu and master history, or be mastered by it. 

[...]

(This is an excerpt of Dr. Hulsman's latest article, which you can read here).

Dr. John C. Hulsman is the widely-read Senior Columnist for City AM, the newspaper of the city of London. Dr. Hulsman is also a Life Member of the US Council on Foreign Relations. His most recent work, the best-selling, To Dare More Boldly; The Audacious Story of Political Risk, was published by Princeton University Press in April 2018 and is available for order on Amazon. He can be reached for corporate speaking and private briefings at https://www.chartwellspeakers.com. 

Real Economy: Lockdown Measures Hit Employment And Growth; CBs Easing Intensifies 

In the US, where about 1 in 3 citizens are in lockdown and most non-essential businesses have been forced to close, initial jobless claims spiked to 3.28mn in March (c: 1.0mn; p: 0.282) – the highest level since the series began in 1967, highlighting COVID-19’s vast economic impact. A lagging indicator, February’s ‘durable goods orders’ rose above-consensus, by 1.2% m-o-m (c: -0.8%; p: 0.1%), as well as ‘durable goods ex. Defense’ – a measure of business investment (a: 0.1%; c: -0.9%; p: 3.6%).

In the EZ, measures to contain the COVID-19 outbreak disrupted businesses and demand; March’s composite PMI fell to its historical low (a: 31.4; c: 38.8; p: 51.6), as: i) services recorded their steepest contraction on record (a: 28.4; c: 39; p: 52.6); and ii) manufacturing suffered the sharpest fall in over seven years (a: 44.8; c: 39; p: 49.2). 

In the UK, CPI inflation fell in February to 1.7% y-o-y (p: 1.8%), while core CPI rose to 1.7% y-o-y (c: 1.5%; p: 1.6%). The BoE kept interest rates at an all-time low of 0.1%, after delivering two emergency cuts in response to virus-induced economic and financial disruption. 

In Canada, in an emergency meeting the BoC cut interest rates by 50bps, to 0.25% (p: 0.75) and started asset purchases, and Governing Council will “closely monitor economic and financial conditions, in coordination with other G7 CBs and fiscal authorities”, to take further action if needed. 

Financial Markets: High Volatility Despite Monetary And Fiscal Stimuli; Oil Down, Gold Up 

Market drivers: Unprecedented monetary and fiscal stimuli: 1) eased a USD squeeze that was threatening the global financial system; and 2) encouraged investors and supported a rebound in stock markets, from their three-year lows. 

Stocks: w-o-w, global indices fell (MSCI ACWI, -22.3%, to 447), driven by DMs (S&P 500, -23.6% to 2,541; Eurostoxx 50, -27% to 2,729) and EMs (MSCI EMs, -24.1% to 851). Volatility remains high (VIX S&P 500, -0.5 pts to 65.5; 52w avg.: 18.4; 10y avg.: 17.0).

Bonds: w-o-w, returns on indices rose (BAML Global, +1.7% to 288.3), as yields on DM 10y bonds fell for: i) UST (-19bps, to 0.74%); and ii) German bunds (-15bps, to -0.49%). 

FX: w-o-w, global demand for USD weakened (DXY, -4.3% to 98.365; EUR/USD, +4.27% to 1.114), and the GBP recovered from multi-decades’ lows (GBP/USD, -7.0% to 1.246). 

Commodities: Oil prices continued to decline (Brent, -7.6% to 24.9 USD/b), while gold rose (Gold, +8.0% to 1,618 USD/Oz), as it keeps its safe-haven appeal.