The coronavirus outbreak – the economic impact

What worries me about the COVID-19 coronavirus outbreak isn’t so much the virus itself. It’s the economic effects of the way people – and societies – have been reacting to it since the outbreak began. Because of the way western economics has gone in the past forty-odd years, what economists call a ‘shock’ can have real-world effects that run far beyond the scale and nature of whatever that ‘shock’ might be.

In economic terms, a ‘shock’ refers to an unexpected shift, usually to do with pricing associated with a commodity. The classic western example is the 1973 oil shock, which sent oil availability plummeting and prices skyrocketing. The resulting economic impact was significantly greater than the scale of the oil embargo that provoked it.

These days, world economies are far more fragile. It’s not just the fact that the ‘General Financial Crisis’ of 2008-10 wasn’t actually resolved. It’s the fact that since the 1970s there has been significant growth in ‘markets’ that trade money-based ‘products’ which have no real physical existence.

A beautiful picture of Earth from 1.6 million km sunwards. NASA, public domain.

I’d better explain that, because it’s key to what I’m worried about. Since the 1970s, particularly, a trade has sprung up in which money, itself, is treated as a commodity. From this have flowed ‘products’, which involve money being packaged and sold in various ways. Currencies are bought and sold, for example, which is why exchange rates shift. Another commodity market has emerged in the sale of debts. Another has emerged in equities (an agreed value of money represented in a thing, such as a building or a company). Now, by nature this has to be unstable. Think about it. ‘I have $100, which I’m going to sell to you for $102’. The buyer thinks they can find somebody else to sell the $100 they’ve just bought for $102, at an even greater price. However, the system works only because the parties agree, in their minds, that what they are trading has these values.

What confuses the issue is that they are negotiating a price for money as if it were a chicken, or a piece of wood. This is separate from the face value of the money itself. You see what I am getting at? In an ordinary exchange, money is a proxy for value. It takes the place of bartering (say) wood for chickens. Instead, both wood and chicken each get an assigned value in money (a ‘price’).

Money, in short, is an abstract concept that has value because people agree it does. But when money, of itself, starts getting transacted – and gaining its own value, separate from the value assigned to the money itself – then things get doubly abstract. That is then wrapped up in the terms and phrases used by ‘the markets’, and people behave as if they are dealing with real products, like wood or chickens. This masks the fact that all they are doing is swapping stuff with no actual existence, whose value is a product of human visualisation. These days most of the world’s money consists of numbers in databases and electron flows, which in turn are traded via further databases and electron flows. It’s about as far from a chicken on sale as you can get.

Much of this was made possible largely by the neo-liberal deregulation that followed Thatcherism, Reaganomics and so on in the 1980s. ‘Money markets’ could develop because there was nothing to stop them doing so. Banks could lend money imprudently because regulations had been relaxed. This was how the GFC happened in 2008. There was a boom in housing speculation across the western world and part of the former Communist bloc. Financial institutions began issuing loans left, right and centre, turning profits from the transactions. Often they were imprudently offered; the debtors couldn’t pay them back, and the security on them – the value of the house – was itself volatile because house prices were rising.

It got worse. Traders then began buying and selling the mortgages. But it wasn’t direct. Instead, these debts were bundled up into ‘packages’ of multiple such mortgages that were then ‘securitised’. What this meant was that the risk associated with these debts (the chance of not being able to recover the money that had been lent) had been defined as a number. These ‘securitised’ debt packages were then traded and re-traded as a commodity of themselves.

All this was well distant from the original debts – most of which were loans offered to people who couldn’t pay them back. Put another way, the system that emerged was trading bundles of other people’s debt as a ‘product’, usually known as a ‘sub-prime bond’ or a ‘mortgage-backed security’. The problem was that this sort of trade – and the confidence in the worth of what was being traded – became part of what kept daily money flows going, enabling financial institutions such as banks to keep on financing their activities and cash-flows. Then, around 2006, house prices began falling across many western nations, particularly the United States. When it all went bang in 2008, nobody knew what risks these institutions were exposed to via the trade in mortgage packages. That undermined confidence in the that had also issued loans to ordinary household borrowers. So the practical results to society in many western nations were very real.

The fear among economists at the time was that this would provoke a second Great Depression. All the signs were there. As it happened, the west purchased its way out of the problem with so-called ‘stimulus’ packages, followed by what is known as ‘quantitative easing’. This has poured vast sums of money into the system. And it hasn’t actually fixed the problem; all it did was inflate world money supplies, a lot of which ended up going into fixed asset prices, hence the housing bubble that’s affected many western nations now. And it didn’t fix the fundamental problem – the imbalances that drove the GFC are still there.

I mention this as an example. Now, all of this might seem to be a digression from the COVID-19 coronavirus. But it isn’t. Aside from the fact that the issues driving the GFC remain – meaning the world is again vulnerable to an ‘exogenous shock’, as a non-economic issue known to economists – these days a large part of the world’s economic prosperity rests on trading in the various meta-markets – stocks, debts, money-as-commodity, and so on. All of this has no real existence and the value is dependent on the confidence that people have of the system delivering value. It’s why central banks can ‘talk’ interest rates up and down. It’s why businesses are so concerned about ‘business confidence’. It’s why ‘money market traders’ have had data-centres built in odd locations to get speed-of-light advantage over other traders in automatic computer-driven trading.

These things – all products of human ability to imagine that something non-existent is real – have become vital to the operation of the world economy. And what this means is that the prosperity of the world is reliant not on producing real things, but on confidence that these trades will continue to function.

All it takes to knock that over is to introduce fear or doubt. A relatively small disruption in real economic activity – the production of real things bought by real people for practical use, such as cars – can translate into a wild panic in ‘the markets’. Sometimes it doesn’t take an actual problem. Shares plunge on rumour; the ‘money markets’ gain or lose value on the slightest whiff of an interest rate change, and so it goes on.

Into this volatile world of imaginary money and meta-trading has swept the coronavirus. We looked at the social impact in the last post – a significant reaction that is disproportionate to the reality of what is going on. Into that mix we add the physical disruption of production caused by China effectively shutting itself down in an effort to control the virus. This isn’t a major issue in the immediate – but, as we’ve seen, the abstract financial markets perform like startled reef-fish on the slightest whiff of anything. And they already have structural trouble, un-fixed from 2008. So suddenly the coronavirus, without even becoming a global health pandemic, has the potential to disrupt the world economy.

Optimistically, I hope all will be well.

Copyright © Matthew Wright 2020


14 thoughts on “The coronavirus outbreak – the economic impact

    1. The technical side is unavoidable with this issue, unfortunately. It’s a Sword of Damocles that hovers, invisibly and largely not understood by the majority, but it is very real – as the GFC showed back in 2008, the last time that this sword scythed through world prosperity.

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  1. I am probably less optimistic about the whole “economic” scenario. I think it will have to fail in a pretty dramatic way in order to be recreated in a more ‘human’ form. Manipulation or ‘spin’ seems to be the flavour of the past and this century but it is neither honest nor true and when truth emerges, such systems will ultimately fail.
    I am, however, somewhat optimistic about the future…but it will take a long time to see the improvements on a mass scale…so we cannot stop doing tehr ight thing now as every small piece of brick or mortar is necessary for taht improvement.

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    1. I’m hopeful that new ways will be found. We have to do it: the only other option is a catastrophic collapse. And it won’t be far off, historically speaking, if things carry on as they are – I’m thinking decades but not centuries. One always has hope, of course, that human sense will prevail.

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  2. This reminds me of the term “sentiment” as used by financial advisers. As well as being reactive, the markets also have a pretty short memory, so something that sounds like good news next week could provoke an upward spurt. It’s too bad that ordinary people have been driven to invest in “the markets,” rather than earn compound interest on their savings accounts, as they did in past decades. Hence financial advisers, I suppose.

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    1. I am quite cynical about financial advisers. Here in New Zealand they have to be licensed, but that doesn’t really mean much, as they have no better data than the rest of us, because the markets always involve crystal ball-gazing. Sigh…

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    1. It is a worry for sure. Australia and NZ escaped the worst of the GFC, but that’s no guarantee when the chickens finally come home to roost, as it were. It’s the cost, I suppose, of thirty years of neo-liberalism. I understand how it began: it was a generational reaction to the post-WW2 economic consensus and the liberal socialism that had been adopted across many western democracies. But times keep moving on and I can’t help thinking that another new way needs to be found – one that doesn’t return to the ‘old days’, but which offers new ideas that allow humanity to move forward sustainably and with prosperity. I’ve seen the term ‘bio-economy’ floating around, which seems perhaps part of the answer, but I think it’ll take quite a ground-shift to adopt it.

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      1. No idea what form a bio economy might take, but pretty much anything different feels like a step in the right direction at the moment.
        The balance between individual freedoms and the survival of the species is severely out of whack. I fear that if we, as individuals, don’t voluntarily give up some of our comforts, far more will be taken from us by external forces.

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  3. Reblogged this on I can't believe it! and commented:
    This fascinating post by Matthew Wright explains why the world financial system is so vulnerable to shocks to the system like COVID-19. The world economy is indeed a reflection of the collective psyche. Collective confidence and fear play very real roles in the direction of the economy. And this is without further considering the increasing effects of climate breakdown.

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  4. Thank you very much for this great post, I thoroughly valued reading it. I have been very disappointed with the media’s coverage of the Coronavirus outbreak so I have recently published an article on my blog about what we should be worried about and how we can protect ourselves and others. If you have time, it would be great if you could check out my post and let me know your thoughts! Thanks 🙂

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  5. Scary times, but plenty of opportunities within! I’ve recently wrote about them.

    May these opportunities help you in struggling well.

    Thanks for sharing!

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