What now?

The spread of coronavirus has come as a shock, proving much more explosive than was anticipated both in Europe and the rest of the world. The situation in Spain and Italy is more reminiscent of events in the Chinese provinces of Wuhan and Hubei than in the rest of Asia, where it was more moderate. This surprise has perpetuated the panic in markets that are unsupported.

Now, the key is to fight on three fronts. The first is to slow the spread of the virus. This is not only because of the health and human factor, which is the most significant issue, but also the economic one; the sooner the rate of infection starts to slow, the sooner we can get back to business as usual. In fact, this is the only thing that seems to be influencing market mood. The problem is that this involves draconian measures of economic paralysis that, in the short-term, lead to even more losses.

The second front to be fought is to maintain financial stability, which is the task of the central banks. In particular, the aim is to ensure that payment systems continue to function normally. Massive cash injections point to this purpose. There is in fact no point in discussing lowering rates to stimulate demand, nor in basing any criticism on this argument. The sole purpose and primary role of the central banks at the moment is to keep the global payment system functioning. By ensuring this, a default crisis or one of chain payment suspension can be avoided, which would otherwise perpetuate the economic crisis. This battle is, however, still far from being won and it cannot be won by the central banks alone.

The third key front, therefore, is directly related to the second. It seeks to mitigate the impact of economic paralysis to the greatest extent possible. Analysts are predicting increasingly deteriorating figures, which, in reality, translate into layoffs and company closures, among other things. The onus in this battle is on fiscal and regulatory authorities. The aim is to limit the losses of those agents who are most affected, as well as to help monetary authorities in the previous objective. There are many options for this, including tax reductions, direct support, changes to credit conditions, regulatory assistance for financial institutions to encourage these and many other conditions. Perhaps the main problem here is the limited room for maneuver in fiscal terms. But, even so, it is something that has been done in the past to help regions and sectors affected by disasters. We are talking about replicating it on a much larger scale. If successful, the economic impact could be limited in terms of duration and in quantitative terms and the recovery of demand could also be subsequently stimulated.

It is much easier to talk about the solutions for fighting on these three fronts than to implement them. However, the main difficulty is twofold. Firstly, it lies in achieving the necessary coordination of all authorities, and, secondly, in ensuring that investors exercise adequate discipline because we cannot yet know where the market will bottom. What we do know is that the market will only bottom once the rate of infection in Europe and the US starts to slow, which is several weeks away. Meanwhile, market’s interpretation of any support action will be negative since the authorities are no longer believed to have the capacity to bear the price of assets, as was the case until recently, generating excess complacency. But we also know that if we see progress on these three fronts, it increases the likelihood that the crisis is only temporary and, therefore, that we can return to normality sooner. Knowing this, we could perhaps interpret the events of the next few days with a cooler head.