Before you can fleece or slaughter sheep, you must first corral them. Whether by accident or design, the stock market is the financial corral into which investors have been herded. The measures used to bail out the global banking system after the 2008 crash – quantitative easing and ultra-low interest rates – may have kept the banks on life support, but they have also led to an ongoing yield crisis.
Whether you manage a savings scheme, a pension fund or an insurance company, you will have experienced a decade during which the returns on investment have been far lower than the returns you needed. Pension and insurance business models – developed in the decades prior to 2008 – require an interest rate in the 5-8 percent range if they are to cover payments and continue to grow. But safe assets like government bonds offer just a tenth of that; one reason why so many pension funds are in dispute with trade unions over cuts to pension rates.
One response to low interest rates in the immediate aftermath of the crash was a switch into so-called “junk bonds,” such as those issued by the US fracking companies. The more risk an investor was prepared to take, the higher the return… assuming the company – or, indeed, the whole industry – did not go bust in the meantime. In the UK, commercial property offered similarly high rates of return, as property management companies assumed they could simply jack up rents whenever they felt like it. This, however, has added to the retail apocalypse on Britain’s high streets, with retail companies using the threat of insolvency to negotiate rents down to something more manageable.
As a result of the antics of the central banks, the stock markets became the single oasis in the yield desert. When a listed company issues shares it is effectively borrowing money from the public. The annual dividend is the equivalent of interest on savings. While this is of little concern to the majority of traders, who merely gamble on the rise and fall of share prices, it is a big deal to corporate managers whose remuneration packages are linked to the share value of their companies. If, for example, the dividend equates to an interest rate of five percent, but the central bank allows corporate borrowers to take out loans at just 0.5 percent, it makes sense for corporate managers to borrow in order to buy back the company shares – the equivalent of paying off a loan earlier than it is due.
The wider problem with this in the post-2008 climate is that everyone has been doing the same thing. And given the broader lack of yield, the result has been massive inflation in the price of shares; both because there are fewer of them for sale and because more and more people want to buy them. The result was the biggest financial bubble that has ever been inflated; and a bubble so fragile that even something as tiny as a virus can puncture it.
The crash in share prices that has followed the central banks’ surrender to the coronavirus – having spent the last month pumping newly created currency into the markets – has filled the newsfeeds of the mainstream media. The BBC, for example, reporting this morning that:
“Stock markets across the globe are suffering their worst week since the global financial crisis of 2008 as fears over the impact of the coronavirus continue to grip investors.
“Markets in Europe fell sharply on Friday morning, with London’s FTSE 100 index sinking more than 3%.
“Asian markets saw more big falls, while in the US, the Dow Jones recorded its biggest daily points drop on Thursday.
“Investors are worried the coronavirus impact could spark a global recession.”
In truth, the only “news” in this story is why it didn’t happen earlier – a question that the mainstream media doesn’t even understand.
The financial economy is based on an illusion – the belief that the real economy will continue to grow in the future at the same rate that it grew in the past. Currency – almost all of which is created in the form of interest bearing debt – only has value so long as the real economy can grow at a higher rate than the compound interest charged on the debt. Growth in the real economy – the harvesting of natural and mineral resources, the manufacture of goods and the provision of services – depends, in turn, upon a growing amount of free energy to power everything.
From the mid-eighteenth century to the 1970s, economic growth has been driven by a growing volume of surplus fossil fuel energy. The crises of the 1970s stemmed from a slowdown in the rate of surplus energy growth; causing a major supply-side shock that economists at the time did not believe could happen. What we have come to call “neoliberalism” – the depoliticising of national economies; the globalisation of production; and the liberalisation of the financial sector – was the intended solution to that crisis. But it no more solved the crisis than quantitative easing and low interest rates have solved the financial crisis of 2008. In both cases, we merely kicked the can down the road in the vain hope that clever people somewhere else would come up with a solution.
As with every previous civilisation that has expanded beyond its energetic limits, industrial civilisation has attempted to resolve its contradictions by adding complexity. The creation of the first truly global economy to replace the interconnected national economies of the twentieth century drove down wages and produced efficiencies which allowed the more energy-constrained economy to continue for a few more decades. But the additional complexity came at the cost of reduced resilience.
In the years after World War Two, western economies duplicated whole industries. Britain. For example, had car and aviation industries which sourced their components from within the UK; the same for France, Germany and the USA. Today, by contrast, western companies are often no more than final assembly points; putting together component parts manufactured on the other side of the planet. Indeed, companies like Apple do not even assemble anything, but simply repackage finished electronic goods that are manufactured in Asia. The positive side of this is that the price of manufactured goods has been driven down to the point that they offset rising food, housing and energy costs in national inflation statistics. The downside, though, is that any disruption to the supply of any of the billions of components and raw materials that flow around the global shipping lanes on a just-in-time basis can bring an entire industry to a halt.
In the aftermath of the Fukushima disaster, several car manufacturers were brought to a halt because the supply of car bumpers was disrupted. Not because car bumpers were made in Fukushima, but because the black pigment used to dye the plastic used in car bumpers was made by a plant based in the Fukushima exclusion zone. The more dependent we become upon complex global supply chains, the more at risk we are from events that may not – at first sight – seem to have anything to do with us. As Richard Wilding at The Engineer points out:
“What might look like a localised crisis quickly has a global impact because supply chains are a network, companies are linked by international processes and network designs. And competition, essentially, is not between individual companies but the supply chains they are part of…
“It’s still common for businesses to just deal with a central HQ of a supplier and not know exactly what route the supplies they need are taking. How many of us when we buy a product from Amazon knows the actual source and transport chain involved?”
This brings us to the Covid-19 pandemic that appears to be the cause of the ongoing collapse in share prices. There is still a great deal that we don’t know about the virus – how quickly it spreads, what proportion of people who contract it become seriously ill, and how many of those die from the disease. Much depends on how the authorities respond, how the public behaves, and on the extent to which advanced western health systems are able to manage. But the virus is not really the cause of economic woes which are only just beginning; they are merely a trigger.
The global economy is a house of cards that was just waiting for someone or something to pull the bottom out from under. If it wasn’t a virus, it would have been a flood, a volcano, a solar flare, or some other unexpected disaster. Nevertheless, the fact that China locked down towns and cities in a major global manufacturing region beginning on 23 January means that Britain is going to experience shortages from the first week in March. It takes around 40 days for a container ship to make the journey from China to the UK, meaning that the goods we are currently consuming set sail before the lockdown began. In the course of next week, the just-in-time container ships that we have come to rely upon for everything from phones to fabrics and pharmaceuticals are not going to appear. And even if China were to lift restrictions immediately, we would still be looking at nearly six weeks without supply; followed by many more weeks in which we are playing catch up. As Rory Butler at The Manufacturer explains:
“China’s output accounts for around one-quarter of global manufacturing when measured by the value added in its factories.
“It also accounts for around one-quarter of global automotive production, and provides 8% of global exports of automotive components, with many using just-in-time manufacturing, according to UBS.
“Volkswagen, the country’s biggest carmaker, said on Monday it was dealing with a ‘slow national supply chain and logistics ramp-up.’
“Global plastic, chemical, steel and tech firms could also face ‘reduced production’, according to UK-based consulting firm, Verisk Maplecroft, with one analyst saying that stagnation is ‘likely’ to last through to the end of September 2020.”
Renaud Anjoran, who heads a quality control and sourcing company in China, has written at length about the potential supply chain disruptions in the coming months. According to Anjoran, even supposedly diversified importers may come unstuck if their alternative suppliers depend upon components which are made in China. The same issue is true within China itself:
“Let’s say you have a manufacturer in Shenzhen. They make product ABC for you. They buy components from 5 other manufacturers in China, who in turn buy some materials & components from another 10 local suppliers. Your supply chain relies on all those 16 suppliers.
“What happens when 1 of the suppliers has restarted their facility late, is severely short on staff, and has very little inventory ready to sell? If it can’t be replaced easily and quickly, this issue may cause a long delay in the shipments of the finished product. Even if the assembler has all the people and machines to do the work.
“Delays, like quality problems, cascade down the supply chain. And their impact often amplifies.”
Just one company – Procter and Gamble – provides an insight into the complexity of supply chains out of China, according to Andria Cheng at Forbes:
“Consumer goods giant P&G, joining a chorus of companies including Apple, Adidas and Starbucks, warned Thursday that its sales and profit in China, its second-largest market, would be hurt by the coronavirus outbreak there. But the risk goes beyond that.
“’We access 387 suppliers in China that ship to us globally more than 9,000 different materials, impacting approximately 17,600 different finished product items,’ Jon Moeller, Procter & Gamble’s chief operating officer and chief financial officer, said Thursday at a conference in New York. ‘Each of these suppliers faces their own challenges in resuming operations.’
“With the U.S. depending heavily on China—‘the world’s factory’—for imported categories from shoes to mobile phones, retailers and brands are on their toes, waiting to see how the outbreak could end up affecting what consumers see on U.S. store shelves.”
Things could be a lot worse even than the likely shortages of consumer goods and final assembly components. Consider just two electrical goods – electricity grid transformers and computer hard drives. The first is an incredibly robust product. So much so that when they fail they are replaced to order. In which case, we had better hope that none fails while China is on lockdown, because without the transformers, the electricity grid won’t work… and without the electricity grid, every other critical infrastructure crashes. Computer hard drives, in contrast, are fragile. Although you and I – fortunately – only experience failures occasionally, the same does not go for the large datacentres that we are increasingly dependent upon. Visit any data centre on any day of the week and you will find someone disposing broken drives and waiting for a van or truck to arrive with replacements. What happens when the disks keep failing but vans and trucks don’t show up with new disks for a month or more because the Chinese manufacturer is on lockdown? No Facebook or YouTube? No Amazon? No international banking system?
What can be done?
According to Renaud Anjoran, not much in the short-term. Offering more money to speed up production/shipping may help. Although if everyone was to follow this advice, shipping problems would remain, but the price of everything would have been bid up. In the longer-term, however, the answer is simple enough; and it plays right into the hands of the nationalist populist politics of Brexit and Trump:
“There is just not enough production capacity in other countries to make the kinds of products (power drills, teddy bears, plastic garden furniture, lighters…) the Middle Kingdom has specialized in.
“Having said that, in the long term, this outbreak (and the resulting incredulity and shock of most decision-makers) WILL have a real impact. Three-year plans are changing, and there is no way back. Long supply chains, and reliance on 1 country for most or all of the supply of certain product lines, are inherently very risky.
“I haven’t read any announcement in the press about this. No big brand wants to be seen as dropping China with it is in a deep crisis (or “shooting on an ambulance”), especially if that brand sells to Chinese consumers. Yet, make no mistake, decisions are going to be made”
In the aftermath of a major supply chain disruption, the Trumpian call to bring the jobs back home will resonate more widely. One of the apparent oddities of the UK’s Brexit result – one which the political left simply refuses to understand – is that the people who voted for it are more than happy to trade increased national resilience for higher priced consumer goods. And in the short-term at least, rebuilding domestic manufacturing and diversifying and duplicating import supply chains will, indeed, be bought at the cost of much higher prices. One reason why both Trump and Johnson seem so relaxed about the spread of the Covid-19 virus may well be that it will prove to be the final nail in the coffin of a neoliberal globalised economic system that both are committed to replacing.
As you made it to the end…
you might consider supporting The Consciousness of Sheep. There are five ways in which you could help me continue my work. First – and easiest by far – please share and like this article on social media. Second follow my page on Facebook. Third, sign up for my monthly e-mail digest to ensure you do not miss my posts, and to stay up to date with news about Energy, Environment and Economy more broadly. Fourth, if you enjoy reading my work and feel able, please leave a tip. Fifth, buy one or more of my publications