Liam Dann: Why the coronavirus correction is no GFC

People wearing protective face masks walk on a street in Beijing. Photo / AP

COMMENT:

Coronavirus fears have finally hit Wall Street, with a big sell-off this week sending financial shockwaves around the world - including on New Zealand's NZX.

The NZX-50 is now off 5 per cent since its most recent high last week. Wall Street is off about 7 per cent.

Unfortunately the high drama of a market crash feeds into fear and panic even though it has no impact on the actual spread of the virus.

We should probably expect more market volatility now as good and bad news on the epidemic ebbs and flows.

But take a step back and look at the long-term graph.

The last week has seen 5 per cent knocked off the 354 per cent growth on the NZX-50 index since the low point of the GFC - almost exactly 11 years ago (February 27, 2009).

If the disruption from the virus outbreak is longer than expected then it is not unthinkable that we'll see the stock market slipping into bear territory - a fall of at least 20 per cent.

We may even see technical recession in New Zealand if economic growth goes on hold for two quarters (most economists still expect just one flat quarter).

But, if it is any consolation, that doesn't mean we face another global financial crisis.

No matter how excited daily market reports get, there a one big difference between what is happening to markets now and what happened in 2008. That is the strength of the banking system.

The financial meltdown in 2008 struck at the very core of the financial system - its credit markets.

It seems perverse (although it won't surprise anyone familiar with our modern capitalist system) but the world runs on credit.

So something like coronavirus disruption, which is causing massive disruption to the productive, wealth-producing end of the economy, is less damaging than a credit crunch.

When the GFC hit it was like a sudden heart attack for the global economy.

Credit stopped flowing, banks started collapsing and there was an immediate and devastating effect on every part of the economy that relied on debt - which these days is almost all of it.

While the global economy has not improved its debt position in the past decade, the global banking system is in much better shape.

The NZX-50 is now off 5 per cent since its most recent high last week. Wall Street is off about 7 per cent. Photo / AP

The economic threat from coronavirus is external to the banking sector.

So while the damage it does specific industry sectors like aviation and tourism is extremely serious, it is something that banks have breathing room to assess and prepare for.

Out in the real world of empty hotels and quiet sawmills, the idea that the bankers in their glass towers are so far largely unscathed may be of little comfort.

But it is important.

Credit will be crucial to containing the economic fallout from this crisis - whether it lasts another month or another 10.

We have to assume there is a temporary nature to the disruption but for many businesses surviving a severe hit to cashflow, holding on to staff and maintaining operations to benefit from a post-virus rebound will be highly challenging.

They will need their banks to take a pragmatic, long-term view on debt repayment. It is logical for banks to take that kind of view with most of their business customers.

In times of real financial crisis that logic goes out the window.

But for now, with bank balance sheets still strong, there is scope for them to take a pragmatic approach.

It looks increasingly likely we will see economic stimulus in the form of government support for business sectors, and potentially, further interest rate cuts by central banks.

While central banks have less head room for rate cuts than they did in 2008 (rates are already at record lows) they are more prepared and more used to taking evasive action.

And the New Zealand Government, already in fiscal stimulus mode, is well placed to deliver more support as required in coming months.

But neither fiscal or monetary policy will flow through to already distressed businesses quickly.

A strong banking system and good credit conditions have the potential to keep the economy moving through this crisis.