If financial markets are all about greed and fear, there’s nothing like a deadly new virus crossing international borders unpredictably to deliver a blow. Except even as China’s coronavirus continues to spread, stocks and bonds have generally rebounded from the initial shock, suggesting that Beijing has a firm handle on the situation.
Or does it? The answer is crucial for the current and potential virus victims, but it also suggests how well Chinese authorities might respond to a future financial crisis when contagion of a very different kind threatens the global economy. This remains a secondary concern as long as the epidemic remains uncontained, but long-term investors in China or anything related to China—which means everyone—should watch closely.
So far, Chinese authorities get good marks for massive administrative response and improving engagement with international counterparts, but the tight control over information flows continues to undermine confidence that we know all we need to know. If they follow that same pattern when this very large, heavily indebted and generally opaque economy hits an air pocket, global markets may be in for a very rough ride.
For all the concerns that Western democracies have about China’s political system, the government has leapt into action as the coronavirus spread. In Wuhan, a city larger than New York, factories, schools and shops have been shuttered. Transportation in and out of the city is heavily restricted. A 1,000-bed hospital has been erected in just 10 days; the time-lapse video is amazing until you learn that an even bigger one nearby is approaching completion.
It’s a breathtaking response that would be unimaginable in, say, New York.
Wuhan and the surrounding Hubei Province are home to roughly two-thirds of the cases and 98% of the deaths from the virus. But the government’s response has extended across the country, dispatching drones equipped with cameras and speakers to encourage people to wear face masks and culling train records to identify passengers sitting near anyone who contracted the virus.
The government’s outreach to international organizations has not been flawless but compares well to its early silence during the 2003–04 Severe Acute Respiratory Syndrome (SARS) epidemic, when it waited nearly three months to report the outbreak to the World Health Organization (WHO). By then there had already been five deaths and hundreds of infections. The government’s initial report to the WHO this time was December 31, 2019, three weeks before the first human-to-human transmission drew broad media attention.
The WHO has generally praised China for its vigorous response to the crisis. President Donald Trump issued supportive tweets, too, following a Friday call with President Xi Jinping. And while Chinese officials have grumbled at what they consider an overreaction by the U.S. government to officially discourage travel to China, U.S. Secretary of Health and Human Services Alex Azar nevertheless recognized the steps Beijing is taking to coordinate its efforts with international public health counterparts, while continuing to encourage transparency.
Transparency, however, has rarely been China’s strong suit. Even as they filed a timely WHO report, Chinese officials kept a tight lid on coronavirus news and social media chatter within the country. This not only may have aided the initial spread of the disease, but it continues to fuel rumors and mistrust among Chinese citizens, some of whom have taken to posting reviews of the HBO series “Chernobyl” as an allusion to government censorship amid spreading danger. Add to this the elements of drama and tragedy following the death last week of Dr. Li Wenliang, the physician whose initial warnings of the deadly virus led to his being silenced by Chinese police.
If it seems crass to draw parallels between a public health crisis and a financial crisis, the lessons are instructive in both directions. Financial contagion spreads when risks are high and transparency is low, in many ways like a virus. Bondholders struggling with debt sustainability analyses rely on poor or underreported data and heroic assumptions about human behavior just as epidemiologists try to model pandemic risks.
Governments often struggle between their understanding of the benefits of market forces and their urge to maintain control, but China’s dilemma is especially acute in its financial sector. A new policy to allow more flexibility in the renminbi exchange rate in 2015 led to a sharp selloff as traders misunderstood the change. The government’s current efforts to allow some banks to fail and share costs with investors has put the entire sector under suspicion.
The worry for global investors comes from China’s increasing integration in both global trade flows and global financial flows. Already, shifts in China’s economy reverberate in Ohio and Baden-Württemberg. A significant disruption in Chinese financial markets will have consequences for the S&P, the Nikkei and many a bank in between.
Successfully addressing any such crisis will require swift action, close cooperation and reliable transparency, which is what makes the handling of the current coronavirus so instructive. For the victims and potential victims of the disease, Chinese officials must succeed as quickly as possible. For investors, however, it is also important just how they succeed.
Dr. Christopher Smart is Chief Global Strategist and Head of the Barings Investment Institute