[Newsphopick=Kingsley Lim] When COVID-19 hit the global economy, I predicted that there would be a ripple effect that would affect all businesses and consumers. No one is spared from this once in a century black swan event. The world was even better off during the Great Financial Crisis. In terms of unemployment, COVID-19 has triggered a higher rate of retrenchments than the Great Financial Crisis.
When the virus first began in Wuhan, China, there was early evidence that businesses would suffer but few paid attention. In Wuhan, all of a sudden, there was little to no demand for both goods and services. Only the essentials was what people needed. Big-ticket items and other expenditures fell sharply. But this was not the end of it. At the same time, there was also no supply. Factories, restaurants and industrial businesses closed.
Businesses which depended on other suppliers for raw materials had no way to produce the products they normally did. For example, a factory manufacturing shower pipes may not have been able to get stainless steel from its usual suppliers during the coronavirus pandemic and this made production harder, even in other parts of China.
Everything came to a standstill. Now, because China plays a part in the world’s supply chain, you will find that this affects its trading partners, and magnify the effects of the coronavirus in a way that people never saw coming. Suddenly, manufacturers in countries in the European Union and in South East Asia, were not able to get the raw materials they needed from China. In a world where we are all interconnected, these issues affect all of us in big way.
When news of these got to the US and the rest of the world, few saw the potential impact it had on the American economy. The American economy is a great consumer among other things. Shortly after, the markets fell sharply by about 30%, before recovering quickly on the back of speculative investing and money printing by the Federal Reserve.
Today, the markets are as high as it ever will be and the economic situation is probably the worst in living memory for most. The loss of jobs faced by the global population and the fall in revenue of most companies have acted to perpetuate this vicious cycle. With that comes the uncertainty of life and a probable second wave of the pandemic, as infections surge.
These series of events has caused bankruptcies for many companies as they fail to pay the interest on the debt due to falling revenues. Many companies have reported filing for bankruptcies in recent times. Virgin Australia, Neiman Marcus, Muji and many other retailers have filed for bankruptcy protection.
After that, the real estate firms start to feel the pinch, as companies default on their rental. This is observable in cases where small to large businesses lease their business premises from another who owns real estate. Suddenly, real estate firms cannot pay their mortgages as they fall due.
Eventually, this flows upwards to the banks who have made the loans to companies in need of them. These loans which constitute a huge part of the balance sheet of many companies, are placed on the balance sheet of banks as assets. Now that many companies are unable to pay their debt and mortgages, these assets will have to be written down drastically.
There are signs that this has begun. HSBC Holdings Plc announced that its bad debt charges could exceed US$13 billion this year, causing profits to fall by half. The bank also warned that it is likely that its capital reserves will decline.
The total bad debt charges that HSBC will incur this year is projected to be between US$8 billion to US$13 billion, higher than the previous estimates of US$7 billion to US$11 billion.
"What we have seen this quarter is quite a sharp shift in economic outlook for the global economy, the famous 'V' has got a lot sharper and as a result we have materially increased our provisions," said the Chief Financial Officer Ewen Stevenson of HSBC.
With the fall in profits and a deterioration in its capital ratios, it is quite likely that the company will review its dividend policy. The markets have reacted and the company’s share price has fallen to an all-time low.
If this was a harbinger of things to come, then quite likely, we are at an early stage of a financial collapse. Banks around the world would likely have to go through some painful times ahead by writing down the value of its assets and recognizing its bad debt. Doing so would force it to cut its dividends or halt them for a few years before resuming them in the future. In my opinion, we are beginning to see this play out and as investors, we should be prepared for it.