THE DAY BEFORE ‘THE DAY AFTER’

As most analysts quickly realized, the abrupt fall of stock markets worldwide this Monday was not caused solely by the uncertainty of the investors as to the size and duration of the impacts of the Covid-19 epidemic on the economy.

Saudi Arabia’s poorly-timed decision of breaking the OPEC+ entente and starting an oil price war with Russia (and with other non-OPEC producers) was an additional, and arguably equally important, cause of market turmoil. The reason why the sudden fall in crude oil prices hit capital markets so hard has more to do with the unpredictable character of the underlying dispute than with the so-called ‘economic fundamentals’, which would normally point in the opposite direction. And although it is true that, technically, there is room for agreement between oil-producing countries on the issue of a concerted reduction in supply, it is also patent that the main players are entrenched in their respective positions for the moment.

On the other hand, the reaction on the part of the US government has hardly been one to inspire tranquility. In the case of oil prices, the laconic message from the US Treasury Secretary to the Russian ambassador in DC – stating that the US wants an “orderly” oil market – seemed like a classic case of too-little-too-early. Any outside observer would be excused for seeing this as merely a pro forma gesture, signaling that Washington is willing to let the oil market “adjust” itself (i.e. to let the Saudis and the Russians duke it out) without stepping in directly.

This prospect raises not a few doubts, considering that low oil prices pose a direct challenge to the economics of American shale gas/oil production. At best, a very sharp or a very long decline in oil prices (or a combination of both) could mean substantial costs for the US Treasury to bailout shale drillers. At worst, disturbances in the oil market could have significant repercussions on other asset prices within the US economy.

By the same token, the “business as usual” approach adopted so far by president Donald Trump regarding the fast-spreading Covid-19 virus has sparked much speculation about potential economic effects throughout North America. The available evidence has shown that only countries that responded with very rapid and widespread mobilization of their public agencies and manpower – and where strong and centralized coordination by health authorities was put in place – managed to reduce the transmission rates for the virus in any meaningful way.

The sum total of this array of uncertainties is reflected in the projections for the VIX index over the next few days. The VIX seeks to measure the implied volatility of the option prices expiring in 30 days, on average, for stock listed in the S&P 500 index. Many brokers are taking up positions that point to the possibility that the VIX may reach 100 points.

It is worth noting that even in the wake of the Lehman Bros. tumult in 2008 – at the outset of what later became known as “The Great Recession” – the VIX did not rise as high as 90 points. The forecast that sees this “fear gauge” breaking the hundred-point threshold is one that, if confirmed, would place international financial and capital markets in a new and unprecedented scenario.

As far as Brazil and several other peripheral economies are concerned, two immediate consequences can reasonably be expected, should such conditions obtain. The first is that those countries’ credit-default swaps (CDS) are likely to react elastically, rising in value more than proportionally and taking other country-risk indicators to similarly high levels.

The second foreseeable consequence is that a general outcry among neoliberal (orthodox) economists in the local media is likely to take place, insisting that those countries only protection against the deflationary and recessive effects of the crisis is to implement economic policy measures of a deflationary and recessive nature, as soon as they possibly can. (In Brazil’s case, this particular brand of economic non sequitur will more likely than not be translated into increasingly vocal appeals to the government, as well as by government officials, to cut expenses with public services in a quicker and deeper fashion than has been done so far. And to sell any and all remaining public assets, at an even faster speed and imposing even less requirements on buyers than before, if at all possible.)

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