Economics today: The key, WE ARE IN A RECESSION.
May 20, 2020
The first lesson from the pandemic is that nobody knows anything. The next thing to know is that we are in a recession, a really bad one. If you think that this recession is solely caused by the pandemic (“supply shock”) you would be wrong. Every recession needs a trigger to set it off. In 2008 it was mainly the Lehman Brothers failure. This time the pandemic trigger is unique but it will, like all previous recessions, expose underlying weakness in the economy.
T his pandemic has made it painfully clear that we never know what’s going to happen next. We live our lives thinking that things will remain about the same but they don’t. Bad things happen. Good things happen too, but we don’t have to worry about them. It’s the bad things we have to look out for.
This pandemic is a tectonic change for us. Things will be different when it’s over. It will affect all of our lives.
The first lesson from the pandemic is that nobody knows anything. Panic, delay, and confusion were and still are the responses from the-powers-that-be. This is true even though many smart people told us years ago that there will be a pandemic (Bill Gates was one of many). So, it’s not a Black Swan.
It’s too soon to discuss the fallout of governments’ response to the pandemic. But so far it appears that (1) local solutions are best, and (2) governments’ actions have potentially done more harm than good—but that is more speculation than fact at this point. Wait until the dust settles.
The next thing to know is that we are in a recession, a really bad one. It will only end when two things happen:
- We emerge from the pandemic; and
- We scrap government barriers on business and allow them the freedom to recover. This will take time.
Between herd immunity, warmer weather, and effective therapeutics and vaccines, we will survive this pandemic. Be patient (and be careful). These factors are all on the near horizon despite what the media experts say.
This recession will be the eighth one I’ve experienced as an adult. I’ve studied each one and they have several commonalities. They all start with some form of monetary inflation by the Federal Reserve and they are all impacted by varying degrees of government regulations and responses which for the most part have made things worse.
This recession is no different. If you think that this recession is solely caused by the pandemic (“supply shock”) you would be wrong.
Even if you aren’t an economist you probably noticed that there were unpleasant things bubbling up from the economic ooze before the pandemic hit. When the powers-that-be-have to tell us that “Everything is fine. Move along” you can guess that there probably is something wrong.
Every recession needs a trigger to set it off. In 2008 it was mainly the Lehman Brothers failure. This time the pandemic trigger is unique but it will, like all previous recessions, expose underlying weakness in the economy.
Weakness? you ask. But jobs were at an all-time high and stocks are way up. Yes, it’s confusing. But this is the economic reality:
- GDP (inflation adjusted) has been sluggish for a decade, barely growing at 2% per year for the past decade.
- Productivity (worker output) has stagnated for the last decade.
- Corporate debt, household debt, and federal debt are at highs never seen in modern times. As of 2020 corporate debt ($15.5 trillion) was 82% of real GDP; household debt was 75%; and federal debt (Q1 2020) was 119%. Recent massive federal spending has raised federal debt even more. (From Mises Institute)
- There has been an explosion of corporate debt, especially in the “junk” category. In 2019, 65.1% of such debt had B or lower credit ratings. Credit rating downgrades are the highest since 2009. (Grant’s 2-7-2020)
- Much of the corporate debt was used for nonproductive things like mergers, stock buybacks and dividends. Stock buybacks might look good in the boardroom but it is a huge increase in companies’ risk.
- Corporate earnings have been stagnating for the past 8 years. Earnings per share appear to have grown, but only because massive stock buybacks have changed the formula to make them look better than they are.
- Personal consumption expenditures (PCE) as a percentage of GDP have been flat for the past decade.
- Tariffs and other anti-free trade policies have undermined the economy.
As a “tell” that something was wrong, the Fed, starting in September, has been pumping new money into the financial markets at a furious pace: a staggering 85% increase! It does this by buying treasury bonds and now corporate bonds (something it has never done). They only do that if they think the financial markets are in trouble. This money has been created out of thin air.
The Fed’s goal is to keep interest rates at historic lows so weak companies and the federal government can service their debt. The federal deficit is projected by the CBO to be $3.7 trillion this year and, with further attempts at fiscal stimulus, it could exceed $6 trillion requiring the government to borrow even more. By monetizing these deficits, the Fed will have almost complete control over the bond market.
These policies are not the cure; they are the problem. The result will be the destruction of capital (savings), stagnant economic growth, stagnant corporate profits, declining productivity, more debt, more federal spending and deficits, and yes, possibly, negative interest rates. In short, we are continuing to go “Japanese”. Their economy has been moribund for two decades and they have done exactly what we are doing, but with even more spending and debt. No one ever learns.
The economy will recover only when business is back on its collective feet. Nothing that the government or the Fed is doing or will do is going to change that. As we’ve learned from experience, government bailouts and new regulations only delay recovery. Despite the Fed’s money printing and the federal government’s bailouts and spending, the Great Recession’s recovery was the slowest in the modern era and with the bonus of declining economic growth (GDP).
As I oft say, neither I nor anyone can predict the future. My “predictions” in my January article have been shot to hell by the pandemic. But I think I can safely say the following:
- Until local, state, and federal governments free up the economy, the economic impact will be very painful for 90% of American families.
- Once freed, the economy won’t bounce right back—there will be a slow recovery.
- Government spending (fiscal stimulus) and Federal Reserve efforts (money printing and bailouts) to revive the economy will do little good.
- Deficit spending by the federal government will increase debt levels to historic highs.
- The Fed will “monetize” new federal debt which may lead to negative interest rates. Negative rates accelerate the destruction of capital.
- High government debt levels have historically accelerated economic stagnation. This time will be no different as they dominate the financial markets and crowd out the private economy.
- Many “zombie” corporations will fail (those debt-heavy companies with junk ratings whose earnings aren’t sufficient to service their debt).
- There will be massive corporate bailouts.
- The trend of the economy will be deflationary keeping price inflation in check.
- The debt problem is worldwide making the recession worldwide.
The final lesson, and the one that is most important to us on a personal level, is understanding that our economic and government systems have become fragile. Nassim Taleb of Black Swan fame says we must develop systems that are “antifragile”. This is not the same as being “robust” where you have the ability to fend off shocks. Antifragile systems get stronger from shocks (your body, for example, develops antibodies to fend off invading viruses). This also applies to economics and government.
In a fragile world, with less certainty and more risk, we need to live our lives with that in mind and become antifragile. To survive a recession and then thrive, that means avoiding debt, increasing savings, and, where possible, arrange your investments to less volatile assets.
If you thought the government was there to bail you out, I think you now understand that is not going to happen. No one said it was going to be easy.