Saving, Not Spending

To combat the COVID19 crisis the US government has gone very deeply into debt through the Federal Reserve, which has ballooned its balance sheet by an astonishing $3 trillion in just 45 days.

FRB Assets (Government Bonds) Soar

The money has gone to individuals as $1.200 checks and to various businesses as subsidies.  Consumer spending accounts for 70% of GDP, so the money was intended to sustain it and thus cushion the economy, even as unemployment soared. But, it didn’t.

Consumer spending collapsed by the most on record, as lots of people chose to play it safe and save it, instead. The strict lockdowns also played a role since most shops, restaurants, etc businesses were closed.

Consumer Spending Collapsed

Consequently, the saving rate jumped.

Saving Rate Jumps To 33%

Consumers will certainly resume spending as the lockdowns ease, but the crucial question is by how much and how fast?: In my opinion, not very much and rather slowly.  After all, unemployment is huge and so is the fear of a second viral wave in a few months.  People will play it safe, I think.

Irrationally Early Hope

Some of us remember Alan Greenspan’s “irrational exuberance” quote in 1996, his way of signaling that the stockmarket’s dotcom craze was founded mostly on mass psychology rather than earnings expectations.  He was right, of course, but way, way, way too early, as NASDAQ peaked a long four years later and at stratospheric levels compared to 1996. As Keynes has purportedly said, markets can remain irrational (far) longer than you can remain liquid.

Irrational Exuberance

To draw a sort of a parallel with the present, share prices are rebounding after the plunge caused by the COVID19 pandemic, with investors betting that new vaccines and drugs will allow the global economy to resume growth very shortly.  Are they rational?  Yes, and no.

Yes, because human ingenuity (aka Science and Technology) works wonders when applied on a massive and coordinated scale.  Remember, we went from the Wright brothers flying a few yards over the Kitty Hawk sands to landing on the Moon in just 60 years.  Medicine is trickier, but I have no doubt that we will eventually find ways to combat COVID19.

No, because viral pandemics take time to die out, even with effective vaccines.  Not only does it take time to produce, distribute and administer them, it also takes lots of time for herd immunity to reach a high enough level, even after vaccination.  We need around 60-70% of the global population to develop effective immunity, either through vaccination or natural antibodies, in order for COVID19 to be dealt with.

Past modern era pandemics such as those of 1918, 1958 and 1968 took almost 3 years to burn out on their own.  Horizontal, massive national lockouts were not imposed back then, so the general population was rapidly infected, leading to millions of victims.  By the same token, herd immunity was also rapidly established and the virus waned.

Today, human lives are considered more precious, and public opinion is shaped more by social media than anything else, leading to a “save lives” vs. “save the economy” dilemma (false dilemma IMO). Thus, we can expect more restrictions to stay in place for longer and even strict lockdowns to be reimposed as the viral infection plays out.  The effects on economic activity are pretty obvious, and so are the risks for corporate profits, dividends and share buybacks.

So far, investors believe that central banks will save the global economy (and thus markets) by printing as much money as “it takes” until medical science comes to the rescue.  (They also seem to bet on vaccines being available in months rather than years.)  However, this is not a temporary liquidity or credit crisis, at least not for a big chunk of consumers and companies out there.  It is an earnings crisis.

Lockdowns have permanently and irretrievably erased earnings and cash flows for a slew of companies and their employees: the entire travel, hospitality, entertainment, gaming, sports, restaurant, leisure, education, the biggest chunk of retailing, oil and gas, transport, logistics and related services... the list is pretty huge, actually.  On the heels of massive layoffs and/or forced time off with minimum wages come mortgage, consumer and student loan delinquencies, hitting the banking sector hard, as well.

Bottom line: markets are hoping for, and discounting on the upside, a very, very rapid recovery from the COVID19 crisis.  IMHO, they are very, very early.

Damage Control, Is It Possible?

The economic damage done by the COVID19 pandemic is enormous.  Unemployment has soared, leading to a collapse in personal consumer expenditure (70% of GDP). Loan delinquencies are also climbing fast.

 Unemployment At Unprecedented Level

Consumer Spending Collapses

Can this damage be reversed quickly?  Some of it will be, as economies around the world come out of lockdowns and adjust to a “new normal” mode.  But, IMHO the level of economic activity will be significantly lower than before.  Consumers will reduce spending for non-essential goods and services (eg travel and leisure) and will add to savings, where possible.  After all, the virus is expected to make a comeback in the coming months.

 Personal Saving Rate Highest In 40 Years

Faced with this unprecedented economic collapse, can governments do anything beyond temporary, one-shot income subsidies?  Yes, of course:  they should create new jobs.  How?  Invest heavily in necessary infrastructure, a type of New Deal for the 21st Century.  We need a new energy system (renewable electric, possibly even nuclear) and sustainable, environmentally friendly plant-based food.

I don’t have any hopes of this happening under the present administration, however...

2008 Was Chickenfeed

Faced with a pandemic, i.e. a REAL crisis as opposed to a monetary/debt one, the entire world has chosen to combat it by throwing money at it!  It’s a bit like treating a broken leg by swaddling it in paper instead of plaster.

And, oh my, what a lot of paper!  The current explosion of the Fed’s balance sheet is making the 2008  operations look like chickenfeed, mere penny ante.

The Fed Balance Sheet Rockets To The Moon

The problem is real in a physical sense, not just perception: economic activity has seized up leading to massive unemployment or, in the case of the EU, massive state subsidies and layoff prohibitions to keep the quarantined workers off the official unemployment statistics.  It’s just smoke and mirrors.

So, we have a triple whammy here: significantly lower production lowers supply, somewhat steady demand  with the $1.200 checks etc. smoothing things out to a degree and a whole lot of new money sloshing around.  Put them together and... yeah, I think high inflation is a real threat, after the immediate health danger is over.

Inflation plus high unemployment?  Here’s  a dirty word from the late 1970s - early 80s:  Stagflation.

I’ll be returning to this theme in my next posts.