April 9, 2020
This is just a short post to highlight some easy to spout crap about markets and government intervention. It is complete hubris to think that explanations for my unusual views are necessary, and perhaps greater hubris to think they are not. Either way, there is a general lack of supporting material here, in an effort to avoid boring the reader.
Today, the US government essentially gave up on their association with free markets and became a significant owner of US industry. Albeit by proxy of the banks, but they have done so nonetheless.
It has become clear that Donald Trump wants the stock market to go up, and to make that happen, he has consistently, gradually and now, in an avalanche removed risk from the investment equation.
As most people know the 2008-9 financial crisis was a debt crisis. When the liquidity of financial instruments is simply not available, buyers disappear and prices drop until value can be found. That collapse was caused by lack of capital and lack of value. To demonstrate this, imagine if you had $100 in your pocket, owed nothing to anyone, and had all of your needs taken care of, and then someone offered you something worth say $150, perhaps $200 or maybe even $500 . . . would you transfer the money to the seller to obtain an item of more significant value for your savings? Perhaps, as there are other factors to be considered, but the only reason why assets of value don’t change hands is because the price is not set properly.
To solve that crisis, which was largely manifested in home sales, the government purchased, guaranteed or otherwise supported the debt of hundreds of companies that were in over there heads. In essence, they put a price floor under assets that were over priced to save banks that took on too much risk, thereby preventing a collapse in the financial house of cards wrought by low interest rates. This process has continued in Europe, China, Japan and plenty of other countries as well for well over a decade. The intent is to try to support a price that is higher than the perceived value. It largely worked and asset prices rose to astronomical levels despite modest improvements in mundane items like wages, groceries and most basic commodities.
Looking at the same events in a different context, all that money failed to spur the inflation measured by the consumer price index. The debt burden remained, but government attempts to inflate the debt away failed. [Artificially low interest rates spurred massive risk taking in production, manufacturing and distribution. The supply of nearly everything was increased, almost risk free. This aggravated the attempts to raise prices as there was oversupply; but that’s for a different post.]
Ever since, governments have figured out two key things.
- Voters either don’t understand or don’t care about sovereign debt enough to complain about deficits or debt.
- People without savings care only about staying solvent (more crudely, staying alive), and people with significant savings want to see their savings balances go up consistently.
Sure, these may be overstated, generalizations and harsh, but in any given election you only have a couple of choices and so if you promise (convince voters) that those issues are taken care of then you can do pretty much whatever you want when you’re in power.
Here we are in 2020 and today, the government announced another $2 trillion of initiatives to save the world of finance. If you’re keeping score, that is about $6 trillion dollars in the past month. Not that it is polite to press a point, but that is more money than was added to the US debt burden during the WORST four years of the last crisis. The key issue is that it took FOUR YEARS to damage the US balance sheet that much. This time it was done in 4 weeks.
Sadly, it still won’t be enough to keep the stock market up. Certainly it all looks good now. The S&P 500 closed the week at 2,789, which is 26% higher than it’s low of about 2,200 set on March 23, 2020. But the government has taken control of significant portions of government and corporate assets and has removed the risk from investing. Today they even made the decision to support junk bonds. That name doesn’t need any further explanation. If you don’t know what they are, the first word is the clue. Junk.
Another point that I will make, without much to back it up, is that those with massive amounts of money are happy to stay invested because the government has assumed all of the risk that the company (or companies) they back won’t go out of business. In a recent survey, 80% of high net worth investors at one major firm thought there was no need to reduce their holdings.
To be fair, there is an effort to support main street businesses with a loan, various payment deferrals and for tax payers, a $1,200 check (in the US). Wow. To put that in context, the US has about 330 million people. If you were to give each person their share of $1 trillion, then everyone would get $3,030. If you doled out $6 Trillion, each person would get about $18,000.
In a perfectly free market, you would give each person their $18,000 and let them decide how to use it, but the government is again, using the story line of ‘saving jobs’. In that context, the government is deciding who gets money and who doesn’t (using their proxy/agents; the big banks that were bailed out of the last financial disaster).
The siren call by corporate leaders is that their business should be saved because it would be sold for a fire sale, or because it will save jobs, or whatever other promises are being made that are not so altruistic (think politics here). But they took the risks and they expect to be saved for failure to adequately plan for the risk.
A wise financial planner would suggest that any individual have a reserve of cash for unforeseen expenses, a job loss or a modest unhappy occurrence. Sadly, 40% of Americans are just one pay cheque away from catastrophe, and it just hit. Yet corporations (and their leaders) who are generally well educated, have massive networks of consultants, advisers, and boards of directors, failed in this simple act and are now demanding to be bailed out for their lack of prudence.
This is all the more difficult when considering that they are trying to save organizations that have, in general, enjoyed some of the best of times over the past twenty years. They have had plenty of opportunity to plan for an unforeseen event, yet most have failed.
How do you reconcile all of this with what is happening in the markets? Well, to put it mildly, don’t buy into the idea that the market has been saved. For most individuals and businesses, the actions being undertaken by governments around the world amount to a 2nd or 3rd mortgage. Offered at a low initial interest rate, it will sustain people for about one month (how long with $1,200 last you?), and for corporations, any loan may provide sustenance for a while, but it won’t overcome the two key problems which will begin appearing later this spring or perhaps summer. First, a very large part of the middle class will now join the poor in being unable to purchase items other than essentials. Secondly, changes in behaviour mean that a significant portion of the economy will not soon, and perhaps never, get back to the frenzied pace of the last two years.
To make matters even more complicated, supply and demand dynamics are going to be altered in meaningful ways. Service industries are likely to be very hard hit with some (hopefully small) percentage failing to re-open, but those that do will likely have to raise prices to recover what has been lost during the downturn. Larger industries like autos or airplanes will be hit with drops in demand, if not due to financial constraints on the part of customers, at least due to uncertainty.
There are hundreds of examples, but it is worth noting that the 26% rise in the stock market does not reflect the damage being done to the balance sheets of nations, corporations and individuals. It will take months to sort through the consequences, and understand the impact of this unfortunate event. It would be foolish to think that the stock market has figured it out in the six weeks since things started going downhill.