May 25, 2020
The world experiences a multitude of bad things all of the time. Many of us in the first world don’t notice. The COVID crash has altered this and turned first world countries upside down.
There is a great list of epidemics on Wikipedia, showing some of the bad things that happen around the world. Measles, Dengue fever and Ebola last year had a significant impact on a variety of countries. Epidemics like those happen every year, but COVID-19 is a step up. It’s a pandemic. There haven’t been quite so many of those but they do cause a lot of damage.
But there are a lot of bad things beyond illness. There have been seven volcanic eruptions in 2020 so far, 21 earthquakes with a reading higher than 6.0 on the Richter scale, one typhoon and one tropical storm well before hurricane season even gets started.
For some events, such as hurricanes, it is easy to tell that things are ‘getting more active’. In other areas, things are not so easy to measure. Some would argue that modern technology simply allows us to better measure all of these significant events. In the end though these events are having a significant impact in the financial world. Here is a chart showing the financial costs of those losses.
There are more problems than that too. Many Sovereign crises are unfolding around the world, with China and the US ramping up disputes over trade and COVID-19, China is clamping down on one of the world’s financial centres (Hong Kong). Meanwhile Iran and the US may be inching closer to war while the Middle East and Eastern Europe continue to boil under the surface as they move forward with their real and proxy wars.
Don’t worry, the stock market is going up and it’s all good.
What does all that bad new have to do with anything? Many of my posts focus on the perception that there will be a ‘V’ rebound from the COVID crash, and of course the stock market is suggesting that will happen. In theory the stock market is a leading indicator of economic activity and so one might expect that things are going to be fine. Unfortunately it won’t be the case, at least not over any reasonable time frame.
While there is a great deal of hope for the ‘fed put’ to put a floor under the price of assets, and for the various government programs to keep Jane and Joe public afloat until the economy can re-open, there are many unknowns. As those unknowns pile up the costs also pile up. The next disaster may be the straw that breaks the camel’s back.
Federal debt has been climbing quickly and with near zero interest rates, the proverbial camel can continue to support the debt levels. But what if there is a loss of faith in the US ability to repay? What if there are too many debtors in need of funds to shore up businesses? What if the economy doesn’t rebound as fast as expected or far enough? We can’t know the future, but the economy has no wiggle room no matter how much the Federal Reserve tells the world about all of their ammunition. What’s worse is that ammunition comes at a significant cost to future generations.
Another way to view this is to look at the Velocity of Money. This is a measure of how fast money moves through the economy. In the US, the Velocity has been dropping steadily since the last injection of cash during the 2008 crisis. Will more money this time increase economic activity or result in further hoarding?
Of course this isn’t a problem for the US alone. China is now the world’s second largest economy and their debt load is officially 48% of their GDP, but S&P Global ratings believes that their ‘hidden’ debts add up to another 50% or more of GDP. At 100% of GDP China’s debt levels may prevent a return to the growth that has driven world demand for the past two decades.
Then of course there is Europe. Prior to the outbreak of COVID-19, the combined debt load vs. GDP for Europe was about 80%. This number hides the fact that some economies are stronger than others (Germany – strong; Italy – weak), and as the COVID crisis unfolds, the crushing debt of countries like Greece, Italy and perhaps even France is likely to ripple through financial institutions around the world.
If there is another hit to the economy, a natural disaster, a health scare, perhaps the COVID crash doesn’t result in a ‘V’ recovery and the economy needs more support than currently envisioned, the outcome is likely to be very negative.
The net of all that is that central banks around the world can only do so much to support private sector debtors (and thus providing liquidity). Should that support disappear, asset prices will be left to find a natural level. There is a good chance that level will be substantially lower than current market prices.
For now, it’s all good. Be cautious.