When a central bank prints money and widens the monetary base for good, it ought to have a negative effect on the currency. If the Fed prints 4-5trn digital USDs through the rest of the year, it would be an increase of close to 20% of GDP. In comparison the ECB expects to print EURs equivalent to around 10% of GDP. Net/net this should be a USD negative story.
Currently, enough USDs have been printed to lead the DXY index 10% weaker on historical patterns. And this is before accounting for all the money printing that will occur over the coming quarters. The USD probably just needs a green light to weaken from other factors, before this liquidity effect will really kick-in.
Chart 4: Enough USDs have been printed to weaken the dollar by almost 10% now
Due to low commodity prices and less global trade, fewer USDs change hands globally and consequently this results in a marked drop in the velocity of USD liquidity, which is one of the reasons why all these liquidity facilities from the Fed are needed. Usually the USD strengthens around 10%, when global trade drops 4-5% as we are currently seeing. Accordingly, the velocity of USD liquidity will not increase again before the global trade rebounds, which is likely a post-lockdown story. Many places are likely to remain locked down for another 4-6 weeks in our view. Once we are out of this mess, the USD could be hammered.
In very prolonged curfew scenarios, the USD will likely remain stronger for longer.
Chart 5: When global trade slows the USD gains, since fewer USDs will float in the global financial system
Should the USD lose its momentum and start a weakening cycle, this would also entail tailwinds for commodities in general. Usually the broad commodity index is a double beta to the DXY index. If the USD weakens 10% then the broad commodity index gains 20%. It is probably not a bad idea to consider adding long broad commodity positions during the second half of 2020.
Chart 6: Commodities usually gain times two, when the USD weakens
A new USD cycle with consequences for asset allocation?
A stronger dollar generally tightens financial conditions outside of the US, which is kind of counterintuitive since that weaker currencies outside of US in principle should lead to a competitive advantage. Some mentionable reasons why a strong USD is bad news for growth are that i) EM countries have borrowed in USD, ii) firms who have borrowed in dollars see debt burdens grow in local currency and iii) the financial sector also empirically becomes less keen to lend out when the USD is strong.
During recessions or times of crisis a strong USD usually builds until a weakening wave takes over. This is exactly what we imagine could happen again this time around. The trade war and corona crisis respectively worked to tighten financial conditions outside of the US alongside the strong USD, and once the crisis is solved it paves the way for a weakening USD trend.
If a new weakening cycle is coming in the USD, it could prove to be lengthy and material. The two most recent USD weakening cycles led the USD BIS REER index approximately 30% on average over a 8-10 year period.
Chart 7: USD cycles from 1970 until today. Usually cycles are lengthy and material
A strong USD usually underpins the return of US equities relative to European or Asian equities, since a strong USD is bad news for financial conditions outside of the US, while the domestically driven US economy usually fares more than OK despite a strong USD.
Hence the direction of the dollar is quite important for asset allocation decisions as a new USD weakening cycle could lead to US underperformance versus rest of the world. During the two periods where the dollar showed a long weakening trend, the S&P500 underperformed the MSCI EAFE index by 15% (1985 to 1995) and 25% (2002 to 2011), while the S&P500 overperformed like crazy during eg the most recent USD bull cycle. We wrote more about in this piece from 2018.
If the USD cycle turns negative, it may make sense to consider underweighting USA already within the next couple of quarters. We don’t necessarily think that a weak USD is right around the corner due to continued curfews, but 6-12 months out we think the tide has turned and structurally it is better to position a little too early than a little too late.
Follow our weekly FX series for continuous esoteric USD liquidity updates.
Chart 8: S&P 500 versus MSCI EAFE (Europe, Australasia and Far-East) and the USD. When the USD is strong US equities outperform and vice versa.
“When she looks at me and laughs, I remind her of the facts….”
In previous years I’ve been able to sneak some marvellous April Fools days jokes on readers. Due to circumstances, it would not be appropriate this year – we’ve had enough shocks. But, this morning’s announcement petrol will be rationed until June 31st has still caught many by surprise…..
As the sun rises over the river, the second quarter of 2020 opens bleak. Another day of market high-jinks as participants arb stimulus packages. UK Banks suspend dividends – so much for investment fundamentals and my buy stocks with a decent dividend strategy then… Who will be next? Oil majors? Long held investment equations are all changing. The laws of financial physics are not as unchanging as we think.
Let me start with a warning:
Under no circumstances allow yourself to read the following media articles. They are dangerous. They will cause conniptions and leave you in an anguished “what if and maybe” frame of mind for the rest of the day. Do Not Read This Article or Any Othersabout Sweden. It will only upset you.
Meanwhile..
Life continues to batten down here in Hamble. Our brilliant little Co-op, where once there was a wider choice of Iberico’s than Waitrose, better Bordeaux than Berry Bros, and more fine chocolate choices than Brussels, is now only offering Cadburys. Things are slipping. Hats Off to the staff of shops around the globe – Proper heroes doing a fantastic job, doing a far more useful to society than parasites like myself, and I suspect most readers.
What to worry about next….
I got a call from a Swiss Broker chum y’day telling me they see a rise in demand for TIPs – Inflation Linked bonds. Although I’m not seeing any significant action in the inflation linked ETFs I watch, it makes sense to keep a weather eye on inflation: the global economy isn’t actually producing anything much, but we are still buying lots of stuff. If demand exceeds supply – that pushes prices higher = inflation.
You could argue that no one is earning any money, therefore can’t spend anything, that’s deflationary – but we just created billions of billions of cash. The real issue is where all that ersatz cash actually goes.
Last time we did that – 8 years of the experimental madness of QE – the result was massive inflation in financial assets, even as contradictory austerity policies in the real economy cut services. Money that would have been directed to building industrial and service capacity, therefore increasing productivity, and raising consumer wages, was siphoned off into financial assets, meaning we got deflation instead.. Too many goods were chasing consumers with stressed wallets whose real incomes tumbled for 10 years.
This time we’re talking about Helicopter money in some economies, and paying wages of otherwise unemployed workers in others by nationalising payrolls. It might just work this time and generate inflation.. Well, at least the ECB will be happy. They should be careful what they wish for… Inflation – for those of you too young to remember – is a vicious and unpredictable bounder, destroying savings, and financial asset values.
If goods are in short supply then prices will rise through the mechanism of the market.
Or…
Governments can chose to avoid riots, and ration goods and services through legislation. I am sure there will be many politicians thinking rationing will not be an issue… they’ve already done just about everything else… How long before we get food stamps entitling us to a rasher of bacon a month, a pound of lard and a packet of dehydrated mashed potato from the Government emergency stocks?
It begs a wider question. Where does government stop? When Jeremy Corbyn called for the nationalisation of the railways a few months ago we fulminated at his socialist communistic insanity. The government did it the week before last, and nobody even noticed.
Or Victor Orban promising to hand back power when the crisis is over. Sure. We know how that ends… although the inhabitants of the US city of Cincinnati could tell us the story of about the only example of a politician voluntarily laying down power.
The stock market has completed the first phase of a bear market with a rapid and sharp Q1 sell-off caused by massive deleveraging
Stocks still need to deal with its valuation problem as well as discounting the long-term financial and economic impact of the Coronavirus shock
Even with the 25 percent sell-off since the February 19th high, stock market capitalization-to-GDP remains extremely elevated, still higher than its pre-GFC high and at the 85th valuation percentile
Our analysis illustrates that stocks still have 40-56 percent of downside to reach the valuation levels where the past two major bear market’s bottomed
Time, rather than price, could bring valuations back into line with historical valuation levels as stocks settle in for a protracted bear market
A loss of confidence in the dollar as the world’s reserve currency could spark inflation and boost stocks as an inflation hedge
Citizens seem to be clamoring for shutdowns to prevent the spread of COVID-19. There is one major difficulty, however. Once an economy has been shut down, it is extremely difficult for the economy to recover back to the level it had reached previously. In fact, the longer the shutdown lasts, the more critical the problem is likely to be. China can shut down its economy for two weeks over the Chinese New Year, each year, without much damage. But, if the outage is longer and more widespread, damaging effects are likely.
A major reason why economies around the world will have difficulty restarting is because the world economy was in very poor shape before COVID-19 hit; shutting down major parts of the economy for a time leads to even more people with low wages or without any job. It will be very difficult and time-consuming to replace the failed businesses that provided these jobs.
When an outbreak of COVID-19 hit, epidemiologists recommended social distancing approaches that seemed to be helpful back in 1918-1919. The issue, however, is that the world economy has changed. Social distancing rules have a much more adverse impact on today’s economy than on the economy of 100 years ago.
Governments that wanted to push back found themselves up against a wall of citizen expectations. A common belief, even among economists, was that any shutdown would be short, and the recovery would be V-shaped. False information (really propaganda) published by China tended to reinforce the expectation that shutdowns could truly be helpful. But if we look at the real situation, Chinese workers are finding themselves newly laid off as they attempt to return to work. This is leading to protests in the Hubei area.
My analysis indicates that now, in 2020, the world economy cannot withstand long shutdowns. One very serious problem is the fact that the prices of many commodities (including oil, copper and lithium) will fall far too low for producers, leading to disruption in supplies. Broken supply chains can be expected to lead to the loss of many products previously available. Ultimately, the world economy may be headed for collapse.
In this post, I explain some of the reasons for my concerns.
[1] An economy is a self-organizing system that can grow only under the right conditions. Removing a large number of businesses and the corresponding jobs for an extended shutdown will clearly have a detrimental effect on the economy.
Figure 1. Chart by author, using photo of building toy “Leonardo Sticks,” with notes showing a few types of elements the world economy.
An economy is a self-organizing networked system that grows, under the right circumstances. I have attempted to give an idea of how this happens in Figure 1. This is an image of a child’s building toy. The growth of an economy is somewhat like building a structure with many layers using such a toy.
The precise makeup of the economy is constantly changing. New businesses are formed, and new consumers grow up and take jobs. Governments enact laws, partly to collect taxes, and partly to ensure fair treatment of all. Consumers decide which products to buy based on a combination of factors, including their level of wages, the prices being charged for the available goods, the availability of debt, and the interest rate on that debt. Resources of various kinds are used in producing goods and services.
At the same time, some deletions are taking place. Big businesses buy smaller businesses; some customers die or move away. Products that become obsolete are discontinued. The inside of the dome becomes hollow from the deletions.
If a large number of businesses are closed for an extended period, this will have many adverse impacts on the economy:
Fewer goods and services, in total, will be made for the economy during the period of the shutdown.
Many workers will be laid off, either temporarily or permanently. Goods and services will suddenly be less affordable for these former workers. Many will fall behind on their rent and other obligations.
The laid off workers will be unable to pay much in taxes. In the US, state and local governments will need to cut back the size of their programs to match lower revenue because they cannot borrow to offset the deficit.
If fewer goods and services are made, demand for commodities will fall. This will push the prices of commodities, such as oil and copper, very low.
Commodity producers, airlines and the travel industry are likely to head toward permanent contraction, further adding to layoffs.
Broken supply lines become problems. For example:
A lack of parts from China has led to the closing of many automobile factories around the world.
There is not enough cargo capacity on airplanes because much cargo was carried on passenger flights previously, and passenger flights have been cut back.
These adverse impacts become increasingly destabilizing for the economy, the longer the shutdowns go on. It is as if a huge number of deletions are made simultaneously in Figure 1. Temporary margins, such as storage of spare parts in warehouses, can provide only a temporary buffer. The remaining portions of the economy become less and less able to support themselves. If the economy was already in poor shape, the economy may collapse.
[2] The world economy was approaching resource limits even before the coronavirus epidemic appeared. This is not too different a situation than many earlier economies faced before they collapsed. Coronavirus pushes the world economy further toward collapse.
Reaching resource limits is sometimes described as, “The population outgrew the carrying capacity of the land.” The group of people living in the area could not grow enough food and firewood using the resources available at the time (such as arable land, energy from the sun, draft animals, and technology of the day) for their expanding populations.
Collapses have been studied by many researchers. The book Secular Cycles by Peter Turchin and Sergey Nefedov analyze eight agricultural economies that collapsed. Figure 2 is a chart I prepared, based on my analysis of the economies described in that book:
Figure 2. Chart by author based on Turchin and Nefedov’s Secular Cycles.
Economies tend to grow for many years before the population becomes high enough that the carrying capacity of the land they occupy is approached. Once the carrying capacity is hit, they enter a stagflation stage, during which population and GDP growth slow. Growing debt becomes an issue, as do both wage and wealth disparity.
Eventually, a crisis period is reached. The problems of the stagflation period become worse (wage and wealth disparity; need for debt by those with inadequate income) during the crisis period. Changes tend to take place during the crisis period that lead to substantial drops in GDP and population. For example, we read about some economies entering into wars during the crisis period in the attempt to gain more land and other resources. We also read about economies being attacked from outside in their weakened state.
Also, during the crisis period, with the high level of wage and wealth disparity, it becomes increasingly difficult for governments to collect enough taxes. This problem can lead to governments being overthrown because of unhappiness with high taxes and wage disparity. In some cases, as in the 1991 collapse of the central government of the Soviet Union, the top level government simply collapses, leaving the next lower level of government.
Strangely enough, epidemics also seem to occur within collapse periods. The rising population leads to people living closer to each other, increasing the risk of transmission. People with low wages often find it increasingly difficult to eat an adequate diet. As a result, their immune systems easily succumb to new communicable diseases. Part of the collapse process is often the loss of a significant share of the population to a communicable disease.
Looking back at Figure 2, I believe that the current economic cycle started with the use of fossil fuels back in the 1800s. The world economy hit the stagflation period in the 1970s, when oil supply first became constrained. The Great Recession of 2008-2009 seems to be a marker for the beginning of the crisis period in the current cycle. If I am right in this assessment, the world economy is in the period in which we should expect crises, such as pandemics or wars, to occur.
The world was already pushing up against resource limits before all of the shutdowns took place. The shutdowns can be expected to push with world economy toward a more rapid decline in output per capita. They also appear to increase the likelihood that citizens will try to overthrow their governments, once the quarantine restrictions are removed.
[3] The carrying capacity of the world today is augmented by the world’s energy supply. A major issue since 2014 is that oil prices have been too low for oil producers. The coronavirus problem is pushing oil prices even lower yet.
Strangely enough, the world economy is facing a resource shortage problem, but it manifests itself as low commodity prices and excessive wage and wealth disparity.
Most economists have not figured out that economies are, in physics terms, dissipative structures. These are self-organizing systems that grow, at least for a time. Hurricanes (powered by energy from warm water) and ecosystems (powered by sunlight) are other examples of dissipative structures. Humans are dissipative structures, as well; we are powered by the energy content of foods. Economies require energy for all of the processes that we associate with generating GDP, such as refining metals and transporting goods. Electricity is a form of energy.
Energy can be used to work around shortages of almost any kind of resource. For example, if fresh water is a problem, energy products can be used to build desalination plants. If lack of phosphate rocks is an issue for adequate fertilization, energy products can be used to extract these rocks from less accessible locations. If pollution is a problem, fossil fuels can be used to build so-called renewable energy devices such as wind turbines and solar panels, to try to reduce future CO2 pollution.
The growth in energy consumption correlates quite well with the growth of the world economy. In fact, increases in energy consumption seem to precede growth in GDP, suggesting that it is energy consumption growth that allows the growth of GDP.
Figure 3. World GDP Growth versus Energy Consumption Growth, based on data of 2018 BP Statistical Review of World Energy and GDP data in 2010$ amounts, from the World Bank.
The thing that economists tend to miss is the fact that extracting enough fossil fuels (or commodities of any type) is a two-sided price problem. Prices must be both:
High enough for companies extracting the resources to make an after tax profit.
Low enough for consumers to afford finished goods made with these resources.
Most economists believe that an inadequate supply of energy products will be marked by high prices. In fact, the situation seems to be almost “upside down” in a networked economy. Inadequate energy supplies seem to be marked by excessive wage and wealth disparity. This wage and wealth disparity leads to commodity prices that are too low for producers. Current WTI oil prices are about $20 per barrel, for example (Figure 4).
Figure 4. Daily spot price of West Texas Intermediate oil, based on EIA data.
The low-price commodity price issue is really an affordability problem. The many people with low wages cannot afford goods such as cars, homes with heating and air conditioning, and vacation travel. In fact, they may even have difficulty affording food. Spending by rich people does not make up for the shortfall in spending by the poor because the rich tend to spend their wealth differently. They tend to buy services such as tax planning and expensive private college educations for their children. These services require proportionately less commodity use than goods purchased by the poor.
The problem of low commodity prices becomes especially acute in countries that produce commodities for export. Producers find it difficult to pay workers adequate wages to live on. Also, governments are not able to collect enough taxes for the services workers expect, such as public transit. The combination is likely to lead to protests by citizens whenever the opportunity arises. Once shutdowns end, these countries are especially in danger of having their governments overthrown.
[4] There are limits to what governments and central banks can fix.
Governments can give citizens checks so that they have enough funds to buy groceries. This may, indeed, keep the price of food products high enough for food producers. There may still be problems with broken supply lines, so there may still be shortages of some products. For example, if there are eggs but no egg cartons, there may be no eggs for sale in grocery stores.
Central banks can act as buyers for many kinds of assets such as bonds and even shares of stock. In this way, they can perhaps keep stock market prices reasonably high. If enough gimmicks are used, perhaps they can even keep the prices of homes and farms reasonably high.
Central banks can also keep interest rates paid by governments low. In fact, interest rates can even be negative, especially for the short term. Businesses whose profitability has been reduced and workers who have been laid off are likely to discover that their credit ratings have been downgraded. This is likely to lead to higher interest costs for these borrowers, even if interest rates for the most creditworthy are kept low.
One area where governments and central banks seem to be fairly helpless is with respect to low prices for commodities used by industry, such as oil, natural gas, coal, copper and lithium. These commodities are traded internationally, so it is not just their own producers that need to be propped up; the market intervention needs to affect the entire world market.
One approach to raising world commodity prices would be to buy up large quantities of the commodities and store them somewhere. This is impractical, because no one has adequate storage for the huge quantities involved.
Another approach for raising world commodity prices would be to try to raise worldwide demand for finished goods and services. (Making more finished goods and services will use more commodities, and thus will tend to raise commodity prices.) To do this, checks would somehow need to go to the many poor people in the world, including those in India, Bangladesh and Nigeria, allowing these people to buy cars, homes, and other finished goods. Sending out checks only to people in one’s own economy would not be sufficient. It is unlikely that the US or the European Union would undertake a task such as this.
A major problem after many people have been out of work for a quite a while is the fact that many of these people will be behind on their regular payments, such as rent and car payments. They will be in no mood to buy a new vehicle or a new cell phone, simply because they have been offered a check that covers groceries and not much more. They will remain in a mode of cutting back on purchases, not adding more. Demand for most kinds of goods will remain low.
[5] There is a significant likelihood that the COVID-19 problem is not going away, even if economies can “bend the trend line” with respect to new cases.
Bending the trend line has to do with trying to keep hospitals and medical providers from being overwhelmed. It is likely to mean that herd immunity is built up slowly, making repeat outbreaks more likely. Thus, if social isolation is stopped, COVID-19 illnesses can be expected to revisit prior locations. We know that this has been an issue in the past. The Spanish Flu epidemic came in three waves, over the years 1918-1919. The second wave was the most deadly.
A recent study by members of the Harvard School of Public Health says that the COVID-19 epidemic may appear in waves until into 2022. In fact, it could be back on a seasonal basis thereafter. It also indicates that more than one period of social distancing is likely to be required:
“A single period of social distancing will not be sufficient to prevent critical care capacities from being overwhelmed by the COVID-19 epidemic, because under any scenario considered it leaves enough of the population susceptible that a rebound in transmission after the end of the period will lead to an epidemic that exceeds this capacity.”
Thus, even if the COVID-19 problem seems to be fixed in a few weeks, it likely will be back again within a few months. With this level of uncertainty, businesses will not be willing to set up new operations. They will not hire many additional employees. The retired population will not run out and buy more tickets on cruise ships for next year. In fact, citizens are likely to continue to be worried about airplane flights being a place for transmitting illnesses, making the longer term prospects for the airline industry less optimistic.
Conclusion
The economy was already near the edge before COVID-19 hit. Wage and wealth disparity were big problems. Local populations of many areas objected to immigrants, fearing that the added population would reduce job opportunities for people who already lived there, among other things. As a result, many areas were experiencing protests because of unhappiness with the current economic situation.
The shutdowns temporarily cut back the protests, but they certainly do not fix the underlying situations. Instead, the shutdowns add to the number of people with very low wages or no income at all. The shutdowns also reduce the total quantity of goods and services available to purchase, regardless of how much money is added to the system. Many people will end up poorer, in some real sense.
As soon as the shutdowns end, it will be obvious that the world economy is in worse condition than it was before the shutdown. The longer the shutdowns last, the worse shape the world economy will be in. Thus, when businesses are restarted, we can expect even more protests and more divisive politics. Some governments may be overthrown, or they may collapse without being pushed. I fear that the world economy will be further down the road toward overall collapse.
What happens to the economics of oil when the global economy shuts down because of coronavirus? Harris Kupperman, CIO and president of Praetorian Capital, breaks down the chaos coronavirus has inserted into global oil markets and provides investors with an investment thesis based on the opportunity that chaos has created. In the context of the global shutdown, Kupperman reveals how the combination of the current oil futures contango, alltime highs in tanker charter rates, and the dearth of crude oil storage could lead to never-before-seen revenues and profits for the tanking companies. He walks viewers through the numbers, explains the underpinning economics of the oil markets, and provides time horizons and potential profit multiples for those looking to find opportunity through uncertain times. Released on March 26, 2020.
There are
only two ways to survive a decline in income and net worth: slash expenses or default on debt.
In post-World War II America, the cultural zeitgeist viewed frugality as
a choice: permanent economic growth and federal anti-poverty programs steadily reduced
the number of people in deep economic hardship (i.e. forced frugality) and raised the living standards
of those in hardship to the point that the majority of households could choose to be frugal or
live large by borrowing money to enable additional spending. Either way, rising income and net
worth would raise all ships, frugal and free-spending alike.
For everyone above the bottom 20%, frugality was viewed as a sliding scale of choice: if you
couldn’t increase your income fast enough, then borrow whatever money you needed. If you chose to
be frugal, in moderation (i.e. clipping coupons and shopping for the cheapest airline seats, etc.)
this was viewed as admirable fiscal prudence; if pushed beyond moderation then it was dismissed as
counter to the American spirit of everlasting expansion: tightwad is not an endearment.
Thus none of us immoderately frugal folks ever fit in. Our frugality raised eyebrows and
drew derogatory exhortations from indebted free-spenders to “get out there and live a little,” i.e. blow
hard-earned money on aspirational gewgaws or status-enhancing fripperies, including the oh-so-precious
“experiences” that have now replaced gauche physical markers of status-climbing.
We are now entering a new era of forced frugality in which incomes and net worth stagnate
or decline while the cost of living rises and borrowing is no longer frictionless.
To say that these changes will shock the system is putting it mildly. Here’s the key dynamic
in forced frugality: income can drop precipitously without any ratcheting to slow the decline,
but costs only ratchet higher, or decline by nearly imperceptible degrees; that is, costs are
“sticky” and refuse to slide down as easily as income.
The second key dynamic in forced frugality is the tightening of lending and the rising cost
of borrowed money. When lenders could assume that almost every household’s income would increase
as a byproduct of ceaseless economic expansion, and assets such as stocks, bonds and houses would
always increase in value (any spots of bother are temporary), then the odds of a nasty default
(in which the borrower stiffs the lender–no monthly payments to you, Bucko)–were low.
But once incomes and asset valuations are more likely to fall than rise, the door to lending
slams shut. Why would lenders extend loans to households and enterprises that are practically
guaranteed to default? Any lender that self-destructive would soon be stripped of their capital
and solvency.
The general assumption is that since central banks are buying bonds, interest rates for borrowers
can only go down. This assumption is misguided. The base assumption of all lenders is that
a very thin layer of borrowers will default. Once this layer thickens, it makes no sense to lend
to everyone who can fog a mirror.
Unwary lenders are about to learn a very painful lesson about the creditworthiness of
supposedly solvent middle-class households: since income isn’t “sticky,” households that
had high credit scores for years can quite suddenly default on their loans once their incomes
plummet.
As for the borrower’s assets, those too can plummet in value, leaving the lender with zero collateral or
an asset for which there is no buyer, regardless of the appraised value.
The income/assets slope is greased while the cost slope is on a resistant ratchet. Income
can slide down effortlessly while costs stubbornly refuse to fall.
The net result of this dynamic is forced frugality. For the first time in decades,
households and enterprises cannot count on a resumption of growth in a few months and higher incomes
and asset valuations.
To the dismay of living-large-on-debt households and enterprises, the only way to get more
than you have now will be to save, save, save cash. Earning more from one’s labor will be
difficult, as will reaping easy speculative gains from simply owning assets.
The debt-free frugal may be forgiven for indulging in a bit of schadenfreude toward
those who scorned frugality in favor of living large in the moment. Now who’s
living large? Not the extremely frugal, because squandering money gives them no pleasure,
and they prefer the anti-status “status” of old cars and trucks, tools that have lasted decades and assets
that look like everyone else’s except they’re debt-free.
As for income–those who control and invest their own capital and labor, the class I’ve long called
mobile creatives–will have far more opportunities than those chained to the monoculture
plantations of corporate cartels and government agencies squeezed by collapsing tax revenues.
A great many people who reckoned moderate frugality was more than enough will discover it no longer
suffices. A great many other people who reckoned they were rich enough to spurn frugality will discover
their income no longer covers their expenses and so expenses will have to be slashed and burned
to the ground.
And many frugal people who did the best they could with limited income will find that even extreme
frugality can’t fix a decline in income.
An economy-wide reckoning of what’s essential is just starting. Netflix subscription? Gym membership? Fast food takeout a couple times a week? No, no and no. A thousand no’s as there are only two ways to survive a decline in income and net worth: slash expenses or default on debt. Both are toxic to “growth” in spending and debt.
As they survey the shattered remnants of the past decade’s bull market, investors are inevitably asking: what happens next? Not next week, and not next month, but what happens for the coming years? Specifically, did this bear market mark the end of an era and, in time, the start of a new one? Or do we still live in a MAGA (Microsoft, Apple, Google, Amazon) era?
In a recent paper, Charles* argued that the Covid-19 outbreak is paving the way for a universal basic income funded by MMT (aka the magic money tree) and that these two profound changes will upend the investment environment. This view leads me back to the most trusty Gavekal framework for linking the macro environment to the investment landscape, namely the Four Quadrants.
For the past 30 years or so, the world has basically alternated between disinflationary booms and busts, which makes inherent sense as the dominant force of capitalism is deflation. Every entrepreneur, everywhere around the world, is always trying to produce more with less. And in a disinflationary world, asset allocation is a breeze: one needs to own government bonds (to hedge the risk of a deflationary bust) and equities (to participate in any deflationary boom). And best yet: in a disinflationary world, not only do bonds and equities both have the wind at their back, but the two main asset classes have in bad times been negatively correlated. So, happiness all around.
