Saturday, April 11, 2020

It's the economy, stupid.

When a large house party is going on, and the guests were getting their beers from the fridge and finally one person opens up the fridge and finds out that, there are no more beers left, It cannot be concluded - he drank all the beers. Similarly the economic recession that is creeping in the world now, is triggered by the Coronavirus pandemic but it is not the only cause. The virus will be gone in a few months. But the economic recession would prevail not just months but for many years to come.

Before the virus ever came into the picture, the economy was so weak. The signs were obvious for the people who looked at it. The rosy picture the mainstream media and the government gave about the economic growth that was completely out-of-place was so obviously misleading. For those people who looked at the right metrics, the data never improved in-spite of all the positive rhetoric peddled by the financial media.

The primary reason, why the western economies look more vulnerable to a crisis like a pandemic is that - they economic breathes  on consumer spending. Unlike the Asian economies, the western nations run on credit cards. Even a bottle of water is purchased with credit cards. With some people using credit cards for convenience, the vast majority of the people use it as a means to delay the payment to future income. The saving economy has the supreme savings as a cushion and can recover from the pandemic sooner. With all business establishments closed and almost no economic activity happening on the ground, the western consumer who is already overburdened with debt has come to the final square. The last thing that was holding him is the job paycheck. With the paycheck now in question, and with no savings from the past, the future looks grim. There is no other way for him to get out of situation unless the government throws him some lifeline money.

This consumer spending on credit has been the major driver of growth. 80% of the American economy is consumer spending. This spending was exacerbated by the artificial low cost of borrowing. Interest rate is the "price" of the money. This is very important for any market economy. Post-2008, interest rates never could go back to normal. We started off with the Fed's funds rate in 2006 that stood at 5.5. It was reduced to 0 in 2008 under George Bush's Presidency and never moved from there until the last year of the Obama Presidency. It went back to 2.5% post-Trump election optimism. The EU's bank-to-bank lending rate never when above zero after they got there in years. Every time they try to make it normal but conveying their intentions to normalize monetary policy - the stock market would slump. Finally the Fed/ECB got boxed in. Overtime it became pretty clear that the low-interest is the only reason there is any growth in western economies. For all those people who looked at it right - It was obvious that the western economies were being propped up by low interest rate and QEs. These easy money polices were not the training wheels to kick-start the economy but it were the only wheels. This created mal-investments across the economy during this boom years. The western government and the Central Bankers knew - that withdrawing the easy money policy will definitely create a recession. So they were just locked.

The economic numbers that came out during this boom time, were to be taken with caution. For example in the US, because a person is unable to get a good paying full-time job, he ends up doing 3 part-time jobs. This makes the jobs count for the month to go up by three. When he loses couple of those jobs, they don't add him to those number of people who lost jobs that month, because he still manages to hold on to that one part-time job. It was just a numbers game. They refined the methodology of counting to make it appear better than what it was. They also do publish the numbers calculated by old methodology, but they don't get enough media attention. The headline number was the most important number for the financial channels and the media. Every time you dig through the numbers, it was apparent the jobs being created were phony. There is always a slide in the count of manufacturing jobs and they get compensated by increase in leisure jobs - like restaurants, bars, hospitality, etc. The surprising part is - how long they managed to do that without a recession. In the end - we had the longest bull market (without a correction/recession) for a decade. The economy growth was touted to be the best in the history of the world. Even the GDP as measured by the government, did not hit the annual 4% mark. Until February of this month - It was hailed the greatest economy ever. Warren Buffet very famously told - when the tide recedes, we will know who was swimming naked. Unfortunately as the virus arrived on the stage, the whole of US economy was exposed naked.

The jobs created during the boom years, were low-paying, service sector part-time jobs. It was always suppose to be gone even at the slightest sign of trouble. 17 million people filing for initial jobless claims is the last 3 weeks explains the quality of jobs that prevailed.

The boom was so big, it has only come down the first leg. The market is at the same level now, when Trump was a candidate. Remember, he called these numbers - the big fat ugly bubble. So market is still over valued.

Filling people's account with free money is not the solution to the problem. That will create more problems that it really solves. The right thing to do is to allow companies who cannot sustain the economic shock now to fail gracefully now itself. Things might get bad. There will be consequences to that actions. People might lose jobs, plants will be shut. Within sometime very soon - things will recover.

The Fed is buying all the bonds it can. This is not limited to the US treasury or the mortgage backed securities any more. It includes pure private sector bonds like corporate bonds. It is buying municipal bonds with an unlimited bag. Fed is the only buyer of these bonds. No one in the market will buy it - because its toxic. Most of them will go to zero. That is the reason it doesn't have a natural demand. The 2T Fed program announced 9th April will buy all bonds including junk bonds. With the Fed buying it all for any price, the whole bond market is phony. There is no longer normal price discovery which the market always does well.

This situation mirrors the start of the economic depression in the west that started in 1929 and did not go away until the second world war was over. The post-second world war was the real economic boom for the many decades to come. What we are starting at, is a long, prolonged period of negative growth that will fundamentally question the American way of financial capitalism that is practiced by the west.

While everything is blamed on the virus now, what will eventually happen is - over the next few months the virus would gradually subside and cease to exist. Lot of people would even forget the name of it and find it difficult to remember its name covid-19. The economic pain created by the unprecedented bubble in the last decade and the reactions by Fed to boost it further citing the covid-19 reason will be enormous and will mirror the great depression. The overdose of fiscal and monetary stimulus practiced will erode the value of the US dollar and eventually kill it.

With a multi-ethnic society like the USA and UK, to an extent EU, financial prosperity is almost the only reason the rule of law is enforceable. Without the economic prosperity, the culture of capitalism (the way it is practiced) cannot be sustained. The richness is what unites the people. The more poorer they become - racial discriminations start to come to the open. The 1929-style economic recession where bulk of the people were white-Europeans did not create social problems in big scale. But now with all western countries heavily populated with multi-ethnic population, particularly Asians - who happen to have more job skills than their white citizens., social issues will prop-up. So the challenge for the governments in the west is not only to quell the economic effects of the slowdown but also the social effects. This can be done only with stringent laws, but only if the government cooperates by enforcing them. With right-wing governments in place, there is a possibility of cohesion based on religious and racial superiority which will have a cascading effect on how societies operate. You see around this world - people who look alike stay together. There are historical reasons for it. The liberal western capitalistic societies in the last 3-4 decades benefited from arriving work forces (immigration) from all around the world and they tolerated it because of the economic prosperity they brought to the nation. With their nations gradually becoming welfare nations - the sharing of limited welfare is no longer sellable to the white majority population. Also the fact that the coronavirus originated in China may lead to a general dislike of Asian people who are already integrated in the western societies causing racial hatred and general dislike for years to come.

Sustaining the economic prosperity is vital for multi-ethnic western societies to thrive. With a long, deeper economic recession in the horizon, things look bleak in social perspective as well.

Whenever things go wrong at the nation level, two things happen. One is - Everybody knows something is terribly wrong. The second one is more important - Everyone knows that Everybody knows something is terribly wrong. The western world may just be getting there, if not there already.