Unprecedented Recession Synchronization and What it Means

Mish

The global recession has no precedent in terms of synchronization.

Deflationary Consequences

Lacy Hunt at Hoisington Management explains the deflationary consequences of the current global situation in its Second Quarter 2020 Review.

Hunt commented on the four economic challenges central bankers face as noted below.

Four Economic Challenges

  1. Over 90% of the world’s economies are contracting. The present global recession has no precedent in terms of synchronization. 
  2.  A major slump in world trade volume is taking place. 
  3. Additional debt incurred by all countries, and many private entities, to mitigate the  worst consequences of the pandemic, while humane,politically popular and in many cases essential, has moved debt to GDP ratios to uncharted territory. This insures that a persistent misallocation of resources will be reinforced, constraining growth as productive resources needed for sustained growth will be unavailable.
  4. 2020 global per capita GDP is in the process of registering one of the largest yearly declines in the last century and a half and the largest decline since 1945. The lasting destruction of wealth and income will take time to repair.

Here are ten key ideas (my estimation) condensed from the article.

Ten Key Ideas

  1. Recessions are either deeper or longer lasting when a very high percentage of the world’s economies are contracting rather than when they are centered on a limited number of countries. 
  2. Except for the very short run, the Federal Reserve’s lending operations for the corporate bond market are a negative for economic growth. The BOJ (Bank of Japan), ECB (European Central Bank) and the People’s Bank of China (PBOC) have all been buying corporate debt of failing entities for more than a decade with the BOJ doing so for more than 25 years. These operations have provided a fleeting lift to economic activity, but at the end of the day they resulted in misallocation of credit, poor economic growth and disinflation/deflation. 
  3. By keeping failing players in the game, this prevents the process Joseph Schumpeter called “creative destruction” as well as “moral hazard”, thereby eliminating these critical factors that make free market economies successful. 
  4. The adverse consequences of an unsurpassed increase in new debt will remain for years to come. Four great past economists – Eugen Bohm Bawerk, Irving Fisher, Charles Kindleberger and Hyman Minsky – all captured the two-edged nature of debt being an increase in current spending in exchange for a decline in future spending unless the debt generates an income stream to repay principal and interest. 
  5. The relationship between debt and economic growth is non-linear, just as is the law of diminishing returns. Significant research indicates that the adverse consequences start as low as a 67% gross debt to GDP ratio. 
  6. A recent Brookings Institute study posits the pandemic will lead to 300,000- 500,000 less births next year. For 2019, population growth in the U.S. and the world, was already the slowest since 1918 and 1952.
  7. In the first quarter, corporate debt jumped to a record 48.7% of GDP, more than 300 basis points higher than during the Lehman crisis 
  8. In 1934, Irving Fisher wrote that the velocity of money falls in heavily indebted economies. We believe that Fisher’s finding will be correct because his view is supported by the evidence and the rationale that the huge additional debt added this year will not generate an income stream to repay principal and interest. Accordingly, the reopening rebound in the economy underway will falter, leaving the economy with a huge output gap.
  9. At the end of the three worst recessions since the 1940s, the output gap was 4.8% in 1974, 7.9% in 1982 and 6.4% in 2009. The gap that existed after the recession of 2008-09 took nine years to close. This was the longest amount of time to eliminate a deflationary gap.
  10. Considering the depth of the decline in global GDP, the massive debt accumulation by all countries, the collapse in world trade and the synchronous nature of the contracting world economies the task of closing this output gap will be extremely difficult and time consuming. This situation could easily cause aggregate prices to fall, thus putting persistent downward pressure on inflation which will be reflected in declining long-dated U.S. government bond yields.

Conclusion

Nearly all economists expect a huge jump in inflation associated with the Fed's massive balance sheet expansion and government fiscal stimulus.

However, I side with Lacy Hunt. 

My Reasons

  • The demand destruction from Covid will last for years.
  • Demand destructuction is greater than Covid stimulus.
  • Buildup up debt is inherently deflationary. 
  • Demographics are deflationary.
  • By bailing out failed corporations, the Fed is creating more and more zombies. 

Unwanted Inflation Easy to Find

Actually, inflation is easy to find. Look no further than the stock and bond markets.

The Fed's balance sheet expansion coupled with trillions of dollars of fiscal stimulus (both unprecedented) has resulted in stock market speculation also at unprecedented levels exceeding the housing bubble boom in 2008.

Six Related Articles 

  1. Banks Double Loan Loss Reserves ‘Everybody Is Struggling’
  2. Housing Starts and Permits Improve But Not Enough
  3. Cass Transportation Index "Not Good By Any Measure"
  4. China’s Unexpectedly Strong Growth Isn't What it Seems
  5. All Continued Unemployment Claims Top 32 Million Again
  6. Work-From-Home Will Reduce Driving by 270 Billion Miles Per Year

Conclusion

Inflation is not where the Fed wants it. 

The Fed can print money and Congress can hand it out, but neither can dictate where the money goes.

In 2020, money has found a home in rampant speculation in stocks and bonds. In 2008 money primarily went into a housing bubble.

But bubbles burst. Thus, speculation too is inherently deflationary. 

Mish

Comments (73)
No. 1-23
anoop
anoop

Is this bullish or not? I’m starting to load up on FANGMAN + Blackrock. Hope I’m not too late to the party.

MiTurn
MiTurn

Excellent article and very timely. Puts the idea (and hope) of a 'safe haven' into perspective.

anoop
anoop

The zombies will continue to linger (nobody will touch them with a bargepole), while productive assets will be lapped up by private equity and banks. You have to be a compleat idiot to think you can put in sweat equity, build something useful, and have any chance of not having it snatched from you by an act of financial engineering.

AbeFroman
AbeFroman

Look at the short squeeze go.

Tony Bennett
Tony Bennett

Lacy Hunt is a Rock Star!

Tony Bennett
Tony Bennett

"The Fed can print money and Congress can hand it out,"

...

In Washington that is all you hear. Not a soul talks about the ever greater debt amount ... or ANY talk of how to service it (let alone pay it down). Tax increases? Haha. It all free money. Wheeeeeee!

The money spent (wasted) NOW. The increased debt will be with us for decades. No one wants to look long term. It is all about seeing who can spend (waste) the most before election. Obviously, POTUS wants another round of checks (with his signature on it) prior to November.

It will be interesting to see the "compromise" on CARES.2. Pelosi passed a $3 trillion House bill. McConnell initially said wait and see ... then keep it under a trillion ... then around a trillion ... probably end up around $1.5 trillion (till CARES.3) ...

Anda
Anda

The dismal science just got dismaler, must be close to limits of dismality, probably turn into a horror eventually.

Casual_Observer
Casual_Observer

Next stop nasdaq 20k.

IA Hawkeye in SoCal
IA Hawkeye in SoCal

If everyone is in debt, does it matter? What is "debt" anyway? It's all a man created concept that can come and go as easy as anything else on this finite earth. I think people need to look at that bigger picture.

Dodge Demon
Dodge Demon

Hayek and Von Mises for $200, Alex

What is a “crack-up boom”?

Roadrunner12
Roadrunner12

More effects of the recession/depression soon arriving. Medicare Part A in difficulty in 2, 3, 4 years? Medicare Part B insolvency likely pushed ahead also several years and social security insolvent in 9 years? Likely a no brainer that no matter who wins the election, the federal debt will be $35-40 trillion 5 years out in 2025. How is this all gonna playout? Greatly reduced benefits as currently there appears to be no impetus to increase taxes.

"Others who make projections agree the insolvency date is getting closer, maybe not as close as 2022.

The Committee for a Responsible Federal Budget, a nonpartisan group of budget experts focused on fiscal policy, estimates that the pandemic will cause the Part A trust fund to be unable to pay all of its bills starting in late 2023 or early 2024. "But we're still very close," said Marc Goldwein, the group's senior vice president."

"Without accounting for the pandemic and the ensuing financial downturn, the federal government estimated last month that the program can fully issue benefits until 2035. At that point, only 76 percent of benefits can be paid out.

“It’s clearly going to be a lot worse than that,” said Alan Auerbach, an economist at the University of California, Berkeley.

When accounting for the pandemic, the Bipartisan Policy Center estimates that the depletion date will move up from 2035 to 2029."

tokidoki
tokidoki

So Dow 1 trillion?

PecuniaNonOlet
PecuniaNonOlet

Where is your maga trumpssiah now?

LarryK
LarryK

When the whole world is going down, and all currencies are being destroyed....is it still better to be on the best of the worst?

All of this is going to end up in a giant reset....debt needs to be extinguished. When that happens, yes, its deflationary, but on the other side of it, the future spending that was brought forward from issuing the debt will then be freed up again to spend. Wouldnt this be inflationary? Its just a giant mess...thank you Fed and spendthrift politicians (both parties....even though democrats are more implicated)

aqualech
aqualech

After waiting like forever for stocks to revert to historic norms or anything near. Now am starting to believe that equities are becoming a store of value as fiat crumbles. Good to see a rotation into value.....am dabbling.

What this syncronized recession means is that the CBs are going to have ongoing cover for transferring of ever-more assets to the financial elites. TBTF and all that.

WildBull
WildBull

And, this synchronous recession is brought to you by CoronaVirus. Type coronavirus xxx into google where xxx are random digits:

coronavirus 345

Pick a few different numbers, and marvel at the similarity of results. Then, tell me that we aren't being played. Conspiracy theory? No. Conspiracy fact.

WildBull
WildBull

So, I'll hold my nose and vote for Trump. I don't know if C19 was deliberately released or a fortuitous accident for the Left, but, apparently, Trump is what stands between sanity and the left's plans for Biden's to-be-announced running mate. I'd expect Biden to be declared incompetent within 6 months after election.

IA Hawkeye in SoCal
IA Hawkeye in SoCal

Typically throughout human history, it's major wars like WW1 and WW2 that handle debts, world order, etc. Tale as old as time. I don't think most humans alive today can fathom what a WW3 would mean, perhaps the (now old) children of WW2 know. I don't want that to happen but it's been done since Bible times, do we really think mankind has changed???

Alfios
Alfios

When everything seems to be lost we still have pussy as a safe harbor and you never get lost with her

caradoc-again
caradoc-again

If history is much to go by, depression next up on stage.

Some are already feeling it and anyone thinking they won't is deluding themselves. Even the super-rich as they will be targetted all and sundry to blame and soak for taxes.

Think the state will leave you alone to get on with business? FORGET IT.
They will poke their nose into everything and now they have the tools to do it better than ever before.

This will take years to play out and its only just getting started.

moverman69
moverman69

Just great! https://www.cnymoving.com/

Rhett3
Rhett3

Then, putting all this debt and deflation together, the best option is to monetize? The Fed holds x trillion in treasuries? Ok cancel that debt $100 billion at a time.

jacob_zuma
jacob_zuma

It seems there is an assumption that the Fed will stop printing at some point, but the Fed has made it clear it will print as much as needed to stave off deflation or even just a correction in equity markets. If anything, they like the deflationary forces in the economy because it allows them to print to no abandon and keep asset prices up (and by consequence their rich patrons happy).


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