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Here’s the state of play as I see it.
COVID-19 fallout will exert very strong deflationary pressures on both asset prices and the economy.
We will see extreme and escalating interventions from CBs and governments in attempt to offset deflationary pressures.
Here’s the state of play as I see it.
COVID-19 fallout will exert very strong deflationary pressures on both asset prices and the economy.
We will see extreme and escalating interventions from CBs and governments in attempt to offset deflationary pressures.
The effectiveness of these interventions will vary among nations due to differing initial circumstances as well as the different capabilities of regulatory authorities.
Current environment is deflationary, policy responses are inflationary.
Achieving balance is what is required, though is unlikely to occur in many nations due to both a lack of regulatory capabilities and the influence of mounting political pressures.
Achieving balance is what is required, though is unlikely to occur in many nations due to both a lack of regulatory capabilities and the influence of mounting political pressures.
The following is a list of some key risks we face in no particular order.
1. Political Instability
Massive inequality leads to political instability. Last analogous period to today is the 1930’s. We are already seeing a shift away from the centre toward extremes, expect this to accelerate dramatically during economic downturn.
Massive inequality leads to political instability. Last analogous period to today is the 1930’s. We are already seeing a shift away from the centre toward extremes, expect this to accelerate dramatically during economic downturn.
Political pressures will likely impede the ability for policymakers to act effectively.
2. Solvency Crisis
Though the liquidity crisis has been resolved for the most part for now, the solvency crisis has yet to come.
Companies don’t fail within 3 weeks.
Expect many corporate bankruptcies as the economic fallout unfolds.
Though the liquidity crisis has been resolved for the most part for now, the solvency crisis has yet to come.
Companies don’t fail within 3 weeks.
Expect many corporate bankruptcies as the economic fallout unfolds.
3. New Monetary Policies/MMT
Though there is no risk of inflation near term (deflationary pressures too strong) - a doom loop through loss of confidence is possible.
Though there is no risk of inflation near term (deflationary pressures too strong) - a doom loop through loss of confidence is possible.
CBs will be forced to purchase more and more risky assets to keep rates down, what happens when we see defaults rise?
What happens if we see CB insolvencies?
Though it may not matter in theory, will investors lose confidence?
What happens if we see CB insolvencies?
Though it may not matter in theory, will investors lose confidence?
Otherwise, assuming reflation works and the economy bounces back quickly (extremely unlikely), massive fiscal deficits will continue due to mass of unfunded liabilities (US).
FED will monetise deficits due to the infeasibility of substantial tax increases or spending cuts.
FED will monetise deficits due to the infeasibility of substantial tax increases or spending cuts.
Inflation clearly a risk in this scenario.
Raising rates would cause major strain on fin system.
Failure to do so may lead to excess inflation.
Though such policies can be managed well in theory, political pressures will likely limit regulators ability to operate effectively.
Raising rates would cause major strain on fin system.
Failure to do so may lead to excess inflation.
Though such policies can be managed well in theory, political pressures will likely limit regulators ability to operate effectively.
4. Eurozone Inefficiency
MASSIVE fiscal stimulus required, is certain to happen. Only question is ECB willingness to buy enormous Q of bonds to keep rates down.
MASSIVE fiscal stimulus required, is certain to happen. Only question is ECB willingness to buy enormous Q of bonds to keep rates down.
If they fail to do so, expect severe credit crunch with bank failures (most likely nationalisations) and widespread economic strife.
If the ECB does succeed, there exists the possibility for defaults to undermine the balance sheet, potential insolvency, and possible loss of confidence.
In any case, due to lack of debts denominated in currencies controlled by each country, it is unlikely that the policy response will be well targeted and executed effectively.
5. US Corporate credit bubble:
Risk of downgrades pushing BBB bonds to junk, FED will be forced to buy massive Q of junk to avoid yield blowout.
Political infeasibility might reduce the FEDs ability to bid junk sufficiently, though failure to do so would have dire consequences.
Risk of downgrades pushing BBB bonds to junk, FED will be forced to buy massive Q of junk to avoid yield blowout.
Political infeasibility might reduce the FEDs ability to bid junk sufficiently, though failure to do so would have dire consequences.
If successful, FED may experience issues with balance sheet (what happens if defaults rise substantially?) + possible loss of confidence.
Also buybacks have come to a halt, which means substantial removal of bidding pressure from US equity markets.
Also buybacks have come to a halt, which means substantial removal of bidding pressure from US equity markets.
6. Structural USD strength
USD denominated foreign debts are very high, dramatic fall in exports means less USD available to service debts. Also if creditors choose not to rollover loans, massive demand for USD whilst there's little supply to meet it.
USD denominated foreign debts are very high, dramatic fall in exports means less USD available to service debts. Also if creditors choose not to rollover loans, massive demand for USD whilst there's little supply to meet it.
The risks posed are defaults from foreign countries, possibility of massive US asset sales and risk of collapse in US X competitiveness.
Policy response is liquidity provision through swap lines and repo.
Policy response is liquidity provision through swap lines and repo.
This should work so long as it is able to scale with the crisis (not impeded by politics). Risk remains if foreign UST sales increase nonetheless, which FED will be forced to fund.
Likely to be politically unpopular, inflationary for USD, possible confidence problems.
Likely to be politically unpopular, inflationary for USD, possible confidence problems.
7. US-China conflict
Strong anti-China sentiment brewing in the west post virus. Economic circumstances coupled with existing tenuous relationship likely to lead to conflict. Unlikely to be physical for now, though will be economic and otherwise.
Strong anti-China sentiment brewing in the west post virus. Economic circumstances coupled with existing tenuous relationship likely to lead to conflict. Unlikely to be physical for now, though will be economic and otherwise.
8. Debtor-creditor nation conflict
To the extent that debtor nations are unable to service debts, there will be conflict.
To the extent that debtor nations are unable to service debts, there will be conflict.
9. Deglobalisation
Strong sentiment shift toward deglobalisation, which is inflationary due to loss of efficiency. Flux may create conflict, particularly between US and China.
Strong sentiment shift toward deglobalisation, which is inflationary due to loss of efficiency. Flux may create conflict, particularly between US and China.
There are many ways in which this can play out, though the net takeaway is:
This is only just getting started.
Cash/bonds for fear of deflation.
Gold/BTC for fear of inflation.
Don’t overestimate your ability to pick exactly how it plays out.
This is only just getting started.
Cash/bonds for fear of deflation.
Gold/BTC for fear of inflation.
Don’t overestimate your ability to pick exactly how it plays out.
