Global economy to suffer worst blow since the 1930s, warns IMF

Most countries’ economies set to be at least 5% smaller, even after recovery

Chris Giles in London

A closed cafe  in Vienna, Austria
A closed café in Vienna, Austria. Businesses around the world have shut their doors © Leonhard Foeger/Reuters

The coronavirus crisis will leave lasting scars on the global economy and most countries should expect their economies to be 5 per cent smaller than planned even after a sharp recovery in 2021, the IMF said on Tuesday.

Forecasting that this year would be the worst global economic contraction since the Great Depression of the 1930s, Gita Gopinath, the fund’s chief economist, said the world outlook had “changed dramatically” since January with output losses that would “dwarf” the global financial crisis 12 years ago.

“A partial recovery is projected for 2021, with above-trend growth rates, but the level of GDP will remain below the pre-virus trend, with considerable uncertainty about the strength of the rebound,” she said.

The IMF expects advanced economies to contract by 6.1 per cent and emerging economies to shrink by 1 per cent this year, although positive growth is still expected in India and China. But even after the sharp rebound which the IMF forecasts for next year, output is still expected to be 5 per cent lower in 2021 than expected in the IMF’s forecasts from October last year for advanced economies.

“This is a deep recession. It is a recession that involves solvency issues and unemployment going up substantially and these leave scars,” Ms Gopinath said.

Bar chart of annual increase (%) showing IMF growth forecasts

Emerging economies are forecast to perform better as a whole, but that is boosted significantly by China which is expected to have output in 2021 that is just 1.4 per cent lower than the IMF forecast six months ago.

If extensive lockdowns have to be extended beyond the second quarter of the year and Covid-19 returns in a milder outbreak in 2021, the overall economic hit would be twice as large, the IMF estimated.

Although the lockdowns are generating large economic contractions across the world, Ms Gopinath said they were necessary to get the pandemic under control. “There is not trade-off between saving lives and saving livelihoods,” she said.

The IMF’s economic forecasts for 2020 are not as pessimistic as many private sector forecasts.

They assume that the lockdowns will result in an 8 per cent loss of working days which will be concentrated in the second quarter for most countries but in the first quarter for China.

Even with these moderate assumptions, global economic performance will be hit hard, the IMF said. It forecast that world output would decline by 3 per cent in 2020, 6.3 percentage points down from the growth forecast of 3.3 per cent that the IMF expected as recently as late January.
 In 2009, the worst year of the financial crisis, global output dipped 0.1 per cent. The IMF considers any growth rate below 2.5 per cent to be a global recession because, 90 per cent of the time, global growth exceeds that rate.

Given the large fall in output, unemployment is expected to rise sharply even though many countries have adopted job retention programmes to keep employees attached to their places of work. As a result, incomes per person are expected to fall in nine in 10 of the IMF’s 189 member countries.

In the US, unemployment is expected to rise from 3.7 per cent in 2019 to 10.4 per cent this year and only dip to 9.1 per cent in 2021. There is likely to be a smaller rise in the eurozone from 7.6 per cent last year to 10.4 per cent this year and 8.9 per cent in 2021. 

Bar chart of lost output in 2021 compared with Oct 2019 forecast showing coronavirus' lasting economic scars

Almost all other countries should plan for output next year to be about 5 per cent lower than thought likely in October 2019, the IMF said — a forecast that reflects significant bankruptcies and lay-offs. This growth performance will result in much weaker public finances as countries seek to limit the damage from Covid-19.

The IMF praised the efforts countries have taken individually to mitigate the pain and provide insurance for companies at the sharp end of the crisis. It said countries were right to lock down their populations to limit the spread of the virus and forecast that those such as Sweden that have followed alternative and looser policies would face just as deep recessions.

She added that the fiscal insurance provided by governments and extraordinary actions by central banks to keep financial markets functioning smoothly “will go a long way toward ensuring that the global economy regains its footing after the pandemic fades, workplaces and schools reopen, job creation picks up, and consumers return to public places”.

But she warned that many emerging economies did not have the resources either to provide adequate health services for their populations or to limit the economic damage. With many confronting simultaneous health, economic and financial crises, they “will need help from advanced economy bilateral creditors and international financial institutions” over the months ahead, she said.

Postponing an Oil Production Catastrophe

By: Antonia Colibasanu

Fresh off helping to broker a global agreement on oil production cuts on April 12, U.S. President Donald Trump has declared American cuts a priority for the country. Texas, however, said it needed more time.

The Railroad Commission of Texas spent April 14 debating whether the state’s oil output should be reduced. The commission regulates Texas’ energy sector, which means it oversees about 40 percent of the United States’ oil and gas production. Like other producers around the world, U.S. shale producers have seen prices crater since late February as the coronavirus crisis set in.

And like other producers, the U.S. was hurt by the price war launched in early March after a first attempt at an OPEC+ deal fell through. But pressure on the U.S. has been reduced by this week’s deal, which came about after the scale of the economic damage in Europe and the U.S. persuaded Russia to give way. American producers were also aided by Saudi Arabia’s decision on April 13 to shift more of its supply toward Asia to reduce pressure on the U.S.

Nevertheless, the size of these moves pales in comparison to the challenges ahead. If no adjustment had been made, the point at which production would have become unprofitable would have been weeks away.

But with the output cuts announced this week, if current conditions hold and economic activity doesn’t pick up in May, the unprofitable threshold will be crossed in a couple of months. The cuts are clearly not enough to restore the market equilibrium, but they are the best that countries can do right now.

An Incalculable Decline

Oil demand is relatively inelastic — the quantity purchased doesn’t change much when the price does. Yet small changes in demand create sudden (and sometimes dramatic) changes in price. According to the International Energy Agency, China’s lockdown caused a decrease in demand in February of 1.8 million bpd compared to February 2019.

Global demand as a whole fell by 2.5 million bpd year-over-year (about 35 percent) during the first quarter of 2020. It also anticipates that the coronavirus pandemic will generate a drop in demand that’s similar to (or worse) than 2009 crisis levels — and that prediction assumes, rather optimistically, that demand returns to normal levels during the second half of 2020.

This is impossible to know: Global supply chains have broken down as the coronavirus put countries in lockdown.

With emergency measures in place all over Europe and the U.S., the key consumers of oil such as airlines and factories have stopped consuming. Social distancing means that people are mostly indoors and businesses are at least partially shut down. If we knew how long this state of affairs was going to last, we could calculate its impact — but we don’t.

In times of less uncertainty, OPEC has often chosen to micromanage the oil market by subtracting small quantities of supply to balance market prices. Countries with the highest levels of production and flexibility, like Saudi Arabia, could use the cartel to manipulate pricing to their advantage.

But never before have changes occurred over a timeframe of several months, with no end in sight, and never before have fluctuations in demand been more than a couple of million barrels per day; analysts now discuss a drop in demand of between 15 million and 35 million bpd over the first quarter, with the bulk of it happening during the last three weeks of the quarter, when the U.S. implemented its emergency containment measures.

The OPEC+ deal on April 12 means to reduce oil output by 9.7 million bpd, just short of the 10 million bpd that OPEC members wanted and market analysts expected. This is obviously too little to bring supply in line with demand, considering the demand projections cited above.

But it helps delay the onset of the disaster and allows key political players to save face.

Russia’s Resistance

The idea of a supply agreement dates back to February, when a drop in demand of nearly 10 percent — led by China, the world’s largest importer of crude — began to affect market pricing. Saudi Arabia turned to OPEC, expecting OPEC members and affiliates to follow its lead and voluntarily cut production by 1.5 million bpd.

Everyone signed on to the idea except Russia. Russia’s budget is balanced at a lower oil price than it is for Saudi Arabia and other OPEC members, enabling Russia to ride out lower prices while maintaining a budget surplus.

And considering its sluggish economic growth since 2015, Russia also wanted to bring more oil to market to bring in extra revenue. Moreover, Moscow saw an opportunity to push U.S. competitors out of Europe by driving prices down to levels at which U.S. shale production would be unprofitable.

Finally, Russia’s climate and geological conditions make it costly for the country to reduce output.

Unlike its competitors, Russia gets most of its output from bitterly cold environments, where costs are higher due to technology needed to keep crude flowing into pipes and to keep gas from freezing.

In fact, oil extraction is currently unprofitable in about 33 percent of Russian fields. The quality of Russia’s reserves has been deteriorating for the past decade, and production is on the wane.

Therefore, the most Moscow was willing to do in early March to reduce output was what it had always done: to feign cooperation and scale up seasonal maintenance periods to slightly reduce output temporarily.

In response, Riyadh launched a price war. It started bringing its spare production online to see how much oil it could dump on the market and to force Moscow to capitulate. Saudi exports grew by over 1 million bpd in March. The effect of cratering oil prices at the same time that the coronavirus crisis’ economic consequences were becoming clear was enough to drive all oil producers back to the negotiating table — at the urging of Washington.

In late March, things changed rapidly for Russia, too. The coronavirus outbreak in the country was so widespread that it could not be denied. The government imposed emergency measures, including quarantine, in Moscow and other major cities.

More important, the virus was hitting Europe hard. Europe is Russia’s most important energy market, and as Europe went into lockdown in the first half of March, Moscow saw its price of oil slip into unprofitability for the first time.

Finally, as the scale of the economic downturn became clear, Russian concern about its financial reserves grew. Russia holds about $560 billion dollars’ worth of financial reserves, but most of it is not denominated in U.S. dollars.

This means the value of these reserves decreases as the U.S. dollar gets stronger relative to other currencies — which tends to happen during global crises as investors rush to the safety of the dollar.

All these factors combined to push Moscow to compromise. The last thing President Vladimir Putin wants is to be blamed for economic mismanagement — if reserves drop in value and Russians have to suffer, it needs to be someone else’s fault and not Moscow’s.

American Holdouts

American shale oil companies, like other producers, have been struggling with falling prices since March. U.S. President Donald Trump, facing a reelection campaign and a plunging economy this year, had to respond and therefore made an agreement on production cuts a priority. Apart from the OPEC+ deal, the U.S. got extra help from the Saudis.

On April 13, Riyadh announced that it had added $5 to the price per barrel of crude shipped to the United States, while cutting $5 from the price for Asian deliveries. This means the Saudis will stop dumping crude oil on the U.S. market, and therefore many U.S. producers — mostly shale producers — will stay in business a little longer.

Without Saudi oil on the U.S. market, American production doesn’t really need to be cut. The nature of U.S. shale is different from that of more conventional oil fields. Shale isn’t pumped; instead, natural pressure in the rock formation pushes the oil up and into pipes that carry it to loading facilities at ports.

Lifting costs are minor, and much of shale producers’ daily operating costs stem from pipeline rates. Under the present circumstances, when little to no other oil will compete for the American market, shutting in may incur higher costs for producers than simply letting things run normally.

Furthermore, even though the U.S. brokered the historic OPEC+ deal, it lacks the legal tools to force its own states to implement oil cuts. The federal government doesn’t have a state-owned company, and its regulations are not as centralized as those of Russia or Saudi Arabia. It is instead up to the states and the companies themselves whether to cut.

At the same time, U.S. producers are very responsive to price changes, which means shale producers will keep production going only as long as it is profitable for them to do so. And with prices continuing to slide despite the OPEC+ deal, that won’t be long.

On April 10, Trump asked the U.S. Department of Energy to purchase crude oil for the Strategic Petroleum Reserve, which will boost prices temporarily. But eventually companies will close down production because of low prices — something Washington can pass off as a “cut” to the OPEC+ countries.

Defining the Limits

The Saudi announcement on price differentiation between American and Asian markets means that, in spite of the OPEC+ agreement, Riyadh will effectively intensify its price war in Eurasia. Whatever Saudi output is not sent to the Gulf of Mexico will be sent to Asia, where Saudi Arabia competes with Russia (and others, to a lesser extent, including Iran, Nigeria and Iraq).

Though Saudi Arabia knows that Russia will break the agreement — as it has before — it also knows that Saudi oil has only limited time to gain profits.

The global storage capacity is estimated to be between 900 million and 1.8 billion barrels. This is equal to roughly 9-18 days of global supply based on output in 2018, when the world produced nearly 95 million bpd. Assuming that 10 million bpd is put into storage, facilities would be filled in between 90 and 180 days.

Since early April reports have been coming in that the United States’ Caribbean and Cushing storage hubs are nearing capacity. The math suggests this will soon be true for the rest of the world. Saudi Arabia, as well as Russia and other producers, is interested in selling as much oil as it can until storage capacity is reached.

At that point, the production price of oil will fall close to or even below zero if the coronavirus crisis hasn’t abated and the world is still effectively quarantined.

Even assuming that all producers stick to the OPEC+ plan, if we take the median of the estimate of global storage capacity — 1.35 billion barrels — then the world’s stocks of oil storage will be full by early June. If the deal collapses, and everyone maximizes output, then production prices will fall to single digits or even zero earlier, potentially by mid-May.

This reality can be avoided only if the coronavirus outbreak is quickly contained and the global workforce is able to get back to work.

Big Picture Thinkers Ponder Deficits, The Fed, The Dollar And Gold

by: Montana Skeptic

- A few weeks back, I wrote of a trader whose goal was discovering where the big money is moving right now and reaching out to grab some.

- Today is something completely different: A focus on two financial industry veterans, Grant Williams and Stephanie Pomboy, who think in big picture terms.

- Williams and Pomboy see the era of globalization unwinding just at the moment when government spending and central bank interventions are reaching a frenzy.

- It's all unsustainable. It will all come crashing down. But how will it end? And how can an investor guard against the damage, or even profit from the opportunity?

- Join me as I eavesdrop on a conversation between these two. And then conclude with a word about Tesla.

Tesla (NASDAQ:TSLA) is not the only thing going on in the world. It's not even the most important thing going on in the world. Indeed, in the big scheme of things, Tesla is a tiny thing.
An emblem, surely, of the financial and monetary excesses of our times, and of lax regulatory standards, and of the reflexive virtue signaling that has come to substitute for serious thinking. But not an important thing.

The Important Things
Today, I want to explore truly important things. Not as important as good health and happiness, but perhaps next in line: The economic health of our nation and world, which affects the livelihood and wealth of each of us, and will shape our future.
I want to detail a recent conversation between Grant Williams and Stephanie Pomboy because I believe the topics they addressed have immense implications for investors everywhere.

Who is Grant Williams? It's impossible to pin him down with a simple description. In a brief biographical sketch, he describes himself as "a keen student of history, markets, politics, and, above all, human nature."

These days, among other things, he's the author of a superbly written newsletter called Things That Make You go Hmmm, which I began reading several years ago.

And Stephanie Pomboy? She is founder of a research firm called MacroMavens which, as its name implies, employs its analytic approach to identify macroeconomic events "and steer our clients around them - well ahead of the curve."

Her firm famously gave its clients early warning about the bursting of the housing bubble, which was a major contributor to the 2008 Great Financial Crisis.

Pomboy is one of scores of fascinating people whom Grant Williams keeps on his radar screen, regularly corresponds with, and periodically interviews.
Pomboy and Williams had their discussion last Friday (April 10) in what Williams calls a "Hmmminar," which are online video interviews he's conducting with personalities from around the globe during the coronavirus lockdown.

As I write this, Williams has posted 10 of these Hmmminars, and has several more scheduled.

The Discussion's Backdrop
On April 9, one day before Pomboy and Williams spoke, the U.S. Federal Reserve announced it would begin including, in the corporate debt it was purchasing to backstop financial markets, so-called junk bonds. The Fed set the size of the purchasing facility at up to $750 billion.
While the Fed had earlier indicated it would purchase only investment grade corporate debt, the April 9 announcement relaxed that rule by announcing purchases of debt that had an investment grade rating before March 23 but had since been downgraded to junk status.

For the junk debt to qualify, it would have had to be rated BBB-/Baa3 (the lowest rankings of investment grade debt) as of March 22.
Pomboy had been tracking the number of credit rating downgrades to junk status, both for particular debt issuances and for companies, in the weeks leading up to the Federal Reserve announcement. She found more than 500 such issuance downgrades since March 22 and another 12 downgrades of particular companies.

As more companies revise their earning guidance, or begin reporting Q1 results, it's all but inevitable that there are more downgrades to come.
Two days before the Fed announcement, Pomboy had published a research piece called Trump Card(s), in which she wrote about where we have been and where we are going.

Even Before Coronavirus, Markets Were In Trouble

Both Pomboy and Williams have for years been warning about the increasingly untenable position of both U.S. and international markets, which they view as having long term, fundamental problems.

While any description I offer will be a simplification, I think it's fair to say both share several key views:
  • Central banks with their various "quantitative easing" projects and reluctance to raise rates have repressed interest rates, thus depriving financial markets of what is perhaps the most important price - the true price of risk.
  • With interest rates beaten down and spreads between investment grade debt and junk bonds shrinking to historic lows, investors have increasingly been forced to buy equities (the so-called TINA effect, for "There Is No Alternative"). Predictably, this has driven up the price of equities.
  • Low interest rates also have encouraged corporations to take on ever more debt, often using some of the proceeds to buy back their own stock. This, too, has contributed to ever-rising equity prices, while making corporations more vulnerable in any downturn.
  • Meanwhile, the U.S. government and other national governments have continued running large deficits and piling on ever more debt. State and local governments, attracted by low municipal bond rates, have added to their debt as well. The governments have been enabled to do so, thanks to the interest rate suppression engendered by monetary policy.
  • All the while, despite the longest-running bull market in history, unfunded public and private pension obligations have been increasing. Compounding the problem has been the paucity of investment grade debt at yields adequate to meet the pension funds' needs, which has forced the funds into ever-riskier investments.
    While the coronavirus shock is unprecedented in its nature and scale, both Pomboy and Williams view it as accelerating and deepening problems that were already bound to emerge.

The Dutch Boy At The Dike

As noted, Pomboy has been tracking the accelerating descent of the bond markets "fallen angels" and so viewed the Fed's decision to begin buying even sub-investment grade debt as inevitable. She and Williams agreed that $750 billion in bond purchases won't be the end of it. Both expect the Fed's bond buying program to increase in both size and scope and believe it may soon include bonds that were below investment grade even before March 23.
Williams wondered whether the Fed will soon begin buying equities as well as debt. That, of course, seems unthinkable now, but it was only a few months ago that the idea of the Fed buying junk bonds was unthinkable.
Both Pomboy and Williams expressed surprise at the recent stock market rallies, as neither believes we have yet seen the worst. Pomboy said she was struck by the widespread expectations for a so-called V-shaped recovery in which, after a terrible Q1 and Q2, the economy roars back to life and a bull market resumes.
Said Pomboy,
"the idea that we are going to bounce out of this and go right back to where we were before just seems absolutely ludicrous to me."

The Inexorable Behavioral Changes

Pomboy sees several changes in behavior that will preclude a return to the bull market mentality at any time in the foreseeable future.
Those corporations that survive this catastrophe will emerge chastened about debt and will do all they can to keep leverage low. With a new appreciation for the fragility in global supply chains, they also will alter some of their business models, resulting in an unwind of much of the globalization that has occurred in the past two decades.
In a related vein, policy leaders will question the wisdom of the U.S.'s reliance on China for many products, starting with pharmaceuticals (or key pharmaceutical ingredients) and proceeding from there.

There also will be a change in individual behavior. Pomboy noted that after the Great Financial Crisis, U.S. households, which had been punished by high levels of personal debt and seen their investments shrink in the market collapse, began saving more out of after-tax income. That higher rate of savings persisted throughout the bull market despite the steady ascent in the values of the consumers' homes and retirement accounts.
Pomboy believes the economic dislocation from this latest and most sweeping economic shutdown will reignite the desire among consumers to increase their savings.
With corporations and consumers suddenly becoming parsimonious in their behavior, the U.S. government will become "the marginal spender of last resort" and the Fed will become the "marginal lender of last resort."

Government Will Become (Even) More Profligate

Actually, and Pomboy hints at this several times, we already are there. The U.S. government has already become the marginal spender of last resort, financed by the Fed playing the role of marginal lender of last resort. The initial $2.3 trillion "stimulus" package is destined to grow ever larger as the Democrats and Republicans discover they were always on the same page after all.
I recall from my youth how many gasped that, under Reagan, the federal deficit ballooned to 2.7% of GDP. The percentage last year was close to 5%.
And 5% will very soon seem impossibly modest. Pomboy believes we will see a deficit of between 20% and 25% of GDP this year. That equates, dear reader, to approximately $5 trillion of deficit spending. A number too large to grasp. With, of course, full-throated support from most of both political parties, and the signature on the spending bills from President Trump.
The received wisdom is that the stratospheric deficit will be but temporary, and that once the recovery (confidently expected to be V-shaped) is in full swing, deficits will quickly shrink to former levels.
Pomboy, though, is dubious, both about the shape of the recovery (which she believes will be more slow and painful than anticipated) and the behavior of the legislators. As she wrote in her April 7 analysis, having savored the taste of spending taxpayer money in a $5 trillion deficit confection, "our porcine politicos in DC will never go back to single-trillion peanut butter and jelly."

The Pension Crisis
There certainly will be plenty of governors and mayors urging the porcine politicos to maintain their caviar spending diet. The great pension crisis, about which many (including Pomboy) have sounded clear warnings for at least the past decade, is well and truly upon us, and the cri de coeur from the states and municipalities will be for pension fund bailouts.
The pension funds have been among the chief victims of the interest rate suppression engineered by central banks.

With investment grade fixed income no longer adequate to generate the necessary returns, pension managers have increasingly looked for yield in all the wrong places.
These pensions have had to take an enormous amount of risk. They were the marginal buyers of all of the most toxic paper out there. You know, "Levered loans with no covenants? Sure, we'll take some of those! Investments in unicorn stocks through private equity that have no business and managed to lose a billion dollars a month? Sign us up for that!"

The U.S. had $5.3 trillion in unfunded public and private pension liabilities at the end of 2019.

That was, of course, before the coronavirus shut down large parts of the economy and caused asset values to plummet.
The pension crisis will rapidly become more acute for two reasons. First, even though the data won't be available for some weeks to come, Pomboy believes market losses from the coronavirus dislocation already have increased the already severe underfunding by several trillion dollars.

She sees the total unfunded pension liability rising this year to as much as $10 trillion, with most of that at the state and local level where money printing and deficit spending are not possible.
Second, with tax revenues certain to fall far short of forecasts made only a few months ago, state and local governments will strain to meet essential services and will have less money to fund pensions.

The problem is here.

Financial engineering tricks will no longer suffice to disguise it.

The only "silver lining," said Pomboy (making clear it is not a good thing at all), is that people, seeing the destruction of both their income and their savings, will be compelled to remain in the work force longer.

Some Wall Street Strategists Have Had It All Wrong
Pomboy has long been critical of those urging (with what she describes as an almost Pavlovian response) that higher deficits will mean higher interest rates.

She presented a chart showing just the opposite: The decline of the 10-year Treasury rate has occurred alongside a corresponding ascent of the Federal deficit as a percentage of GDP (and the inverse relationship held between 1960 and 1980, when Treasury rates rose as deficit spending fell).
Why should that be?

Pomboy cites two reasons:

First, the government typically borrows more when the economy is in trouble, so the backdrop for borrowing is not conducive to inflation.

Second, for the past several decades, the rise of globalization has recycled U.S. dollars into the hands of foreign lenders, who in turn used them to buy U.S. Treasuries, thus tamping down rates.
In the interview, Pomboy noted how the financial system was unable to abide the rise in the 10-year rate to 3%, or even 2.5%, from several months ago.

Some part of the economy would run into trouble, the pressure for further rate cuts would build, and the Fed would cut in rapid order.
This is not to say that there was no price to pay for what Pomboy calls our "policy sins." There has indeed been penance to perform, but it has been performed by the U.S. dollar rather than interest rates.

While foreigners were purchasing massive amounts of U.S. paper, the dollar declined as debt and deficits rose.
Another Pomboy chart, showing how closely the Federal deficit has tracked the trade-weighted dollar, nicely illustrates her point that "the dollar has become the valve for this angst, as it were, over our profligate fiscal policies."

The Vendor-Financing of our Profligate Spending
Why has the U.S. been able to run hefty deficits for the past several decades? Pomboy's answer is the fulcrum to her entire world view:
The U.S. has been able to run those deficits because large parts of the rest of the world have been willing to buy our paper to, in effect, vendor-finance the export of their own goods.
In other words, because they were selling goods to us, buying our debt inured to the benefit of the exporting nations. It was seller financing, even if we didn't realize it. And that relationship carried us a long way.
Pomboy illustrates this with a remarkable chart on which foreign holdings of U.S. Treasuries are plotted against U.S. debt as a percentage of GDP:

As Pomboy observed, it's difficult to tell the two lines apart.

But Now, Change Is In The Air
So, why will that not continue? Why will the rest of the world cease to vendor-finance their exports to the U.S., soaking up Treasuries in the process?
Pomboy believes it will not continue because, for a host of complex reasons, the era of globalization is coming to an end. The nationalistic trends already evident with Trump's election in 2016 are receiving a powerful new impetus from the coronavirus crisis.

The behavioral changes outlined earlier, in which both corporations and households dramatically trim their spending and have a heightened reluctance to rely on foreign (especially Chinese) supply chains, mean there will be fewer exports for the foreigners to vendor finance.
With the changes to corporate and household behavior, and the government as the marginal spender of last resort, the credit proposition for those who would consider buying U.S. debt is not compelling.

Consequently, Pomboy expects the demand for our federal debt to shrink. Indeed, it already has begun to shrink. This is evident from another stunning Pomboy chart, plotting the amount of Treasury securities on the Fed's balance sheet (in other words, bought by the Fed for its own account) over time vs. the amount held in the Fed's custody accounts (that is, held by the Fed for foreign government purchasers):

What just happened, earlier this month, to cause those lines to cross? For the first time, the Fed's holdings eclipsed the foreign holdings in the Fed's custody account as the Fed kept adding to its purchases while foreign central banks unloaded some $131 billion of their own Treasuries.
Pomboy sees this historical divergence as only continuing to grow. She does hold open the possibility that divestment of Treasuries by foreign central banks may have been temporary, prompted by a "dollar shortage" that will be cured by the Fed's unlimited swap lines and oil prices finding a bottom (thus putting more petrodollars into circulation).
However, she sees no chance that foreign purchases of Federal debt can keep pace with the immense amounts of Treasury purchases she anticipates the Fed will continue making. Indeed, she expects the Fed's balance sheet will grow to double digits (in trillions of dollars).
Will households and corporations, determined to save more and consume less, step into the breach as purchasers of U.S. Treasury paper? "Maybe that will be the great surprise," said Pomboy. Both she and Williams, though, expressed skepticism it would happen.

Who Will Buy Our Debt?
What happens now?

As foreign purchases of U.S. paper fail to keep pace with additions to the Fed's balance sheet, will the floor fall out from beneath the dollar?
Pomboy offers the answer from the dollar bulls: the dollar won't decline so long as central banks in the rest of the world are also printing money as fast as they can to support their own domestic stimulus programs.
But that means we will see "the whole world printing money in unprecedented and unlimited fashion to support their economies." How does that finally end?

Pomboy (and Williams is in accord) dare to think the unthinkable: The hypertrophy of government spending and hyperactivity of central banks could soon spell the end of the fiat money system, which was inaugurated here when the U.S. untethered the dollar from gold in the 1960s.

From the interview:
Serious people are going to start to discuss: "How are we going to work our way out of this and how are all the developed world economies going to grapple with the massive amount of debt that they're facing?" 
I again come back to the idea that the only way that aging, demographically-challenged, highly-indebted developed world economies can get out of this is to print money like crazy, because deflation is not an option for them. They have to inflate away the burden of this debt. 
But if we all do it at the same time, and we have this race to the bottom, at some point the creditors, which are really China and other EM (emerging market) nations, are going to say, "Look, we're not schmucks. We see what you're doing over there. We're not having it."

Add to this the growing skepticism about whether China is truly a friendly nation, and whether we should be outsourcing much if any of our production there, and what we will see, believes Pomboy, is a debate between the developed world debtors and the emerging world creditors that comes to the center.

All Roads Lead To Gold

Who will want to buy our debt? With the benefit of vendor-financing removed, and with the explosion in money printing evident, no sensible creditor will. Unless, that is, the creditor can be assured that the U.S. dollar, in which loans are made and repaid, is somehow subjected to a discipline that will rein in the danger of inflation.
Ultimately, this business of currency is a confidence game. If the creditor lacks confidence that your currency will retain value when time for repayment comes, it will not agree to make the loan in the first instance. How does a creditor protect itself? By demanding repayment in something solid. Something real.
[I]t's going to have to come back to a hard asset tether, going back to a gold standard or something along those lines.
Pomboy noted in her recent research piece that the U.S. may have one significant advantage none of the other deeply indebted nations has: a huge gold reserve.
Should the de facto embrace of overt monetary finance (aka unlimited money printing) around the globe call into question the whole fiat money system, and we go back to a hard-money tether via a gold standard, the fact that the US has the largest gold reserve of any country gives us great advantage.
Yes, both Pomboy and Williams are advocates of a gold standard, or something similar. This is different from the attachment to gold cherished by those who value its concentrated value or portability, and who might perhaps imagine slipping a gold coin to a border guard in a time of great unrest, or exchanging bullion for produce in a time of famine.
Pomboy and Williams are attracted to gold because they believe that, for all its faults as an anchor of currency, it is the least faulty solution out there, and far preferable to the place where fiat money ineluctably leads.
In Pomboy's recent piece, one of the "Trump Cards" from the title was the notion that our President might require China to pay for the coronavirus by forgiving the trillion dollars or so that we owe its central bank.

But even if it doesn't come to that (which it probably won't since the $1t we owe China is a drop in our rapidly expanding bucket of borrowing) the US still has a trump card it can play in the new world order. And this one is also one of the President's legendary affections. No. I'm not talking about exotic models. I'm talking about gold. 
Should the de facto embrace of overt monetary finance (aka unlimited money printing) around the globe call into question the whole fiat money system, and we go back to a hard-money tether via a gold standard, the fact that the US has the largest gold reserve of any country gives us great advantage.
Pomboy said that if the idea of Trump reverting to the gold standard sounded familiar,
it was because she had written about it six months before the 2016 Presidential election:
I'm stunned by the prescience of that passage, all the more prescient because written at a time when it seemed inconceivable to most (certainly to me) that Trump could be elected.
Of course, long would be the trail of tears leading to a gold standard, and great the wreckage strewn along the way. But who has a better idea?
Investment Implications
Am I persuaded by the arguments of Pomboy and Williams? I'm certainly taking them seriously. I have a small amount of gold in my own portfolio, and am wondering whether it would be wise to add more.
Anyone intrigued by the thinking of Pomboy and Williams might consider several actions.
First, a subscription to Things That Make You Go Hmmm and to the work of MacroMavens.
Both may be among the most valuable investments you ever make.
Second, a careful consideration of what types of investments are likely to hold value in a time of high inflation and, as importantly, what types of investments are especially vulnerable to inflation.
Third, a careful consideration of whether gold should be a part of one's investment portfolio.
There are several ways to invest in gold.
They include:
  • Purchasing the physical asset, though that presents custody and storage issues;
  • Investing in gold mining companies, such as Barrick Gold (NYSE:GOLD) and Kirkland Lake Gold (NYSE:KL);
  • Buying mutual funds focused on companies engaged in the exploration, mining, or processing of gold;
  • Purchasing shares of a fund that replicates the price of gold, such as SPDR Gold Shares (NYSEARCA:GLD); and
  • Trading gold futures and options in the commodities market.
It's beyond the scope of this article to recommend any of these types of investments. Rather, my intent is simply to introduce the reader to the big picture thinking of Stephanie Pomboy and Grant Williams, and to suggest such thinking is ever more important in this, the most uncertain economic era of our lifetimes.

A Short Word About Tesla

Adam Jonas of Morgan Stanley was out with a note today (I'm writing this on April 15), which included the following passage:
4. Extraordinarily high trading volume. At the risk of reading too much into technical factors, we do pay attention to the extremely high levels of volume traded in Tesla shares. For example, the value of shares traded yesterday (4/14/20) was close to $22bn.  
On the same day, Apple (NASDAQ:AAPL) traded $14bn of value and Amazon (NASDAQ:AMZN) traded less than $19bn of value.  
Our own efforts to investigate exactly where the volume comes from (retail, institutional, index, quant, options/vol hedging, etc.) have proven to be in many ways opaque and, frankly, inconclusive. It seems to us that, to a degree, the trading of Tesla shares has been driven by factors that go beyond the fundamentals influencing an electric car or even a technology company.

If Adam Jonas is mystified by what's going on with the trading of TSLA, do you imagine this is any time for you to be considering initiating or adding to a short position? I certainly don't.

Will it be an Inflationary or Deflationary Depression?

by Doug Casey


At some point, the economy is no longer controlled by individual citizens in the marketplace but by government "planners," who find they have only one of two alternatives: stop "stimulating" and permit a full-scale credit collapse, or continue stimulating until the dollar loses all value and society breaks down.

Depending on which they choose, we will have a depression characterized by deflation or by hyperinflation.

Deflationary Depression
This is the 1929-style depression, where huge amounts of inflationary credit are wiped out through bank failures, bond defaults, and stock and real-estate crashes.
Before 1913 (the inception of both the Federal Reserve and the income tax), having the dollar pegged to gold (at $20 an ounce) inhibited the scale of monetization.
When depressions of this type occurred, depositors acted quickly to collect their money; they had no illusion that the government would bolster their banks; once the banks ran out of gold, their bank accounts were worthless.
Their quick response and the fact that the federal government could not monetize its deficit spending as freely as it now can forced the market to correct distortions rapidly.
Until the 1930s, depressions were sharp but brief.
They were short because unemployed workers and distressed business owners were forced to lower their prices and change their business methods to avoid starvation.
The 1929 Depression was deeper and more widespread than any before it since the Federal Reserve (by becoming the lender of last resort) allowed banks to maintain far smaller reserves than ever before.
By backing the dollar with Reserve Bank IOUs instead of gold, the money supply could be increased enormously, and large distortions could be built into the economy before a depression liquidated them.
It was far longer than those before it, because government attempted to hold wages and prices at levels few could afford to pay, while its make-work and income-redistribution schemes retarded the rebuilding of capital and the productive employment of labor.
Meanwhile, the government discovered the freedom with which it could have its deficit spending monetized and proceeded to spend at an unprecedented rate to finance the New Deal’s spending programs and World War II.
Since the end of the last depression, there have been numerous small recessions. Since at least the ‘70s, anyone of them could have snowballed into another 1929-style deflation.
Government has been able to forestall a deflation each time, since it has far more power than it did during the ‘30s. But the government’s success so far has linked all the cyclical recessions since the end of World War II into a much larger "supercycle."

Just as each of the past recessions had its moment of truth, so will the current one. And it could well be the turning point for the bigger supercycle as well.
Hyperinflationary Depression

This is the Weimar-style depression, like the one Germany experienced in the early ‘20s. Here, rather than let a collapse of inflationary credit wipe out banks, securities, and real-estate values, the government creates yet more currency and credit to prop things up.

It pumps massive amounts of new purchasing power into the economy to create "demand" (even, or rather, especially among corporate and individual welfare recipients, who produce nothing in return).

The government extends past misallocations of capital, when the economy instead needs to readjust to sustainable patterns of production and consumption.

Hyperinflation could result from overstimulation when the authorities try to boost the economy out of a trough. If they expand the money supply too quickly, it might encourage the trillions of US dollars owned by foreigners to flood back here at once, in a bid for real wealth in competition with domestically held dollars. That would reverse, overnight, the muted inflation figures of the last 40 years, and prices could jump at a 20 percent to 30 percent clip.

It is hard to anticipate all the implications of that happening but, presumably, everyone would panic out of dollars and into real goods.

There would be a wave of bank failures. Possible government reactions would be price controls, withdrawal restrictions, foreign-exchange controls, and many other forms of "people controls."

This country is arguably unique in having a gigantic long-term debt market; bonds and mortgages are worth several times what the stock market is. If the dollars that debt is denominated in were to evaporate, it would be a world-class disaster.

Previous runaway inflations in other countries have been characterized by the printing of literally tons of paper money. But the US economy is based largely on credit.

Would credit cards be accepted if the dollar were to start losing value at a very high rate?

Quite possibly not. In other hyperinflations, there was usually some alternate currency to facilitate trade.

Weimar Germans had substantial amounts of gold coins salted away.

In South American inflations, people simply used US dollars.

In the ex-USSR, dollars (and deutsche marks) practically became the new national currency for a few years.

But what would Americans use?

All this would be an academic discussion, or perhaps an interesting topic for a science-fiction treatment, if the US government were a manageable size, and instead of a "legal tender" currency, "dollar" were just a name for a certain quantity of gold.

But that is not the case, and we have to deal with things as they are.

Which Will it Be?

The current administration, Congress, and the Federal Reserve are confronting a far, far more serious problem than ever in past business cycles.

At the bottom of each past cycle, interest rates were high (bond prices were low), inflation was high, and the stock market was very low.

This set up ideal conditions for recovery, as each of these situations went into reverse.

But now, stocks and bonds are already very high, and inflation is already at (what have come to be accepted as normal) very low levels.

At the same time, the government has far less flexibility than in the past, despite being more powerful than ever.

Most of its revenues are already spent before they come in, and it has a gigantic debt load to service.

If some unexpected shock hits, it will be like watching a tightrope walker over the Grand Canyon during a windstorm.

In their efforts to quell inflation, the authorities could make the supply of credit either too small or too costly.

With as much debt as there is today, the wave of bond and mortgage defaults would cascade through the economy. Loan defaults would wipe out banks, and foreclosure sales would depress prices and wipe out the net worth of individuals.

A corporate bankruptcy can take down its suppliers, its workers, its community, and its lenders as well. Perhaps a scramble to pay debt would result in the wholesale liquidation of assets at distress-sale prices, further reducing everyone’s net worth, even while the dollars they owe gain value.

In their efforts to head off a deflation, the authorities would undoubtedly attempt to supply liquidity by creating more currency and credit. But that would just bring back the inflation scenario.

And world credit and currency markets are far larger than they were during the early ‘80s, when things very nearly collapsed.

The financial problems the government has created have taken on a life of their own, and there is a good chance we’ll have a nasty surprise when the next recovery is slated to occur.

Betting on inflation has been the winning strategy since the bottom of the last depression, but a financial accident could change all that overnight.

The inflationists will almost certainly be right in the long run, but they may get wiped out in the short run.

In any event, the moment of truth is approaching, and there likely will be a titanic struggle between the forces of inflation and the forces of deflation. Each will probably win, but in different areas of the economy.

As a result, we’re likely to see all kinds of prices going up and down, like an elevator with a lunatic at the controls. It will not be a mellow experience.