Small Business Blues

By John Mauldin

Politicians love saying small businesses are important to the economy. In this case, it isn’t just rhetoric. The millions of little companies with a handful of workers are, collectively, more important than the few hundred large enterprises we see in the news.

That’s one reason the corona crisis has been so economically devastating. It hit hardest the small businesses that are both critical to growth and vulnerable to disasters. 

Yes, I know, some large businesses have been eviscerated (e.g., airlines) but small business have been hit harder. Furthermore, the policy responses haven’t been especially helpful or equal, either, and possibly harmful. 

This will have wide-reaching, long-term effects. Today we will discuss them.

I should mention, I’ve been one of those small business owners or managers my entire career. I know how it feels when employees are like family (or perhaps literally are), the desire to protect them as any parent or friend would, and the agony when you can’t. This situation hasn’t just cost jobs and income. It’s killed hopes and dreams.

The good news: Dreams are a renewable resource. We can replace the lost ones. We’ll talk about that, too.

Closed for Good

The New York Times has many issues but its writers excel at finding personal examples to illustrate broader stories. Though this time, they didn’t have to look hard.

On the last Friday of June, after Gov. Greg Abbott of Texas said that bars across the state would have to shut down a second time because coronavirus cases were skyrocketing, Mick Larkin decided he had had enough.

No matter that Mr. Larkin, an owner of a karaoke club in Wichita Falls, Texas, had just paid $1,000 for perishable goods and protective equipment in anticipation of the weekend rush. No matter that the frozen margarita machine was full, that 175 plastic syringes with booze-infused Jell-O were in place, or that there were masks for staff members and hand sanitizer for guests.

That day, June 26, Mr. Larkin and his partner dumped what they had just bought into the trash and decided to close their club, Krank It Karaoke, for good.

“We did everything we were supposed to do,” Mr. Larkin said. “When he shut us down again, and after I put out all that money to meet their rules, I just said, ‘I can’t keep doing this.’”

Mick Larkin’s only mistake was owning a business that combines crowds, drinking, and singing, all of which help spread respiratory viruses. Now, he’s done. And he’s not the only one.

For nearly two decades, Rich Tokheim and his wife sold sports memorabilia—hats, T-shirts, coffee mugs, and other trinkets—to fans in Omaha at their store, The Dugout. Since 2011, The Dugout has occupied prime real estate across the street from the city’s 24,000-seat baseball stadium, which usually hosts the College World Series each spring.

The 2020 World Series was canceled in March. In the weeks that came after, other sporting events were scrapped—starting with college sports and extending to professional leagues that have struggled to relaunch their activities.

Mr. Tokheim, 58, watched his business fall off with growing unease, but it was only after a friendly chat with a retired college athletic director in May that the gravity of his situation hit home. He was already worried about the state of the virus in Nebraska, and whether there was enough tracking. Then the athletic director predicted that if college football was canceled for the year, it would be the end of Division I sports as a whole.

“That really put me in overdrive,” Mr. Tokheim said. He negotiated an early exit on his store lease and announced a clearance sale at the store. The Dugout closed for good on June 30.

And another one:

Many small businesses are also finding it onerous to keep up with constantly changing local guidelines, while others are deciding that no matter what their local officials say, it just is not safe to keep going. 

Gabriel Gordon, the owner of a tiny but popular barbecue restaurant in Seal Beach, Calif., decided to close permanently after studying the restaurant’s layout. He had determined that the kitchen would never be safe for multiple staff members to occupy at once while the virus was still active in the area.

“It’s essentially two hallways that are 11 feet wide,” Mr. Gordon said, describing the shape of the restaurant, Beachwood BBQ. “There are food trucks that are larger than my kitchen.”

Those are just three of many tens of thousands. The owners did everything right. In any other circumstances, they would be providing jobs and helping their local economies grow. Now they’re out.

The NYT article mentions Yelp estimates that 66,000 small businesses will never reopen, and then cites a Harvard study which estimates 110,000 small businesses have shut down permanently.

What is causing this? It’s not entirely government orders. A study from the University of Chicago’s Becker Friedman Institute used mobility data to measure foot traffic at 2.25 million US businesses. Traffic fell significantly weeks before shutdown orders took effect.

The mobility data was not only granular enough to compare similar businesses in the same area, it compared businesses across county lines or city limits at which the legal restrictions changed. The businesses in places without shelter-in-place orders had only slightly higher traffic.

In other words, consumer choices are driving this, not governments. And that’s something every business owner understands. I don’t know any bar owner who wants people to risk their safety or health. The problem is when your entire business model is suddenly perceived as hazardous.

False Start

Small business owners succeed by laser-focusing on their strategies. They aren’t, and shouldn’t have to be, public health experts. They just need to know what is required to operate safely. 

And, after the initial March/April closures, most were allowed to reopen with various modifications. So, acting in good faith, many did (but not all, as we’ll see in a minute).

The National Federation of Independent Business does a monthly “optimism” survey. Its members’ moods perked up considerably in June. 

Owners reported improved sales outlooks and said they anticipated better business conditions in the coming months.

But NFIB collected that data in June, when we now know virus cases were just beginning to resurge in some states. Texas Governor Greg Abbott ordered bars to close on June 26. Other restrictions returned as July unfolded. 

So the optimism NFIB found is disappearing fast, at least in parts of the US. (Here in Puerto Rico the government restored many restrictions  yesterday.)

We talk of a second virus wave, but it’s an economic second wave, too. New orders are hitting businesses still trying to rebuild from the first one. 

But again, it hit businesses indirectly. The real problem is consumers choosing to stay home and buy only essentials, often ordering online. Small businesses feel it when even a small percentage change their behavior.

In theory, this shouldn’t have been a problem. Washington responded quickly (and at near-lightspeed, by government standards) with Congress passing the CARES Act in late March. It included, among other things, a “Paycheck Protection Program” to help small businesses avoid layoffs and survive the shutdown period.

Unfortunately, PPP didn’t work as envisioned for many businesses. 

The application process seemed simple enough but even simple things are hard when you’re struggling just to stay afloat. Then the initial funding tranche ran out quickly. And then the well-intentioned restrictions on how businesses could use the money kept it from helping some, particularly those in high-rent areas.

By the time all that started to get sorted out (and it’s ongoing even now), many small business owners had given up, or had already laid off the workers whose paychecks the program was supposed to protect. Worse, the number is still growing.

Small Businesses Need Customers

Many small businesses serve individual consumers but just as many provide services to large corporations. 

It’s no secret that large corporations are struggling. You can see it from corporate tax receipts which are down 92% in the last year (hat tip to Lance Roberts). 

Corporations cutting back every possible cost means less money spent at small businesses.

Further, Mike Shedlock at Mish Talk gives us the most recent data (as of Thursday) on unemployment. This needs a little technical setup.

States pay unemployment insurance. That’s what you see in the data on new applications for unemployment and continuing claims. But that’s not the whole picture. The CARES Act complicated the jumble of federal and state unemployment programs.

Here is Continued State Unemployment Claims. It’s like it’s beginning to trend down. Yay home team.

Source: Mish Talk

It looks even better if you are looking at Initial State Employment Claims for 2020. 

Clearly the trend is down, although it flattened in the last few weeks.

Source: Mish Talk

That’s all well and good until you add in the federal numbers. Then the picture becomes markedly uglier. 

As Mish says, any improvement at the state level looks like a mirage. 

Here are the claims for federal unemployment:

Source: Mish Talk

On a phone call with Mish, asking for clarification, he pointed out that the data above has a reporting time lag of two weeks. As you can see, the trend has clearly been accelerating since early April or the initiation of the program. It is probably not unreasonable to assume that we will find out in two weeks there are an additional 1.4 million unemployed workers.

So what happens when you add all these unemployed numbers together? 

You get a chart labeled All Continued Unemployment Claims:

Source: Mish Talk

Let’s see what that 32 million unemployed workers means to the employment picture. The US had 132 million full-time workers at last year’s peak.

Source: Statista

Pew Research tells us that “more than 157 million Americans are part of the U.S. workforce,” which would include those who are working part-time.

Some part-time workers do not qualify for unemployment insurance either at the state or federal level. That would mean a best-case unemployment rate of almost 20%, but if unemployment claims are skewed to full-time workers, which they likely are, unemployment is closer to 23% including lost part-time jobs.

These workers are generally spending less money, but wait, it may/will eventually get worse. Sigh.

I don’t know what it is about Danielle DiMartino Booth, but her Quill Intelligence newsletter usually hits my inbox while I am finishing my own letter. And it always seems to have a data point that is absolutely on target with what I am writing. Today was no different. Note how those in the highest income ZIP Codes are spending less.

That spending by the lowest income brackets will disappear if the $600 per week federal unemployment benefit is not extended after July 31. Quoting Danielle:

As we’ve written in the past, the top two quintiles of income earners in America account for 61% of spending, or 42% of GDP. If they don’t spend, the economy comes to a screeching halt. As you see, as of July 8, spending among high-income earners was off by 10.8% compared to -1.9% for the lowest income earners.

J.P. Morgan’s findings not only square this circle but stand as a stark reminder for lawmakers duking it out on Capitol Hill: “While aggregate spending of the employed was down by 10%, the spending of unemployment benefit recipients increased by 10%, a pattern which is likely explained by the $600 federal weekly supplement. At the same time, our second finding is that among the unemployed who experience a substantial delay in receiving benefits, spending falls by 20%.” We’ll translate—if the unemployment insurance supplement is not extended full board, the hit to spending will be immediate.

If you are in the restaurant business, that brief ray of hope has disappeared. 

After seeing a high point of -49.8% nationwide year over year on July 2, OpenTable reservations are back down to -64%. With the closures in Texas and other states, that will not improve in the next few weeks.

I think it is highly likely the extra unemployment benefits will be extended, at least until the election. But at some point, the country simply cannot afford to pay people $30,000 a year. Democratic candidate Andrew Yang’s $1,000 per month idea seems like small potatoes now.

The national debt is $26.5 trillion and will be $30 trillion sometime in 2021. Ugh.

It’s a Global Depression

Today we sent Over My Shoulder members an annotated version of Lacy Hunt and Van Hoisington’s latest quarterly letter

I’ll quote from the introduction, though you should look at the entire piece. Read it three times and then meditate. Then try to figure out where V-shaped recovery beliefs come from.

Four economic considerations suggest that years will pass before the economy returns to its prior cyclical 2019 peak performance. These four influences on future economic growth will mean that an extended period of low inflation or deflation will be concurrent with high unemployment rates and sub-par economic performance.

First, with over 90% of the world’s economies contracting, the present global recession has no precedent in terms of synchronization. Therefore, no region or country is available to support or offset contracting economies, nor lead a powerful sustained expansion.
Second, a major slump in world trade volume is taking place. This means that one of the historical contributions to advancing global economic performance will be in the highly atypical position of detracting from economic advance as continued disagreements arise over trade barriers and competitive advantages.

Third, 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.

Fourth, 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.

The same legislation that created PPP authorized the Federal Reserve to lend to larger companies. It has been buying corporate bonds in the secondary market, which basically means many public companies can get low-cost capital just by making a bond issue. Such loans aren’t forgivable like PPP, but they have fewer strings attached.

That’s one reason large businesses are generally enduring this period better than small ones. They tend to have deeper pockets, more access to financing, and are better able to implement safety requirements. Their scale lets them demand better terms from suppliers and landlords. 

A small restaurant owner might go to their landlord and ask for lower rent. 

The national chain simply says, “We will pay this much” (which might be zero) and dares the property owner to sue.

The likely outcome, once we get to the other side, will be more consolidation, less innovation, and the continued presence of zombie companies that in other circumstances wouldn’t survive. 

I can’t tell you how sad this makes me. The dynamism and staggering variety of our small businesses is a prime reason the US has led the world. Millions of people implement millions of ideas every year. 

Most don’t work, but some do and they make our lives better. We will feel this loss for generations.

This is the opposite of Schumpeter’s creative destruction. Let’s call it noncreative protection. The whole concept behind Schumpeter’s thesis was that smaller companies, or new technologies, and so forth would come along and provide better services, thereby taking away the business of large companies and in some cases simply killing them. But the economy and consumers would win.

Now we are trying to save those large companies. Some deserve it, I’m sure. But which ones and how many? You may remember Global Crossing

In the 1990s investment mania, it spent billions of dollars on undersea data cables, connecting the world. 

The data didn’t materialize fast enough, and Global Crossing went bankrupt. 

The new owners used the now-cheap assets to sell lower-cost connectivity. 

Huge losses for those investors, for which we should all be grateful, helped fund the era of cheap international communications.

The same happened with railroads in the 1870s. There was a mania by states and local governments to fund railroads connecting their cities and states. Every one of them went bankrupt, with the exception of one privately funded company (another story for another day about government programs). 

The bankrupt railroads with new owners offered cheaper travel which opened up the West.

The point is, keeping companies from going bankrupt is not always best for consumers and the economy. 

Now we are in different times. This is a crisis of unbelievably different and epic proportions. 

But the current “mania” to save all large businesses because they represent jobs should not become a habit. Fighting Mother Nature—or creative destruction—is not a good practice.

I want to end with a suggestion. Especially if you are retired, think about small, independent businesses where you spend money. Maybe a favorite bar or restaurant, a retail store, barber shop, or anything else. The owner is probably having a rough time right now. 

Find a chance to speak privately and see if you can help. Maybe you have capital, expertise, or other resources the business owner can use. Just offer whatever help you can, on whatever terms make sense for you.

Small business owners have their hands full even in normal times. Right now, they need all the help they can get. 

And we will all win by helping them pull through.
Our local Puerto Rico government and my own homeowners association have been very cautious about COVID-19. But on a small island where people are typically clustered together in communities of all sizes, and the culture is to socialize a great deal, cautious is not a bad thing. Masks are the norm in business situations.

Which brings me to one of my great frustrations: the maddening politicization of this situation. I get that we can politely and aggressively debate taxes or regulations or any number of issues. But the practice on both left and right of cherry-picking data to score points on your political opposition about a virus that is affecting us all so deeply just seems beyond the pale to me.

A plague on all their houses, if I can use that pun without being too politically incorrect.

On a positive note, I am following credible research from highly respected scientists right now which has the potential to be a true game changer, dramatically shortening recovery time. Hopefully, I will be able to tell you more in about a month. I hope it’s good news. So far, it seems to be.

And with that, let me hit the send button and wish you a good week. Stay safe out there!

Your looking for that Hail Mary pass analyst,

John Mauldin
Co-Founder, Mauldin Economics

Drone Money

Doug Nolan

“In particular, to maintain downward pressure on longer-term interest rates, the Federal Open Market Committee (FOMC) likely will provide forward guidance about the economic conditions it would need to see before it considers raising its overnight target rate. And it likely will clarify its plans for further securities purchases (quantitative easing). It is possible, though not certain, that the FOMC will also implement yield-curve control by targeting medium-term interest rates.”

- Ben Bernanke and Janet Yellen, Testimony on COVID-19 and response to economic crisis, July 17, 2020.

With highly speculative securities markets having fully recovered COVID losses – and Nasdaq sporting a 17% y-t-d return – why the talk of more QE?

And with 10-year yields at 0.63% and financial conditions extraordinarily loose, what’s the purpose for discussing the pegging of Treasury bond prices (aka “yield curve control”)?

Aren’t the markets already conspicuously over-liquefied?

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.”

- Milton Friedman, “The Optimum Quantity of Money,” 1969.

It was Dr. Ben Bernanke that, in the wake of the “tech” Bubble collapse, elevated Friedman’s academic thought experiment to a revolutionary policy proposal.

And in this runaway real world experiment, “often repeated” supplanted Friedman’s “will never be repeated” – and it changed everything.

“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper‐money system, a determined government can always generate higher spending and hence positive inflation.”

- Ben Bernanke, “Deflation: Making Sure ‘It’ Doesn’t Happen Here,” 2002.

“To be clear, the probability of so-called helicopter money being used in the United States in the foreseeable future seems extremely low… Nevertheless, it’s important that markets and the public appreciate that, should worst-case recession or deflation scenarios occur, governments do have tools to respond.”

- Ben Bernanke, “What Tools Does the Fed Have Left? Part 3: Helicopter Money,” 2016.

“From what I have seen thus far, Dr. Bernanke is well on his way to creating a place for himself in economic history.”

- Doug Noland, “Death to the Bubble Poppers,” November 22, 2002.

I didn’t take Bernanke all that seriously when he arrived at the Fed back in 2002.

My thinking at the time: How could any central banker openly contemplating using the “government printing press” and “helicopter money” ever be taken seriously?

The raging policy debate in 2002 was how to counter so-called “deflationary forces.”

But there was as well the critical issue of the Federal Reserve having failed to safeguard financial stability.

The Greenspan Fed actively promoted (and backstopped) the financial markets - while ignoring resulting late-nineties Bubble excess.

It was obvious the Fed had really blown it.

That this academic, and recently appointed Fed governor, referred to the “bubble poppers” from the late-twenties and their role in fomenting the Great Depression made it difficult not to be disdainful.

I underestimated both the man and the world’s gullibility.

Bernanke 2002: “I think it is extraordinarily dangerous for the Fed to make itself the arbiter of security values. And I think, moreover, that if the Fed tries to, quote, ‘pop bubbles,’ it’s likely that it creates disasters.”

Over his long career, Dr. Bernanke has accumulated a remarkable body of work, replete with historical revisionism and dangerously flawed doctrine.

A few Bernanke sentences from 2002, in particular, changed the course of history.

Bernanke: “The first part of the prescription implies that the Fed should use monetary policy to target the economy, not the asset markets. As I will argue today, I think for the Fed to be an ‘arbiter of security speculation or values’ is neither desirable nor feasible… The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system.”

Clearly, the so-called macro-prudential regulatory framework was an abject failure throughout the mortgage finance Bubble period.

Moreover, the resulting catastrophe ensured a momentous transformation in policy doctrine.

The Fed turned to directly targeting asset market inflation.

And Bernanke’s decision to exploit financial market manipulation as the primary mechanism for (financial and economic) system reflation over time ensured the Fed would evolve into the unqualified “arbiter of security values.”

After excoriating the “Bubble poppers,” Bernanke’s Fed unleashed dynamics that would have the Federal Reserve and global central bankers desperately resuscitating Bubble excess some 18 years later.

Milton Friedman never contemplated “helicopter money” being used - not for spending on goods and services in the real economy – for, among other things, to fund Robinhood trading accounts ( helping raise the price level… of Tesla’s stock).

Friedman did a lot of thinking over many decades, yet I’m rather confident the thought of the Fed injecting $3 TN into the securities markets over a limited number of weeks never crossed his mind.

Ditto the Fed monetizing Trillions of fiscal deficit spending in a few months’ time.

Ben Bernanke has never grasped speculative dynamics and financial structure evolution.

He failed to appreciate the great danger associated with late-twenties speculative leveraging and the impact massive expansion of speculation-related liquidity had on financial and economic structure (especially late in the cycle!).

As we’ve been witnessing, central bankers either must develop a policy course to rein in excess – or they will invariably become hostage to it.

Future historians will look back at central banks using financial markets as their primary stimulus mechanism with contempt.

Cracks were more discernible this week.

New daily U.S. COVID cases surpassed 70,000, with no end in sight.

Many states – including economic heavyweights California, Florida and Texas – are being forced to clamp down. Trillions of additional fiscal stimulus will be forthcoming.

New infections surged over 1.6 million globally over the past week.

The U.S./China cold war chilled markedly.

Chinese stocks reversed sharply lower this week, as policymakers confront the dilemma of massive monetary stimulus reigniting a stock market mania.

In Europe, EU officials begin a contentious meeting with leadership hoping to muster a COVID stimulus giveaway within a backdrop of sharply lower infections and economic dislocation.

The Shanghai Composite sank 5% this week, with the CSI 300 down 4.4%.

An official signaled the People’s Bank of China is not inclined to add additional stimulus at the present.

Beijing must appreciate that resurgent stock and property Bubbles only add to already acute systemic risks.

With 600 million Chinese earning monthly incomes of less than $140, inequality in China is a festering issue.

A Bloomberg headline from earlier in the week: “A Spate of Bank Runs Breaks Out in China, Fueled by Social Media.” At this point, panic is limited to a few smaller banks, although the entire banking system now faces mounting loan quality issues. The above Bloomberg article includes the ominous sentence: “Confidence in the $43 trillion banking system is eroding among the nation’s more than 1 billion account holders, threatening a cornerstone of China’s rise into an economic powerhouse.”

Banking system vulnerability is a global issue.

July 14 – Wall Street Journal (Ben Eisen and David Benoit): “The largest U.S. banks signaled that the worst of the coronavirus recession is yet to come, opting to stow away tens of billions of dollars to prepare for an expected wave of loan losses… ‘This is not a normal recession,’ said James Dimon, JPMorgan’s chief executive. ‘The recessionary part of this you’re going to see down the road.’ For years after the last financial crisis, banks made big profits lending to consumers and companies eager to take advantage of low interest rates. Heading into the current collapse, Americans had taken on record amounts of auto loans, credit-card debt and student loans. Corporate debt also reached record levels.”

We’re early in the pandemic; early in the crisis; and early the global economic downturn.

I would heed Jamie Dimon’s warning.

Most loan portfolios will show major deterioration over time.

Yet the huge boost to reserves for future loan losses announced this week by the major banks was largely ignored by the markets.

No surprise, considering the marketplace has been disregarding the spike in COVID infections and the move by states and municipalities to slow or reverse reopening measures.

Equities are instead predisposed to rally on positive vaccine news.

“Risk on” got another boost Wednesday from Moderna’s release of “promising” details from its phase 1 vaccine trials.

All 45 of the healthy adults in the trial developed antibody responses.

That most vaccine recipients experienced side effects was irrelevant to the markets.

At this point, the company does not know if the immune response is adequate to provide COVID immunity – or antibody longevity.

July 17 – San Francisco Chronicle (Peter Fimrite): “Disturbing new revelations that permanent immunity to the coronavirus may not be possible have jeopardized vaccine development and reinforced a decision by scientists at UCSF and affiliated laboratories to focus exclusively on treatments. Several recent studies conducted around the world indicate that the human body does not retain the antibodies that build up during infections, meaning there may be no lasting immunity to COVID-19 after people recover. Strong antibodies are also crucial in the development of vaccines. So molecular biologists fear the only way left to control the disease may be to treat the symptoms after people are infected to prevent the most debilitating effects, including inflammation, blood clots and death. ‘I just don’t see a vaccine coming anytime soon,’ said Nevan Krogan, a molecular biologist and director of UCSF’s Quantitative Biosciences Institute, which works in partnership with 100 research laboratories. ‘People do have antibodies, but the antibodies are waning quickly.’ And if antibodies diminish, ‘then there is a good chance the immunity from a vaccine would wane too.’”

I profess no vaccine expertise.

Yet from my reading and listening, I’ll offer a few observations.

The general public will question the safety of rapidly developed vaccines.

Understandably, at this point trust is thin.

And for a disease that causes only mild symptoms for the majority of those infected, a large swath of the population (i.e. young people) will be willing to take their chances.

Vaccines with side effects will be a tough sell for many.

Moreover, the issue of antibody duration will be crucial – and there could well be little clarity on this issue for vaccines rushed to market early next year.

Markets are content to disregard the risk of vaccine ineffectiveness.

After all, COVID resurgence ensures further rounds a fiscal stimulus.

Thursday from Nancy Pelosi (via CNBC): “They know there’s going to be a bill. First it was going to be no bill. And then it was going to be some little bill. Now it’s $1.3 trillion. That’s not enough.”

The Federal deficit surged to a record $864 billion in June, crushing April’s $738 billion.

The deficit reached an unprecedented $2.74 TN through nine months – and $3.0 TN over 12 months.

The CBO had projected a fiscal year deficit of $3.7 TN – though additional stimulus bills could push the deficit to $5.0 TN – or approaching 25% of GDP.

People are hurting and deserve help.

My issue is we ran enormous deficits even as the economy was booming with the unemployment rate down to 60-year lows.

The Fed inflated historic market Bubbles, creating acute financial and economic fragility.

Reckless fiscal and monetary stimulus fueled a Bubble Economy replete with deep structural maladjustment.

Years and decades of flawed policies cultivated the current predicament: The real economy will require ongoing massive fiscal spending, while inflated assets Bubbles will demand ongoing massive monetary stimulus.

It’s a fuzzy black hole lately coming into clearer focus.

Markets – staring maniacally into the abyss – are plagued by visions of endless liquidity and ever higher securities prices.

Myriad major problems come with runaway “helicopter money” – although this is a misnomer.

Indeed, the whole notion of “helicopter money” is dangerously flawed.

The idle masses, eyes locked skyward, anxiously awaiting the next helicopter drop.

Little attention was paid at first to the swarm of Drones zooming by.

Suspicions were raised, however, when the choppers began arriving more infrequently and with less bountiful drops.

It was at this point when more attention was paid to the fleet of sophisticated drones covertly delivering their monetary cargo to “special interests,” the well-connected and powerful.

Anger and desperation grew both with “Drone Money” and the daily jumbo cargo flights to the market exchanges.


Why zero interest rates might lead to currency volatility

There is little scope for them to adjust to economic trouble. So something else must

A generation of English cricket fans know the Aussies are loth to surrender a lead. For much of the past two decades, Australia has been a high interest-rate economy. But not any more.

In March the Reserve Bank of Australia (RBA) cut its benchmark cash rate to 0.25%. That is the lowest interest rates have ever gone, and as low as they are likely to go. To signal its intentions that rates will stay put, the rba has pledged to fix three-year-bond yields at 0.25%.

The Australian case is telling. Near-zero interest rates are the norm in rich countries. Very low interest rates are common elsewhere, too. Indeed, among the more prosperous sort of emerging market, only Indonesia, Mexico, Russia and the inflation-prone Turkey have short-term interest rates above 4%.

Rock-bottom rates have gone global to a much greater extent than after the financial crisis of 2007-09. And a lot of central banks, like the RBA, are committing themselves to keeping rates low.

It is natural to think that if interest rates are glued to their effective lower bound, exchange rates will be similarly stuck. An axiom of foreign-exchange analysis is that shifts in policy rates, or in expectations of policy rates, drive currencies up and down.

Yet a zero-rate world might plausibly imply more currency volatility. There is little scope for interest rates to adjust to economic trouble. So something else must. The exchange rate is the likeliest candidate.

To understand why, start with the idea that trade and capital flows are mirror images. Say a country runs a current-account deficit worth $10bn each year. To fund this, it borrows $10bn from abroad. The higher its short-term interest rates compared with other countries, the more it attracts such funds.

But short-term borrowing is not the only way for a country to finance a current-account deficit. It could instead sell some of its assets—property or shares, say, or even whole businesses—to foreigners.

It is useful to think of the exchange rate as the shadow price of these assets. The currency finds a level that keeps the current and capital accounts in balance.

Now put our hypothetical country in a zero-interest-rate world. Assume its exports are split between raw materials and manufacturing goods. And imagine an economic shock that lowers the demand for commodities. Our country’s exchange rate would fall, helping boost demand for its manufactures.

Were interest rates positive, the central bank could cut them to fire up domestic spending and make up for the shortfall of raw-material exports. But at zero interest rates, this is not possible.

A consequence is that the exchange rate will need to do more of the work of ginning up an economy, notes Steve Englander of Standard Chartered, a bank.* A plausible outcome of widespread low rates, then, is currency volatility.

If the exchange rate is the only game in town, the more closed your economy is, the more it has to fall. In a more open economy, the currency would fall less.

What else might attenuate currency volatility? Fiscal policy might seem an obvious influence. The more a government spends in response to a shock, the less stimulus is needed by other means, including by currency depreciation. Rich countries have more fiscal space than they ever imagined, says Kit Juckes of Société Générale, a bank.

But they must employ it in a way that is useful. Getting the timing and effectiveness of fiscal stimulus right is tricky. An ill-judged or ill-disciplined fiscal stimulus would be a poor substitute for an interest-rate cut. Fiscal policy might then add to currency volatility, not detract from it.

Which brings us back to capital flows. A key influence on currency volatility is the attractiveness, or otherwise, of a country’s asset markets. The broader the range of assets on offer and the easier they are to buy or sell, the less the currency needs to fall to entice foreign buyers.

Conversely, the tighter a country’s restrictions on cross-border asset sales, the more volatile its currency is likely to be. Put simply, if you lack the sort of assets—and growth story—that foreigners can buy into, your currency is at more risk in a zero-rate world.

The lesson is that fixing policy rates does not mean that capital and trade flows are set in stone, too. If central-bank rates cannot adjust to changing economic circumstances, then something else must.

So do not be surprised if the new era of globalised zero-interest-rate policy leads to currency instability.

*“If policy rates are zero, what drives fx?” June 17th, 2020.

China’s Deepening Geopolitical Hole

The UK's decision to ban Huawei from its 5G networks is only the latest diplomatic setback for China. So, as China’s leaders ponder how to respond, they should heed the first rule of holes: when you are in one, stop digging.


pei66_TOLGA AKMENAFP via Getty Images_UKhuawei

CLAREMONT, CALIFORNIA – The United Kingdom’s decision to ban Huawei from its 5G networks has dealt a painful blow to China. Until recently, China was still counting on the UK to stick to its earlier decision to allow the Chinese telecom giant to supply non-core equipment for the country’s 5G networks.

The lack of a coordinated national response to the COVID-19 pandemic in the United States has predictably resulted in an unmitigated economic and public-health disaster. The problem is and always has been that those in a position to do something about such crises do not speak for most Americans.

But two recent developments made such a decision untenable. The first was the United States’ escalation of its war on Huawei. The US instituted a new sanction in May banning suppliers that use American technology from providing semiconductors to Huawei. Because US technology is used to manufacture the advanced semiconductors that Huawei’s products, including 5G base stations, require, the company’s supply will be cut off, making production of its 5G equipment in the future nearly impossible.

The prospect that a key supplier of the UK’s 5G networks would no longer be able to build and maintain its system is a far more serious threat than potential Chinese snooping is. No responsible government can afford to take such a risk. So, Huawei’s days were numbered as soon as the US government pulled the trigger in May. The only question was when Prime Minister Boris Johnson would tell President Xi Jinping the bad news.

The second development, which made it politically easier for Johnson to embrace the Huawei ban, is China’s imposition of its new national security law on Hong Kong. This draconian legislation, which was proposed in late May and passed by China’s rubber-stamp parliament on June 30, has for all practical purposes ended the autonomous status of the former British colony. From the UK’s perspective, China’s action is a blatant violation of the 1984 Sino-British Joint Declaration on Hong Kong, which includes China’s pledge to respect and protect the city’s legal system and civil liberties for 50 years after its reversion to Chinese rule in 1997.

Chinese leaders might think that the UK is too weak to fight back. Clearly, they are wrong. The UK has decided to take a stand on Hong Kong, and Huawei is an easy and obvious target.

China may be tempted to strike back, and would seem to have plenty of leverage. It can squeeze UK firms doing business in China. For example, the British banking giant HSBC is especially vulnerable to bullying, because its operations in Hong Kong account for slightly more than half of its profits and a third of its revenue. China may also want to cut down financial transactions it conducts through London and reduce the number of Chinese students it sends to UK colleges and universities.

But such retaliatory measures, however tempting, would ultimately boomerang. Driving HSBC from Hong Kong would surely ruin the city as a global financial center, because China would be unable to find another global bank to take over its vital role. Given the spiraling tensions between the US and China, it is hard to imagine that China would favor Citi or JPMorgan Chase as a successor to HSBC.

Similarly, restrictions on studying in the UK would hurt China more. Currently, about 120,000 Chinese study in the UK. The challenge for China is that there are few good alternatives if it wants to send students elsewhere. The US is considering restricting Chinese students on national-security grounds. China has threatened Australia that it will reduce the number of Chinese tourists and students.

Canadian universities, which now host about 140,000 Chinese students, have limited capacity.

With China and Canada embroiled in a diplomatic standoff over the extradition to the US of Huawei’s chief financial officer, Meng Wanzhou, it is unlikely that China will send more students there.

This merely illustrates the daunting reality Xi now faces: China is fast losing friends just when it needs them most. In the last few months alone, China’s relations with India have suffered a devastating blow after a bloody border clash left at least 20 Indian soldiers (and an unspecified number of Chinese soldiers) dead.

To punish Australia for daring to call for an international investigation into the origins of the COVID-19 coronavirus, China imposed tariffs on Australian barley and threatened other punitive measures. On July 14, China’s foreign ministry denounced Japan’s recent Defense White Paper in unusually harsh language, raising doubts about the rapprochement Xi has been trying to engineer with Prime Minister Shinzo Abe.

Chinese leaders have only themselves to blame for their growing international isolation. With an inflated sense of their power, they have overplayed a weak hand and driven friendly or neutral countries such as the UK, Canada, India, and Australia into the arms of the US, now China’s principal geopolitical adversary.

So, as China’s leaders ponder how to respond to the UK’s ban on Huawei, they should heed the first rule of holes: when you are in one, stop digging.

Minxin Pei is Professor of Government at Claremont McKenna College and a non-resident senior fellow at the German Marshall Fund of the United States.

Corona Mutations

The Changing Virus

Scientists are suspiciously tracking every change in SARS-CoV-2, with dangerous looking mutations regularly appearing. On the long term, though, experts hope that the pathogen could prove less aggressive.

By Philip Bethge

The best analyzed pathogen of all time: A 3D model of the surface proteins (spikes) on the SARS-CoV-2.

Open eyes, hollow cheeks, a face torn by dread - Edvard Munch’s painting, "The Scream,” is an icon of horror.

Some experts believe its central figure is meant to be in the grips of an illness. The first version of the painting dates back to 1893, when the Russian flu had just spread around the world. The pandemic began in Central Asia in May of 1889. It spread to China, Russia and Europe via trade routes.

The epidemic reached New York in December, arrived in Montreal in January of 1890, then made its way to South America, Australia, Borneo. Its symptoms included severe fever, headache, aching limbs and fatigue. An estimated 1 million people died worldwide.

The epidemic is widely believed to have been caused by a flu virus, but researchers working with Marc Van Ranst of the University of Leuven in Belgium have a different theory. They believe the pandemic was caused by a pathogen with the abbreviated name of HCoV-OC43. HCoV-OC43 is a coronavirus.

Genetic studies suggest that the pathogen jumped from cattle to people before – much like today’s SARS-CoV-2 – setting off a health crisis. Interestingly, HCoV-OC43 is still around today, as one of seven coronaviruses that can infect humans. But the killer has been tamed: These days, the virus causes only a mild cold.
For half a year now, the new coronavirus has held the world hostage. Officially, more than 8 million people are or have been infected, and the virus has already claimed over 500,000 victims. Virologists, epidemiologists and hygienists are doing their best to get the situation under control. But they are also learning that SARS-CoV-2 is an unpredictable opponent.

The crisis’ outcome will depend not just on whether drugs or vaccines can be developed, but also on how SARS-CoV-2 will change biologically in the coming months and years.

Initial indications suggest that the virus could continue adapting to humans, which would be good news. Over time, viruses tend to get along better with their host, because a relatively peaceful relationship works to the pathogen’s advantage.

A virus that kills fewer people has a better chance of spreading. But things can also unfold differently.

"In principle, evolution is not predictable,” says Christian Drosten, a virologist at Charité hospital in Berlin. "I am cautiously optimistic that the danger from SARS-CoV-2 will decrease, but we can’t be sure.”

It’s Here to Stay

François Balloux, a microbiologist at University College in London, is also researching the properties and genetics of the new coronavirus. "It will take a few years, at worst a decade,” he says, "then the virus will probably seem as severe to us as the seasonal flu.”

He argues that all that can be said with certainty is that "the virus will be with us. We won't get rid of SARS-CoV-2 anymore."

The novel coronavirus has only been around for a short time, yet it is already one of the best analyzed pathogens of all time. Researchers have decoded over 50,000 genomic sequences and uploaded them to a global databank called GISAID (Global Initiative on Sharing All Influenza Data).

With the help of this gene sequence, experts are investigating which points on the pathogen could be vulnerable to drugs or vaccines. They are also examining how SARS-CoV-2 is changing and how the virus spreads.

Since 2015, physicist Richard Neher from the Biozentrum at the University of Basel and U.S. biologist Trevor Bedford have been trying to better understand the course of epidemics. The experts have been tracking influenza, Zika and Ebola viruses for years with their online application called Nextstrain ( Since January 2020, the data researchers have also been looking into SARS-CoV-2. 

The software on Neher’s computer turns chaotic, real-time data into a colorful pathogen family tree. The first SARS-CoV-2 genomes date back to December 2019 and to the central Chinese metropolis of Wuhan - the city where SARS-CoV-2 first appeared.

From there, the family tree forks into hundreds of branches, each marking one or more mutations in the pathogen’s genome.

"Most of them are insignificant, so they have no effect on the contagiousness or aggressiveness of the virus,” Neher explains. "But the mutations do give us clues about how the virus spreads.”

Thanks to their tree, Neher and his colleagues can see, for example, that SARS-CoV-2 was introduced from Asia to Europe in January and February by various paths. In Germany, the sequences of early cases in the western German state of North Rhine-Westphalia resemble samples from the Netherlands, Austria and Belgium, but differ from those in other German cases.

On average, the experts record two mutations per month on each branch of the virus family tree. Most of them are so-called silent mutations that have no effect on the properties of the virus. Some, however, stand out. And that’s where things get interesting for the researchers.

Spike Issues

Neher moves his mouse over a branch close to the root of the virus family tree. An information box appears on the screen reading "D614G," the abbreviation for a mutation event that is currently being intensively discussed among experts.

D614G describes a change in the S-proteins, or spikes, of the virus – the club-shaped appendages that allows the SARS-CoV-2 virus to dock with human cells. A team of researchers led by Bette Korber at the Los Alamos National Laboratory say that the mutation appeared in early February and has since spread in "alarming" fashion.

The scientists suspect the mutation gives the virus has an evolutionary "fitness” advantage relative to the original virus-type from Wuhan. Researchers at the Scripps Research Institute in Florida have confirmed this assessment. In viruses with the D614G mutation, the number of spikes is "four to five times greater” than in other variants – an ideal prerequisite for faster replication.

Does that mean SARS-CoV-2 will become even more infectious than it already is? There are still uncertainties. The success of certain variants of a virus doesn’t necessarily have anything to do with their genetic makeup. Other factors play a role that can be just as important – such as, in the case of SARS-CoV-2, lockdown measures, international air routes or simply chance.

Researchers therefore warn against prematurely drawing a line from small genetic mutations to changes in the virus’ infectiousness or the course of the illness.

Researchers from Hangzhou in China made headlines after reporting that some variants of SARS-CoV-2 reproduced 270 times better in the laboratory than others. Drosten, however, is skeptical: "In its current condition, the study says nothing," he says, arguing that the publication has technical defects.

Not Enough Time to Change

Much discussion has likewise focused on research into the origin of the virus by a team under the leadership of Michael Forster from the University of Kiel in Germany. The geneticist identified three different types of the SAR-CoV-2 virus. The differences between the types could be the result of a "complex founder scenario", the researchers noted.

Another explanation could be that the dominant type in Wuhan "immunologically or environmentally adapted to a large section of the East Asian population." Other researchers have criticized the methods used in the study and, in the same journal, criticized "several serious flaws." Forster rejects the criticism, saying that the publication is a consensus in science.

The reason for the skepticism is simple: SARS-CoV-2 hasn’t had enough time to change much. Although coronaviruses mutate constantly, they have their own repair mechanism that allows them to eradicate harmful mutations.

Only about 15 mutations separate the genome of any of the currently circulating SARS-CoV-2 viruses from the original Wuhan virus, therefore making all SARS-CoV-2 viruses largely identical. There are no different types.

And there is an additional factor holding back the virus from rapidly evolving new characteristics: So far, SARS-CoV-2 has been subject to very little selection pressure. Things are going pretty well for the virus. The pathogen can expect little resistance because very few people have developed antibodies. "With immunity within the population still low, the virus can find many easy targets,” says Michael Lässig, an evolutionary biologist from the University of Cologne.

His research group is trying to predict the evolution of viruses using mathematical models. "The mutation rate of SARS-CoV-2 is five to six times lower than that of the flu virus,” says Lässig. It is a finding that offers a glimmer of hope, because in competition with human antibodies, this level of mutability is likely not sufficient. "At some point, the majority of people will have developed immunity against the virus,” says Lässig. "If the pathogen cannot significantly develop by that point, it will disappear again or at least be severely curtailed.”

Targeting Mutations

Balloux and his team at University College London have classified the mutations that have been discovered thus far. They identified around 200 mutations in the virus’ gene pool that occurred several times independently of one another - an indication that they might offer an evolutionary advantage. They include instructions for making four important viral proteins – including one that is part of the spikes.

But Balloux says that it is still unclear how and if these mutations affect the behavior of the virus. Many of the mini imperfections, he says, are likely due to attacks from the human immune system as it tries to stop the virus from multiplying.

Using the mutation rate, the experts have at least been able to determine that the pandemic probably started between October 6 and December 11, 2019. This refutes speculation that the pandemic started last summer and was kept secret by the Chinese government.

More than anything, though, a better understanding of how the pathogen changes can be helpful in developing drugs to treat the disease it causes. "We need medications and vaccines that can’t easily be circumvented by the virus,” says Balloux. "We should therefore concentrate our efforts on the parts of the virus genome that show the least number of mutations.”

Ultimately, the only way to speculate about the future of SARS-CoV-2 at this point is to look at the behavior of other viruses. Drosten’s working group, for instance, published a paper two years ago on the first SARS virus, which claimed almost 800 victims globally between 2002 and 2003, according to the WHO.

It could potentially have been a lot worse. Researchers discovered that the first SARS coronavirus lost a small part of its genome during the epidemic, which served to weaken it. When Drosten’s team experimentally re-inserted the lost components into the genome, the virus was better able to reproduce.

"Virulence can also be lost during the process of adapting to humans,” says Drosten. What’s fascinating is that SARS-CoV-2 has also occasionally lost a piece of the same section of its genome – at least, in a subpopulation. In virus sequences isolated by researchers in Singapore, 382 genome building blocks were missing.

Is that why the COVID-19 outbreak in the country was relatively mild? It is no longer possible to answer that question with any degree of certainty. The apparently less-harmful version of SARS-CoV-2 has since disappeared again.