There are cycles in economies. There are debt cycles, actual economic development, and liquidity and credit that encourage purchasing capacity to boost investment and changes in the values of financial assets.
In 1944-45, we began a new monetary cycle in which the US was established as the most dominant economic, military, and technological power in the world. As such, the US dollar has been the world’s primary reserve currency since the end of the Second World War. We have begun the debt process from that point on. Central banks are creating money and loans. The Federal Reserve is developing the US dollar. It regulates how much of it is written and determines how much liquidity the economy creates through the different triggers it can pull (e.g., changing short-term interest rates, buying and selling financial assets).
Creating money and credit is becoming increasingly difficult to do as interest rates get closer to zero. Technically, negative interest rates and negative longer-term interest rates (i.e., negative bond rates) can be achieved.
But the interest rate and bond markets will only go too far into negative territory. There is a constraint on how far you can drive interest rates to attract money into riskier investments (i.e., purchasing investments that can fund spending). And driving rates to negative territory is not necessarily the solution to get lenders and borrowers eager to do business with each other. Negative rates make cash a little less attractive, but not so much.
Savers will continue to invest and require liquid means of financial security, and lenders and creditors should be careful with each other if the economy slows down. However, the effect of negative rates does not have the same form of boosting effect on economic activity as it would have if the rates went down by the same amount while the rates were positive.
When interest rates have reached zero – or an appropriate lower bound – as they did in the early 1930s, 2008, and 2020, central banks must switch to a secondary form of monetary policy to buy financial assets to reduce longer-term interest rates as well as short-term interest rates.
If asset purchasing is out of space as the spreads are still close to zero, central banks need to move to a new monetary policy mode based on fiscal policy coordination. There are several ways to do this that run on a spectrum – from who gets the money and the compensation (public sector, private sector, or both) and how directly or indirectly it is provided.
The 2020 downturn was due to a public health pandemic. But that was just a trigger, though. It could have been anything. Whether it was due to a virus or any other reason, it occurred when the central bank had limited capacity to stimulate the economy.
Each individual, each company, and each country has a certain amount of income and expenditure. A balance sheet with a certain amount of debt and a certain amount of savings, either liquid (cash and cash-like securities) or less liquid, such as physical possessions. (Most money is illiquid.)
If revenue sinks to a level below spending, they exacerbate their balance sheet by dipping into their investments or taking on additional debt.
There has been a decline in income, and many individuals, corporations, and countries do not have sufficient savings to cover that.
Even if the virus never returns, there is still a large amount of financial damage that will last for a long time, with a sustained decline in income and a worse-off balance sheet.
The world’s central bank, the Federal Reserve, because it’s in a privileged position to have the world’s top reserve currency, has created a lot of money and helped stimulate credit creation, and that’s going to be a big deal for Americans and American companies. And this method performs imperfectly because it needed to act rapidly.
This means unprecedented amounts of government debt creation (borrowed money) to fill gaps in lost income and damaged savings and overall balance sheets.
It’s the same as in March 1933, when President Franklin Roosevelt took the US off the gold standard to easily generate liquidity to help fill financial holes in the economy.
Similarly to today’s situation, the wealth gaps were high, which meant that the political gaps were wider than normal. There was political infighting over how to divide the wealth pie.
And we’ve gone through the loop as time passes, having to do with success and coping with tough times.
There are gaps in income and balance sheets in each country. Sixty to seventy percent of overseas financial transfers and asset investments are in US dollars. So the US does not have a monopoly on the international financial system, but it is very influential.
Although it is a bit bigger than the US Federal Reserve, Europe has a central bank, as do England and Japan (and Switzerland, Canada, and the developed countries of Oceania), which are smaller than the ECB.
China is the second-largest economy in the world. But the yuan (also known as the renminbi) is not much of a reserve currency, considering that it has a very little portion of its currency participating in the way capital is deposited internationally. But the People’s Bank of China (PBOC) should take care of China’s domestic problems.
Basically, a lot of items tend to be paid abroad in dollars. The Fed’s output of dollars is doing to assist with the economy is mostly going to the Americans.
Many with financial shortages outside the US (78% of all global economic activity happens outside the US), mostly in dollars, may not be able to support them.
Around $60 trillion in debt is owed by non-Americans or around $3 billion in US GDP. They need dollars, although it’s hard for them to get dollars to pay off. Worse still, those who receive their income in domestic currency still have many of their dollar obligations, particularly if their domestic currency is down compared to the dollar (as most did during the coronavirus crash). In these situations, it’s like seeing a rise in interest rates, and the debt burdens get higher.
Europe will have to go through its own cycle of developing the euro, and Japan and China will have to create domestic currencies with their own central banks. They do have savings in the form of reserves to help support this cycle.
But most of the rest of the world has no reserve currency, has difficulty borrowing material amounts of money, and will have to look effectively at its own balance sheet. In certain countries, based on their total savings rate, they will have to rely on them if they have savings. And some of them are going to run out of such savings.
This also refers to wealthy countries, such as oil and gas exporters, some of which have higher or at least equivalent capital incomes to the US (e.g., Qatar, Norway, Kuwait, Brunei, UAE).
Their sales, owing to a demand-related crash, are much smaller than their expenses. And, after that, they’ve got savings (in some cases, significant savings), and they’re going to have to cut that down. A lot of the world will need a backstop to assist them in navigating this crisis.
The IMF is the largest regional “last resort source” for monetary assistance. The IMF has about $1 trillion in reserves. There is also a controversy on how much money will be spent supporting the big economies (i.e., the G-20 economies) and how much to benefit anyone else. And the amount of aid is likely to be inadequate.
These countries require funding from their own central banks. Some have fixed currency systems that limit what they can do. However, they will still change these fixed exchange-rate systems if necessary, and unavoidably, the economic conditions compel them to do so.
The challenge is that in emerging markets, their currencies are not generally recognized or desired globally by central banks, sovereign wealth funds, or private investors as a store of equity or as means of investment that will contribute to higher potential buying power expectations. And they are not commonly recognized or desired globally as a form of international exchange and payment invoice.
Therefore, as they print certain currencies, they drop their value because there’s no demand for them. It’s going to be really difficult for those nations, particularly those who owe a lot of money to the rest of the world (i.e., the debtor nations).
Should we expect inflation?
There are two types of inflation here. There is inflation of goods and services, which means that the demand for something in an economy goes beyond production, and its price starts to rise. Labor inflation is the type of inflation that central banks try to corral at the end of normal economic cycles, boost interest rates, and push down production before inflation is under control. Then the central bank will ease interest rates, and the process will continue again.
But this is not the kind of inflation that has applied to the economic cycles of the US or other developing economies since the financial crisis.
Instead, we had monetary inflation, or rises in the value of financial assets, even though the pick-up in goods and services produced was small. The two (the real economy and the financial market) are compatible. As the prices of financial assets increase, they feed the real economy with stronger creditworthiness among households and companies and lower borrowing costs.
But there was a dispersion. Financial capital has risen even more than the production of goods and services. It also fuelled the wealth disparity between those who possess financial assets (those who are wealthier) and those who do not possess financial assets (those who have little money). It bled into political movements and a stronger polarity between the left and the right.
Moreover, it’s easy to make financial wealth because printing money is easier than creating goods and services.
The inflation rate (real economy inflation vs. inflation of financial assets) will depend on where you are in the world.
In the US, Europe, and Japan (largely the developing world), all this wealth production literally fills the revenue and balance sheet holes. This is not a process that causes inflation. It simply negates deflation by providing a monetary offset.
But when it comes to other countries without reserve currencies, they’re going to have a tougher time.
They will have their own money created by their central banks, but there will be low demand.
Has the US stimulated enough through monetary and fiscal policy to launch (or at least set the stage for) the crisis recovery?
The all-around losses in the States are around $5 trillion in personal and business damages. Economic damages are up to $25 trillion on a global scale.
And it’s not just about generating this sum of capital to offset the expenses on a nominal basis. It’s got to go to the right people and in the right proportions.
At the time, seeing what’s been done, this is a little lacking in the US. Globally, it is dramatically short-lived, particularly as the global “printing” power is much more constrained due to the lack of demand for their currency. Federal Reserve programs are structured mainly to benefit Americans.
Increasingly over time, the world is becoming more intertwined financially, so these problems of income and balance sheet matter even if they are not domestic. And this would be true even if the virus did not play a role in the future, even though it is likely to do so. (But that’s a whole different subject.)
And there are also aspects of how targeted it is and how quickly it gets there (e.g., businesses need to pay by a certain date). And in that regard – having it go where it needs to go and pace – it wasn’t flawless.
The income disparities that cause political disparities
Nearly every time there is an expansion, there is a parallel widening of the wealth divide. When growth comes to an end, and there’s a slowdown, there’s an allocation of resources. These gaps tend to be highest when the power to lower interest rates is out of place. Central banks can then buy financial assets to support those that have them in an unequal manner to those that do not.
That feeds on left populism and right populism, and there is a higher degree of social conflict. There is a lot of controversy about how to split the economic pie. This was true in 1930-40 (after a debt crisis in which interest rates reached zero) and is true today following a similar form of recession in 2008 and again in 2020.
As it is necessary to have a hand on the levers of control. Since the spread of policy results is broader during these periods, this continues to result in high price uncertainty due to investor premiums throughout such spreads. Elections will affect asset prices.
And both 2008 and 2020 were big electoral years, with US presidential elections. Before the coronavirus, the result of the 2020 presidential election was a top priority for investors.
The virus-related recovery took place at the end of February but is still an important determinant of the market discounting process (e.g., discounting results based on poll numbers).
So, there’s going to be a discussion over how to distribute capital through government systems and tax policies.
Usually, during the downturn, more moves to the left on the political spectrum, and more calls are being made to place higher taxes on those with the highest incomes and wealth.
The struggle itself will contribute to more changes away from the corporate system, which has contributed to the success of politicians such as Bernie Sanders, Elizabeth Warren, and Jeremy Corbyn, whose strategies and general campaigns threaten certain aspects of the profit-making structure that control much of the framework of how markets are managed and ultimately operate.
Investments coming out of the Coronavirus?
When it comes to where to put your money leaving the coronavirus pandemic, the first step is to get back to who has the income and balance sheets available to invest. This was damaged during the downturn.
So, looking at where to invest, a lot will depend on who gets the government’s monetary and credit support and its various programs.
Take, for example, the case of airlines and cruise ship operators. How they move forward will depend not only on how quickly the economy returns and the sustainability of the process but also on whether they get the monetary resources to cope with the downturn.
Many individuals have demands on goods and services by financial assets – i.e., how the financial system applies to the actual economy. These financial assets are only worth what they are supposed to be worth if cash flows are available.
As a result of this crisis, savings rates will rise between individuals and companies. It is natural for all entities to want greater safety after this period. In the long-standing bull market, it is easy to get used to and extrapolate current conditions forward and take greater risks. The bad times of the past have vanished from memory, and the threats are overlooked.
We’re all moving away from an environment where the most productive producers get the job, and then higher-cost countries would purchase those products. As a result, businesses benefited from higher margins and profits, and consumers benefited from cheaper products that were imported. Those in the US and other developed market countries enjoy all kinds of products made in emerging markets where labor is cheaper and far more efficient on an hourly basis than more costly domestic workers.
This is changing now. Instead of a more effective, integrated world with a degree of specialization, some countries would be moving back and doing more of their own production. There is a trade-off between efficiency and self-sufficiency.
Self-sufficiency has to do with not depending on other areas of the world to do things for you, particularly when there is a degree of tension. It is a new strategic environment and an increasing desire not to be vulnerable or a greater awareness of the weakness that appears when you are interdependent.
When the US buys items from China, there’s going to be more of an urge to internally produce certain stuff. This will make certain items produced less effective in terms of output per hour, leading to higher costs on other goods, but there would be a larger desire to do so, assuming that the trade-off is worth it.
China will continue to expand its power along commercial, military, and technical lines. This is going to shape a more volatile or multipolar culture. This might lead to an increasingly pronounced bifurcation in the global economy. For example, both economies could have different supply chains and be in virtual competition to create future technology separately (especially those in 5G, AI chips, information and data processing, and quantum computing).
Rather than be settled soon by trade traces and bilateral trade negotiations, and what is not these numerous economic and geopolitical tensions (e.g., over Taiwan’s reconciliation with mainland China, global spheres of influence) will be with us for decades to come.
Final Thoughts on the impact of Coronavirus
This phase of coronavirus reconstruction will continue for the next 2-5 years. It’s a long time, but it’s going to be like a blip in the radar over the scope of history. The human capacity to adapt and innovate and to come out of something more and more evolved than they were before is immense.
Such times, such as 1929-1933, 2008-09, and the present case, are difficult but comparatively brief reconstruction cycles.
What does the future feel like? It is primarily a topic of data and digital tech.
In previous centuries, the economy was agriculturally-focused, and wealth mainly meant land ownership.
Then it shifted more towards manufacturing and producing goods that could be sold all over the globe. First, it sold domestically, then globally via trade routes, which started strongly with the Dutch empire and then the British empire. And that revenue was what the money was.
A strong army is needed to protect these trade routes and overseas territories and interests. Powers ultimately overextend themselves, become heavily indebted, and conquer new empires, which then have the same problems. This dominant power conveys benefits, such as having the world’s highest reserve currency from which the profit benefit is extracted (can borrow more cheaply).
But the reserve currency status does not last, although it typically lasts for several generations (75-150 years).
Since the late 1800s, developed economies have gradually changed from manufacturing to services. Agriculture has become an even smaller part of the economy (e.g., more decentralized with fewer players) as manufacturing has become an increasingly old industry. Many of these jobs have been taken over by other developing economies.
And now we are moving more and more into digital technology. Digital interaction, instead of in-person interaction, has been a prevalent trend in the cycle of social distancing, even more so than before. That’s going to keep on happening. Technologies that increase productivity and efficiency in this respect, and all of their implementations, will be well-regarded, and consumers and builders will be a part of it.
Some industries are experiencing major structural changes. Many of these changes will end up being inevitable and forever. Demand for e-commerce, electronic banking and telebanking, and telemedicine is emerging during the crisis. This is especially true of the under-40s concerning the former two and the rural population.
Zoom’s PR has gone through the roof as teleconferencing picks up, both for remote work and lessons as schools are closed down. Below is the Google Trends for Zoom for the past year.
Online education is going to see a further boost. Telemedicine has already become a widespread tech phenomenon, but its growth is accelerating more, particularly for the elderly, as there is now more opportunity to use this technology.
Jobs from home may get higher in demand. Many businesses are or have been resistant to remote work schemes, believing that people would “mail it in,” and their productivity would be unacceptably poor. Some businesses will find that profitability has been steady by the required measures to be placed to get research completed through the coronavirus crisis. This is expected to contribute to a more favorable understanding of remote job policies. This, in effect, could also reduce commuter traffic, especially in notoriously overcrowded cities.
Could less time commute increase economic productivity? Will demand for things like, for example, petrol and auto parts decline? These are the types of microeconomic questions that investors will need to answer as trends emerge from this crisis.
There will be a difference in the supply and demand of expertise, and some will be affected by this shift. Many jobs will be lost, but new opportunities and technology will be created to accelerate society’s transformation and, in exchange, create more jobs than they have lost on the net.
To use the old example, in 1812, crowds of manual laborers demolished and destroyed a textile mill near Nottingham, England, as a way of protesting its use of mechanized looms. They were scared that these new instruments would put them out of business. Inspired by Ned Ludd, an earlier opponent of technology (even though it is unclear how much of that story is historically accurate), these demonstrators were known as Luddites, who remain associated with people who oppose industrialization technological progress. However, in the decades that followed, England produced more jobs than any other country ever had, given that its industries were more mechanized.
We’ve got enough money, ingenuity, and inventiveness to get through the coronavirus slowdown. It’s a matter of whether the issues will be dealt with effectively in a cooperative manner or are going to be dealt with poorly, with infighting between the two sides that are more divisive than ever.