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06 May 2020

When Rubber meets Road



This article was written by Richard Horswill. All views and opinions offered are strictly his own. 


In a previous article, I wrote about a possible dollar melt up with the dollar continuing to strengthen regardless of massive monetary creation in order to maintain solvency in an already debt bloated global financial system. (All as a consequence of the "everything bubble" being popped by the pandemic.) The slow motion economic crash that has persisted for the last decade has just been taken to warp speed as viral terrorism takes hold.

This article attempts to provide a possible outline of the potential consequences of the actions of governments and central banks for the financial health of society and the common man if they continue on their current trajectory. It also considers possible honest remedies and how humanitarian actions may be able to soften ideology and force a change of direction. This current situation affects all countries, however, based on the dollar system we use globally, I am primarily outlining current US measures being used to attempt to stem the tide.

Because of ongoing lockdowns, the global economy is diving into a deflationary abyss. Of course, the trillions of dollars in financial packages put forward by the Federal Reserve are designed to slow the monetary economic deflation; these include tried and tested monetary QE measures, but due to the double whammy of simultaneous demand and supply shock, fiscal measures have also been introduced by the government. Free cash going directly into the pockets of the common man in the US in a form of universal basic income. Depending on how long the economy takes to heal, this policy could be open ended, and based upon scientific expectations, the need for ongoing public health measures will not provide for an economic revival any time soon. Potential unintended consequences of central bank activism may provide the circumstances for inflation in certain areas, such as consumer goods. However, the over-riding force at play remains deflation.

Deflation is seen by central banks as the worst of all possible outcomes and therefore they will fight it tooth and nail. (It increases the value of debt in real terms, placing their balance sheets in difficulty, but it also bankrupts society as leverage cannot find enough cash to repay outstanding debt due to money supply contraction.) 

This of course does not mean that deflation is not a justifiable policy as purging the system of uneconomic practices could be seen as a positive motive to allow it to happen. The last bailout mechanism for the Great Financial Crash in 2007/8 assisted many uneconomic businesses to survive, inherently adding a deflationary factor to the economy and thus not allowing growth to return to normal levels (below the previous trend of around 3%+ annualised growth). The term zombie economy was coined. This outcome never allowed the generalised global economy to reach the so called nirvana of “escape velocity”. Thus, if the Central Bank medicine provided for the last crisis did not work, maybe we should take the financial medicine of mother nature and allow the honesty of deflation and bankruptcy to prevail.

The course currently set out is seemingly one of dishonesty, providing for mass bailout (socialisation of the burden of debt) and potential bail-in (theft of savings). The current bailout negotiations taking place with big business, particularly when it comes to billionaire entrepreneurs, should not be happening unless equity stakes are on the table by way of recourse to the taxpayer. Bail-in legislation provides for the appropriation of cash in banks over insured levels in the amount in the US of $250,000 (£85,000 in the U.K).

I recall a comment from a well known UK Chancellor of the Exchequer some years ago claiming to have tamed the cycle of boom and bust. We now know he was advising us about the use of dishonest policies or financial chicanery to kick the can down the road. Have our financial leaders become so arrogant as to ignore the natural mechanics of free market capitalism and creative destruction? As a consequence of this arrogance, capitalism is on life support. It looks like we’re heading towards a leveraged buy out of the entire global economy potentially costing $100 trillion from the "magic money tree”. This of course is a guess, as who really knows the full extent of dubious debt in the system, let alone the secondary leverage provided through the derivative markets.

So, how does this all play out in the coming months and years for government, society and the common man? Much depends upon the dogmatism of the financial authorities. An opinion, for what it's worth, is that the bailout/bail-in will not work in the long run, as we are too far down the deflationary rabbit hole. It only temporarily delays the day of reckoning, but certainly not for the decade that the can was kicked in the last crisis. If losses of confidence in governments and global banking systems (and European banks are already verging on insolvency) both converge, the possibility of hyperinflation could ensue as confidence is thus lost in government currency. This would likely come as the hypothetical printing press would be kicking into overdrive - think Zimbabwe - in a last gasp attempt to stop the deflation. The psychological moment when the populace realises that the gig is up and the currency is becoming worthless is the point when monetary velocity goes parabolic. This would be the extreme end of any scenario and one really not worth wanting to attempt to consider for obvious reasons. I actually think this is highly unlikely as solutions will be found ahead of this type of crisis, potentially in the form of a reintroduction of a quasi gold standard by the revaluation of gold, thus devaluing the dollar, and creating enough inflation to reduce the burden of debt whilst simultaneously providing a financial anchor for dollar system: a step back into pre 1971 monetary methods.

In the short to medium term, potential stresses on people's cash flow will come from several sources. First, due to the uncertainty of the employment picture going forward, particularly in the hospitality and travel sectors, many people will remain on some form of government benefit which will be likely to be less than previous earnings. This squeeze on income will likely be exacerbated by increases in consumer price inflation driven by supply chain disruption. Whilst forced cost of living increases inflict damage to household budgets, deflation will likely occur on higher ticket items like cars. The housing market, being highly leveraged, will also likely suffer significant devaluation and losses, placing mortgage providers at significant risk due to default rates surging. This scenario is of course the worst of all worlds for the many but also for a banking system that could well require some forced nationalisations. A pretty picture it is not, however, and even though the music has stopped, as last occurred in 2008, the options for policy makers seem even more limited this time round with interest rates practically zero; which is why attempting the same playbook seems foolhardy. The big question for me is this: is plan B being discussed??

There is one other picture that we are seeing playing out in real time. This is in the way that we see good people prove through the effects of the pandemic that humanity prevails. The way societies are tackling the pandemic is heartening in many ways. Healthcare workers and other low paid key workers are proving to be the heroes and heroines that had been taken for granted for so long. This suggests to me that humanity can overcome the "modern" greed is good mantra, to the benefit of the common man/essential worker and therefore with this hope in mind something profound may develop out of the current global crisis. Spurred on by this show of humanity, maybe our political leaders will be able to force a change of direction that will soften the financial blow that we will all suffer. Potentially debt forgiveness or jubilee may well be another answer to the conundrum we face. It has been used historically, just not in modern history or on the scale we would need today. Hopefully with calm heads and common cause we can overcome this very real and present financial danger.


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