Gordon T Long
Global Macro Research | Macro-Technical Analysis
FOCUS
STAGFLATION
A SECULAR PROBLEM: INSUFFICIENT SUSTAINABLE REAL ECONOMIC GROWTH
ECONOMIC GROWTH WILL FAIL TO FULLY RECOVER TILL 2022
Investors are awakening to the fact that the V-shaped recovery was a fantasy!
The markets have priced in the “V” shaped recovery as evidenced by a “V” shaped market bounce since the March lows to within points of prior market highs. Markets fully anticipate better days ahead and although the timing is uncertain, the stock market is expressing confidence the pandemic will end with a vaccine and better interim treatments. Frankly, it all rings of a major “Buy on the Rumor, Sell on the News” set-up!
Irrelevant of this prognostication, the reality is we are in fact in the early stages of a deepening global economic recession. Soon this reality will set in and market sentiment will slide from confidence to angst in a ‘New York’ minute!.
1- THE FACTS: THE “V” SHAPED ECONOMIC RECOVERY IS NOT OCCURRING!
It’s tempting to take the recent rebound in business confidence and activity measures as a sign that the global economy is well on track to make up for its coronavirus-induced losses — except it’s misleading evidence. The speed of channeling policy stimuli into the economy, as well as pandemic relapse risk once lock-downs end will significantly hamper the economic recovery. We have shown many charts regarding why we don’t expect a “V” shaped economic recovery in recent UnderTheLens and LONGWave videos. (We list further evidence in Addendum I below).
2- PROBABILITIES SUGGEST THE EARLY 1930’S ECONOMIC PATTERN AHEAD
The Trump administration and Congress will need to pass trillions of dollars more in direct payments to tens of millions of broke Americans, or face a crash in consumption. The virus-induced recession has financially ruined the bottom 90% of households while additional economic shutdowns due to rising virus cases and deaths will exacerbate the second round of layoffs.
Presently Wall Street is ignoring the deep economic scarring from the virus. Permanent job loss now stands at nearly 3 million, up from 1.6 million people in February.
“Wall Street has misread the shape of the economic recovery, as he (Gary Shilling) warns a 1930s-style decline in the stock market could be ahead.” — CNBC: Gary Shilling, President of A. Gary Shilling & Co.
3- THE FRAGILE & FRACTURED GLOBAL FINANCIAL SYSTEM HAS BEGUN UNRAVELING!
As my colleague Charles Hugh Smith says:
“Fragile systems break. This is why the unraveling is accelerating”. Additionally, he feels “Financial catalysts tend to result in sudden, cataclysmic collapses in liquidity, solvency and sentiment….This is particularly problematic when the top 20% of the workforce that accounts for 50% of all consumer spending and 80% of the citizenry’s political voice is in distress”.
HIGHER DEBT = LOWER GROWTH (‘This Time IS Different’ – Rogoff)
Large parts of global stock markets are massively under-performing… because they are under-performing. Its going to get worse as they deal with the costs of delayed deliveries, foregone cap-ex, supply chain breakdown, unpaid rents and crashing returns. Many companies are struggling with increased debt – it’s kept them afloat, but leaves them with a massive leverage burden, which will seriously impact their ability to grow, innovate and introduce new products. Even before the crisis began we were looking at 20% of US companies as effectively “zombies”.
Right across commercial enterprise companies have been forced to take on debt to weather the pandemic. This is happening at a time when a demand-shock – from massively increased unemployment – looks nailed on. The result will hamper growth for these companies and across economies, potentially for the next decade. It’s a recipe for stagnation.
We examine the economic growth formula “GDP = C + G + I + X(E-I)” in Addendum II below to highlight the central flaws.
“In 2008, in response to the financial crisis, the Fed started to pay interest on its reserves. But there is no interest on the currency, and currency is exchangeable for reserves on demand by the banks. So based on classic monetary theory, you don’t really know what’s determining inflation at this point. There is no control over the stock of what qualifies as money, since reserves aren’t really money anymore because they are paying interest. That means you can’t control the currency supply.
In other words: Inflation is totally out of the control of central banks
….. in principle, you can see the effects of inflation on long-term interest rates, but you can’t see them in stocks very well because the volatility is so high. Hence, we don’t know what effect inflation will have on markets. It depends on the effect on real activity: High, but stable inflation wouldn’t be a big deal. What’s really a big deal is when it gets unstable.”
Eugene Fama, Professor of Finance at the University of Chicago.
ADDENDUM TO THE AUGUST LONGWave VIDEO –‘STAGFLATION INVESTING”
1- INCREASING EVIDENCE WE DO NOT HAVE A GLOBAL “V” SHAPED ECONOMIC RECOVERY
We expect the speed of channeling government policy stimuli into the economy, as well as pandemic relapse risk once lock-downs end, to significantly hamper economic recovery.
- According to calculations by Bloomberg Economics, it may take the global economy until the end of next year to fully recover from the pandemic. Its baseline scenario sees output shrinking 4.7% in 2020. In a more pessimistic view — assuming the pandemic runs longer, recession scars slow the recovery, and the ceiling on activity from residual social distancing is lower — global GDP contracts 6.7%.
- Even though many economies have already passed the trough, uncertainty about new waves of infection is keeping a lid on spending and investment. That means many parts of the world will see worse contractions this year than during the financial crisis. The International Monetary Fund has downgraded its outlook again and now foresees a drop in GDP of 4.9%.
- Emergency spending by governments is set to push the global debt ratio above 100% for the first time. The IMF forecasts the burden this year alone will jump by close to 19 percentage points, dwarfing the increase after the global financial crisis more than a decade ago.
- Purchasing managers’ indexes from Asia, Europe and the U.S. are among indicators that have recorded impressive gains that look just like the V-shaped recovery many once spoke about. But that short-term rebound doesn’t say much about the more important medium-term outlook. On top of that, measures of demand, employment and prices in the PMI offer reason for caution.
- U.S. consumer spending surged by a record in May but the annualized rate of household outlays remains well below pre-pandemic levels, indicating a long road to recovery from a deep recession.
- The misery spreading through the U.S. economy as a result of the pandemic may well have political consequences. An index combining unemployment and consumer prices has spiked to an extent that historically would suggest a loss for the incumbent party in the White House.
- In China, where the coronavirus first broke out, the economy continued its slow recovery in June, with a better performance in the services sector and among smaller companies tempered by the still-grim global outlook.
- Central banks have been key to rekindling growth momentum. Demand for Bank of Japan loans aimed at helping struggling companies have jumped fivefold to 8.3 trillion yen after the introduction of a second loan program.
2- WE HAVE INSUFFICIENT SUSTAINABLE, REAL ECONOMIC GROW!
The GDP formula is hopelessly flawed for a Fiat Currency world. The formula creates the illusion through debt growth that the real economy is growing. It does this through increasing government debt adding to “G”, then through Transfer Payments it adds to “C”, then because it is partially financed by foreign investment it adds to “I”. The distortion is further compounded when the debt goes into non-productive assets and financial engineering.
THE MEASURE OF ECONOMIC GROWTH IN AN ERA OF ‘FIAT CURRENCY” REGIME & DEBT OVER 90% OF GDP IS FLAWED!
The GDP formula works if the value of the currency remains a store of value and “Savings” occur which are invested into Productive Assets. This creates rising standards of livings, employment and real wage growth. A productive economy produces more than it consumes and therefore net exports are positive and competitive pressures assure consumers get more for less!.
As Creditism grows due to slowing real economic activity we see the Velocity of Money fall while Government Deficit spending takes on increasing size and scope within the economy. Ever increasing government debt in the form of deficit spending adds to “G”, then through Transfer Payments it adds to “C”, then because it is partially financed by foreign investment it adds to “I”. Debt is compounded into representing economic growth. This distortion is further compounded when the debt goes into non-productive assets and financial engineering. Standards of Living fall and consumers get less for more as competition is usurped by increasing numbers of “Zombie” Corporations.
Once an economy has entered the social expectations realm of Credtism it is a natural and likely step to see increasing levels of Socialism emerge. Governments become increasingly dominant in the allocation of resources and wealth. More and more Consumers get only what the government determines, awards or rations. The society becomes increasingly unproductive, globally uncompetitive and the purchasing power of their currency falls. Standards of Living as a result fall and are “universally one” as entrepreneural incentives are lost.
The end game for Socialism is currency failure!
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