Global trade in goods amounts to about US $ 32.4 Trillion and US$ 3.6 Trillion of that trade is conducted with China. So, if the Coronavirus slows the Chinese ability to trade by 20% over a one year period, then Chinese trade will fall by about $ 700 Billion. That equates to a reduction of 2% of global trade.
If the Coronavirus slows the Chinese ability to trade by a disastrous 50% over a one year period, then Chinese trade will fall by about $ 1,800 Billion. That equates to a reduction of about 5% of global trade.
Global trade is about 37% of Total Global GDP, so that disastrous situation would result in a reduction in Total Global GDP by about 1.8% – 2.0%. The IMF is forecasting Global Growth of about 3.3% in 2020 so this figure would then be reduced to about 1.3 – 1.5% growth. That would probably be a worst case scenario.
A best case scenario would result in a reduction of Global GDP Growth in 2020 by only 0.3 – 0.4%. And this would leave Total Global GDP Growth at around 3%. No big deal.
The economic world will not end in such scenarios. It will slow in its growth trajectory a little but it will not die. The numbers here are big ones but we must all keep it in perspective. Panic is not the correct approach.
THE FED TO THE RESCUE
On 15th December, the BOOM Editorial stated —
“Since September, the US Federal Reserve has been increasing liquidity into the banking sector fast via the repo market. BOOM strongly suspects that this is due to the rescue of a foreign bank.”
That comment was triggered by a whole host of DOOM and Gloomers writing panic articles in many financial publications about what was then happening in the US Repo market (Repurchase Agreements). They were all predicting “a crisis of mammoth proportions in the US banking sector”. Most even said it would all come to a head on 1st January with a major calamity — presumably a market collapse of some kind. But BOOM stood steadfast. A foreign bank rescue appeared to be the most likely explanation.
So — guess what? The shares of a major foreign bank, famous for being a bank in great distress over many years, suddenly surged UP last week by 13.77%. And overall, those shares have appreciated by 48 % since early December.
BOOM stands firm. The US Federal Reserve appears to have just rescued a foreign bank. That is good work and it is what central banking was designed to do. The alternative would have been unthinkable. So BOOM says — Don’t End the Fed — Reform It (!).
ENERGY IN THE ECONOMY
BOOM read a strange statement last week made by an economics expert.
” …. the economy is an energy system, not a financial one, and money plays a secondary role”.
The statement sounds convincing but it cannot be true. Energy does not leap out of the ground by means of magic. Primitive human societies function for only a very short time using the energy available from each individual’s muscle power. Then the idea of money quickly emerges. Money is embodied in a promise. “I promise to help you with your garden if you will help me build my house”, “I promise to hunt rabbits if you promise to grow me some vegetables”. These are credit contracts and they are the early building blocks of money. The contractees enter into the contract first and then, with the future assured and trust enshrined, they look for the energy to deliver on their promises. That is how an economy emerges and grows in complexity. Each human agent plays a different role but each agent needs to trust in the future and then find sufficient energy to complete that role. However, the energy is not found or used until the promises are made, so finance always comes first.
Of course, there is a complex interaction between finance and energy required to create and sustain an advanced economy. And Banks have evolved to assist in creating credit contracts (promises) as a business in itself. This speeds economic activity, creates more money and generates more economic complexity. Trust is a key part of this stage of economic development because banks trust their borrowers to pay back their loans. And borrowers trust banks to keep the details of this relationship confidential.
Interestingly, mainstream economists ignore almost all of these essential elements when they build their macro-economic models. They exclude banks, debt, energy and money. Whenever BOOM explains this to a non-economist, the answer is always the same — “how can they do that when everyone knows that banks, energy, money and debt are clearly the basic building blocks of any economy?” “Is that why economists never know what is happening?”
So, to get back to the subject of energy, it is clear that money digs energy out of the ground …. not vice versa. There is one exception to this rule but BOOM will let the reader guess what that is.
OUR CURRENT PREDICAMENT
At present, there is no shortage of energy worldwide. There is abundant coal, oil, natural gas, sunshine, wind, hydro, nuclear, tidal and waves. So energy is not the cause of our economic problems.
Our current economic difficulties lie inside the financial system which is reaching its limits in providing enough money. How can this be so?
Our current system of finance evolved rapidly during the 16th century in Venice. Since then we have had expanding populations, expanding trade, expanding credit, abundant and expanding energy, expanding labor. All of that created economic growth and a virtuous circle of financial expansion followed by economic expansion followed by financial expansion followed by economic expansion followed by financial expansion followed by economic expansion.
But that whole expansion phenomenon is slowing in the advanced economies and aging demographics is certainly a major cause. Old people clearly engage in fewer originations of financial contracts. So an aged demographic economy with a low birth rate must result in a lower rate of money creation. Less promises, less money creation. Our major economic problem is now, for the first time in history, a permanently decreasing rate of fresh new money supply leading to low wages growth, low CPI inflation and lower rates of GDP growth.
So far, the (correct) response from our central banks and governments has been to try to expand the money supply via Quantitative Easing, Lower Interest Rate Policy, Zero Interest Rate Policy, Negative Interest Rate Policy and by boosting Deficit Spending. But clearly, not enough has been done because our system of new money supply depends principally upon willing borrowers applying for bank loans and those low interest rate policies are not enticing enough borrowers. Also, deficit spending, by definition, does not affect the creation of fresh new money.
Without sufficient willing borrowers in the advanced economies, those systems must slow and then eventually contract. The alternative is to find new ways to expand the fresh new money supply (that is where Quantitative Boosting comes in).
So we are facing two possible long term options — 1. Persistent economic slowdown Or 2. Quantitative Boosting (an effort to increase our Sovereign Money supply in digital form as opposed to our Credit Money supply).
MONEY IS WATER
Money can be thought of as water (not energy). In this analogy, we must choose between watering our economic garden or not.
“Mavis, the garden is dying in the drought. Let’s not turn on the tap. We’ll see if it can grow without water”.
BOOM would expect Mavis to reply — “Don’t be stupid Harry, turn on the tap (!)”.
It’s that simple.
In economics, things work until they don’t. Until next week ………… Make your own conclusions, do your own research. BOOM does not offer investment advice.
EMAIL: gerry [@] boomfinanceandeconomics.com
Return to the BOOM Main Website – BOOM Finance and Economics at http://boomfinanceandeconomics.com/
HOW MOST MONEY IS CREATED
BANKS CREATE FRESH NEW MONEY OUT OF THIN AIR (but they always need a Borrower to do so)
THERE IS NO SUCH THING AS A DEPOSIT
BANKS PURCHASE SECURITIES, THEY DON’T MAKE LOANS
How is Most New Money Created ?
LOANS CREATE DEPOSITS — that is how almost all new money is created in the economy (by commercial banks making loans).
From the Bank of England Quarterly Bulletin Q1 2014 —
“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.“
Quarterly Bulletins Index
Most economists are unaware of this and even ignore the banking & finance sectors in their econometric models.
On 25th April 2017, the central bank of Germany, the Bundesbank, released a statement on this matter —
“In terms of volume, the majority of the money supply is made up of book money, which is created through transactions between banks and domestic customers. Sight deposits are an example of book money: sight deposits are created when a bank settles transactions with a customer, ie it grants a credit, say, or purchases an asset and credits the corresponding amount to the customer’s bank account in return. This means that banks can create book money just by making an accounting entry: according to the Bundesbank’s economists, “this refutes a popular misconception that banks act simply as intermediaries at the time of lending – i.e. that banks can only grant credit using funds placed with them previously as deposits by other customers”. By the same token, excess central bank reserves are not a necessary precondition for a bank to grant credit (and thus create money).”
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