ECONOMIC CONSEQUENCES OF THE CORONAVIRUS
This week’s BOOM editorial begins with the exact same statement as last week’s editorial. Why? Because it is so important.
To date, Coronavirus deaths number around 3,500 globally. To put this into perspective, consider the fact that 60 million people die every year on this planet and 130 million are born. Well over 1 million die from road accidents while heart disease and stroke kills 15 million.
So — let’s look at the potential economic and financial impacts of an epidemic that has caused just 3,500 deaths to date. It is clear that the impact will be limited.
It is BOOM’s opinion that, at this stage, the Coronavirus epidemic is essentially a mainstream media panic phenomenon, designed to create maximum fear and some financial market distress but with minimal real world economic impact.
Panic and fear promoted by the mainstream media has a purpose. Its purpose is to make people more susceptible to suggestions, messages and more likely to follow instructions.
Of course, some industries will be severely affected such as the travel and tourism sectors but the biggest impact so far has occurred in the financial sector rather than in the real economy. Stock markets have dropped alarmingly, bond prices have risen and the US Dollar Index has dropped sharply. Central banks have responded with interest rate cuts and indications of further actions “if required”.
“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”
In other words, a global recession would not occur, even in BOOM’s worst case scenario. However, the Chinese economy will be severely affected internally.
China is a big exporter but of many non-critical items — the world can cope easily with a delay in the supply of knick knacks. On a global scale, China does not export many cars, buses, trucks, aircraft, large engineering items, pharmaceuticals, commodities, software, food or entertainment products. It does not export energy. However, it does export smartphones, computers, electrical components, TVs and solar panels — all of which are non critical in the short term and which thus can be replaced by consumers later rather than sooner. So a 12 month drop in consumption of such items in the advanced economies will have a big effect inside China but a marginal economic impact globally. Think it through — we can all delay a laptop, TV or phone purchase by 12 months.
Half of Chinese exports go (as components) to other nearby Asian nations so a knock-on effect will occur in nearby economies such as Thailand, Malaysia, Indonesia, Japan and Korea.
But the advanced economies of Europe and the USA should see a marginal decrease in overall economic activity. They may see their annual GDP numbers reduce by 1 – 2 % at worst in BOOM’s estimation. This will hurt (a little) but it will not harm.
To quote BOOM again from 9th February —
ASSET PRICE EFFECTS
We have seen an initial panic in the advanced economy stock markets but there has been a strong rebound, followed by interest rate cuts by some central banks followed by further stock market weakness. Many investors appear to be sitting pat, waiting for the dust to settle and then the bargains will presumably be bought in a “buy the dip, NOW” recovery.
Advanced, modern economies are largely service based (60 – 80%) — so a temporary marginal drop in goods imports from China should have marginal overall impact on most businesses except in the travel and tourism sectors where BOOM expects severe damage.
Investors eventually have to put their money at risk. So, BOOM can see asset prices slowly recovering as the year progresses with the acceptance of the Coronavirus as just another health risk. If containment of the virus fails dramatically, then we could see a more significant drop. But that appears unlikely as governments are taking strong action to prevent this.
THE MINSKY MOMENT
A BOOM reader recently asked “is this the Global Minsky Moment?”
Note: BOOM defines the The Ultimate Minsky Moment as Peak Private Debt — excluding Government debt.
Hyman Minsky was an American Professor of Economics during the 1970’s and 1980’s in St Louis. He proposed The Minsky Moment of financial and economic collapse as one which will occur when debt reaches its ultimate, unsustainable peak. Many economists watch for this moment tirelessly, often ruminating about “excessive government debt” and endlessly predicting the Moment of collapse.
Regular readers will know that BOOM discounts these analyses because Governments do not borrow money as a bank loan, they issue bond contracts instead. And bond contracts do not increase the supply of fresh new money or increase CPI inflation (unlike bank loans). So BOOM watches private debt levels much more closely.
Are the advanced economies at Peak Private Debt? BOOM can’t see this right now, especially in the United States. US private debt has been increasing slowly since 2015 with no great surge happening. I summarized this in my BOOM editorial of 16th February —
“After the Global Financial crisis in 2008, total US household debt fell from around $ 13 Trillion to $ 11 Trillion in the next 5 year period. Then it started to rise again and over the last 5 years up to 2019, it increased from $ 11 Trillion to $ 14 Trillion. That is an increase of 27 % in five years. No matter how hard BOOM tries, that current rate of increase just does not induce panic. It seems to BOOM to be a slow and steady increase, not something that will destabilize the whole economy and result in a sudden collapse.
Also in that period, the annual GDP of the United States grew from around $ 17 Trillion to $ 21.5 Trillion — an increase of about 27 %.”
So, US private debt has grown by 27% over 5 years and US GDP has grown by 27%. That does not seem to be an excessive accumulation of private debt.
BOOM went on to say —
“The bulk of Household debt involves mortgages — bank loans used to purchase homes — and bank loans that are tied to home equity. Those loans are about 70% of the total household debt. They are also the key component in the fresh new money supply for the economy. So it makes sense to watch the mortgage originations occurring in the US economy. At present both mortgage originations and mortgage refinancings are growing strongly in the US and that is happening during winter which is unusual. This is a sign of faith in the future and is a strong positive for the US economy going forward.”
Government “debt” is certainly growing …. but it is via sovereign bond issuance and that is not debt in the same sense as private debt. For the capitalist system to fail in an ultimate Minsky Moment, we must reach unsustainable, peak private debt — which would signal the end of our fresh new money supply.
Of course, this is hellishly difficult to judge because (eventually) private debt may still be growing but inadequately (in speed) to keep GDP growing. If the velocity of money slows and the fresh new money supply slows, then GDP will inevitably slow from these system effects. But at which point that becomes a terminal, collapse event and not just a cyclical event is very difficult to judge.
The capitalist system is entirely dependent upon private credit demand for mortgages to rescue such a situation because collateralized private credit is the very core of our fresh new money supply. BOOM suspects that near zero (or negative) mortgage interest rates must be reached in all advanced economies before that might happen. Currently, fixed 30 year mortgage rates in the US are around 3.38% while adjustable rate 10 year mortgage rates are around 3.25%. Average home loan interest rates in Australia are plunging but are still around similar levels. In Europe, average mortgage interest rates in 2019 were all under 6%. In Denmark and Finland, they were under one percent. Twenty year fixed rate mortgages are available below 2% in the following European nations — Germany, Belgium, Denmark, France, Slovakia, Switzerland, France. In Japan, they are also below 2%.
These dynamics reveal how hard it is to predict exactly when the Global Minsky Moment could arrive. It will probably arrive nation by nation over time. Perhaps some nations in Western Europe have already reached it. But in the United States, the money supply looks like it is ready to grow dramatically — a great sign for the US economy this year (despite the current Coronavirus Panic).
Note this Bloomberg article last week —
“A drop in interest rates in response to the coronavirus outbreak is adding urgency to a hiring spree across the mortgage industry.
Executives at four of the nation’s 15 biggest mortgage lenders, already gearing up for a busy 2020, anticipate hiring thousands of employees this year to keep up with what they expect to be a flood of demand for purchase loans and refinancings.
Lenders are zipping through applications so fast that some expect to blow past origination records they set just last year. At Quicken Loans Inc., the nation’s largest mortgage lender, Monday was the busiest day for mortgage applications in the company’s 35-year history, said Chief Executive Officer Jay Farner.Michigan-based United Wholesale Mortgage, meanwhile, approved $2.5 billion of preliminary loans, a single-day record for the company, according to Alex Elezaj, its chief strategy officer.”
A FALLING US DOLLAR BAKED INTO THE CAKE
One aspect of the Coronavirus panic has been a falling US Dollar index. BOOM suspects that the US Dollar will continue falling for some time during 2020 against certain key currencies, especially the Euro and the Yen in particular but also against the Chinese Yuan.
The strength in the US Dollar since early 2018 has become a major problem for the US economy. If it were to continue, it would cause increased CPI dis-inflation and deflation inside the borders of the US.
Dis-inflation is falling rates of CPI inflation while Deflation is negative rates of CPI inflation.
Any economy that suffers persistent, uncontrollable CPI dis-inflation or deflation will eventually suffer a collapse of its banking system. And if that were to occur persistently over many years, it would destroy the US economy eventually because it is dependent upon its banking system and new bank loans for its supply of fresh new money.
No economy can prosper with a persistently declining money supply. As BOOM has said before, new money (in the form of fresh new bank loans or Quantitative Boosting) is like fresh new water to a garden.
EMAIL: gerry [@] boomfinanceandeconomics.com
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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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