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The gathering storm - don't expect a rapid recovery

Bill Blain
August 5, 2020

Governments can't afford to write a permanent blank cheque to the economy while providing all the public good services we expect from them in the longer term, argues Bill Blain 

I am becoming increasingly worried about the R word. Recovery. I sense the economic damage is escalating rather than easing. What do record low negative real yields and the rise of gold tell us? Something's awry.

I've been relatively optimistic that recovery from the pandemic could be faster than expected – after all, it's not like a war destroyed factories and infrastructure, shattered consumer demand, and broken supply chains are quickly fixed. Governments and central banks acted swiftly and decisively. Recent economic reports and signals of resumed activity have been increasingly positive.

So … Why does it feel like this nascent recovery is stalling?

The obvious threat is that coronavirus policy decisions will tip us back into a meltdown.  There is a sense the recessionary forces kicked into motion by the virus are taking on their own momentum. Look at the rising number of job losses – not just in sectors being hammered by the virus like airlines, hospitality and tourism, but across the economy.

If I can use a sailing metaphor: it feels like a gathering wave. Every negative economic pulse is each individually a small ripple on the surface of the economic ocean, but they are combining into storm waves that threaten to swamp economic activity. (If I mention anything stupid like "Perfect Storm", please shoot me.. but you get the drift).

The bad ones come in three parts…

The first issue is an increasing element of "wobble" in the background noise.  The pandemic is setting the economic agenda – and driving what feel to be increasingly reactive government responses.  We need to be ahead of this thing – not behind it!  If it looks reactive, it hammers sentiment. Confidence is what will get us out of crisis. Confidence feels in increasingly short supply. It's not the virus that created this storm – it's the policy decisions taken to address it that are doing the damage. Regrettable, but fact.

Second, add the Coronavirus shocks to damaged global supply and demand chains and the friction from known geopolitical threats like China/US tension, global trade, Brexit, and the issues likely to be triggered by Europe's recovery fund. Then layer on top the economic tensions multiplying in the emerging markets… Oh, and yes, the possibility of a messy US election triggering a constitutional crisis. (Long shot – but possible.)

Third is the reality of solvency – the number of SMEs being kept afloat solely through government schemes and emergency lending, plus the larger corporates that have borrowed in markets. That money that's keeping companies open may be at ultra-cheap rates, but when it comes due and companies struggle to repay we face a wave of defaults. The result is going to be more-for-longer government support alongside permanent lower-for-longer rates and the distortions of QE Infinity. The longer it lasts the more established permanent intervention becomes, and the more unlikely it ever ends – in effect, a whole private sector utterly dependent on state aid.

The alternative is a tidal wave of defaults and rising unemployment. The rating agencies are seeing defaults set to rise – delayed by the pandemic but certain to lift as support polices ebb, and businesses realise it's impossible to go on.  And governments can't afford to write a permanent blank cheque to the economy while providing all the public good services we expect from them – defence, education, health, social care, etc. Something will break – and hoping that Modern Monetary Theory can bail us out indefinitely.. well that's a hope – which is never a good strategy.

We were talking about the threats yesterday and one of my colleagues used the analogy that we're in the Phoney War phase of the Covid pandemic and its economic/social consequences. His fear is the real war will begins when Governments recognise that they can't keep impoverishing future generations by maintaining subsidies and grants in perpetuity.

It's a war we won't be winning if the whole economy remains dependent on state support, and we still suffer massive and rising long-term structural unemployment and crashing disposable incomes. The danger is null-entrophy economies may work in consensus economies like Japan – but won't work in the socially volatile occidental economies where strife and unrest is much more likely. Tensions will be massively inflated by rising inequality and the perception of bailed out markets benefiting only the elites.

There is, of course, a more optimistic perspective – that the pandemic will act a catalyst from the old, tired, debt dependent pre-Covid economy to something new and much more exciting. I've mentioned a couple of times my expectations we'll see Covid spur new efforts on the environment – bringing forward new clean energy and related technologies that will be transformative and wealth creating.

We are also on the cusp of a healthcare paradigm shift as new ways to monitor our health will decisively shift the medical profession towards early interventions – much more prevention over treatment.

That is an attractive vision for future growth. I think it happens – but not before the current storm passes through.

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Bill Blain is market strategist and head of alternative assets at Shard Capital. He has a 35 year career in financial markets behind him, in capital markets and fixed income. After the last financial crisis, Bill wrote a book called “The Fifth Horseman: A Polemic on how to destroy the Global Economy - and other matters”. He writes a daily market commentary called The Morning Porridge (www.morningporridge.com).
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