In the short- and mid-term, it really comes down to not-yet-fully-manifested challenges to the banking sector.
First, new traditional lending activity has pretty much ceased. Not a lot of people are going to venture out and purchase homes or cars when they can't interact with anyone and aren't supposed to travel. In the week before
the United States started mass movement restrictions, new mortgage applications were already down by one-third. And since granting loans is how banks make money, the longer the quarantine drags on, the more impaired banks will become. The quarantine needs to be in place for two to three weeks before it begins
to have positive impacts on case numbers, so a week-by-week building impairment is pretty much baked in.
Second, normal life requires financing, and there was a lot of normal life before the stay-at-home orders snapped into place. Just because no one is taking out new
mortgages or car loans doesn’t mean no one has current
mortgages or car loans. Only roughly 30% of American workers can reliably work from home. That leaves a lot of people who suddenly face constrained earning potential…and constrained debt-paying potential. Credit cards can help bridge the gap, but even in the hilariously impossible outcome of everything snapping back to “normal” the day the quarantine lifts, missing a month of income will translate into a lot of missed mortgage and car loan and college loan and credit card payments. We may not have started the coronavirus crisis with conventional financial stress, but we will certainly end the crisis with plenty.
Third, the normal tools the financial sector would use when payments are missed – for example, fees and foreclosures – are flat-out unavailable. Everyone understands the coronavirus is the very definition of an exogenous event. People might not have been in the best financial position before, but coronavirus is exactly the sort of thing the average person cannot
The biggest issue for the government is keeping everyone – citizens and firms both – on life support so few “real economy” companies crash due to the exogenous stress. Banks and private equity firms will be expected to play their part. Both will have to figure out how to handle mass loan delinquencies without
triggering mass bankruptcies or mass foreclosures. If they fail to cut the population sufficient slack, the Federal Reserve or – God forbid – Congress will force
them to. Expect a lot of debt restructuring to be forced upon all
creditors at some point down the line.
Fourth, and in the long-run most significantly, the world is running out of tools. Most of the world never truly recovered from the 2008 financial crisis. The Chinese massively expanded sub-market cost lending to push their system along, and their post-crisis deficit spending has steadily produced less and less economic growth. China’s coronavirus stimulus will have similar diminishing returns, starting from an already diminished level.
For their part the Japanese and Europeans reduced their interest rates to below zero years ago. Only the Canadians, Brits and Americans had any conventional monetary stimulus wiggle room, and in this crisis’ opening days the Canadians cut to 0.75%, the Brits to 0.1% and the Americans to zero. What traditional monetary stimulus that is possible has not only all
been deployed already, for most of the world it had all been deployed before
anyone even heard of this coronavirus. There simply isn’t any more string to push upon.
Which brings us to the new global disconnect. We can all argue over whether American financial, monetary and fiscal actions will ultimately be effective at mitigating the coronavirus recession, but it is clear to everyone that from points of view financial, monetary and fiscal the Americans not only had more freedom to maneuver and act, but they have front-loaded a lot of activity.
More such activity, much more, is coming. One of the perks of having your own currency is that you can expand your money supply (call it quantitative easing or printing currency or currency debasement if you prefer) to whatever level you feel is warranted by circumstances. The bulk of that $2.2 trillion relief package is deficit spending. The Americans can and will literally throw a bottomless supply of money at this problem. Add in the fact that the American demographic structure makes it the only large, independent, sustainable consumer base of size, and investors still feel that the US economy is the only truly safe one in the transformed economic environment.
Capital flight to the United States – already at record levels pre-coronavirus – has only accelerated. As one might expect, when the Americans finalized their plans for $2.2 trillion in deficit spending, the US dollar dipped for the first time in the crisis. That dip isn’t going to last a week (based on the currency you’re looking at, it hasn’t even lasted the weekend).
Expect the US dollar to continue to rise. Expect US dollar shortages globally as everyone tries to put their money into the only safe(ish) market available. Expect the 10-year Treasury to follow the 3-month Treasury into negative yielding territory before the end of April. Never before has the “exorbitant privilege” of being the world’s reserve currency felt more exorbitant or more like a privilege.
This is just the tip of the iceberg. The centralization of global wealth into US dollar assets will trigger cascade effects throughout the financial system domestically and globally, throughout the real economy domestically and globally, while simultaneously triggering political convulsions throughout the world that will impact…everything. Many of these follow-on effects will be the subject of subsequent installments in our Coronavirus Guides series.
And now the pitch: the Coronavirus Guides are our primer documents, intended not to finish the discussions of this or that topic, but to launch them. Contact us at Zeihan.com/consulting
to inquire about rates and scheduling options for teleconferences, videoconferences and in-depth consulting calls.