Sharemarkets have been pocketing a recovery that does not yet exist
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Markets have been celebrating $US9 trillion ($12.9 trillion) of stimulus across the world but have turned a collective blind eye to the other side of the equation.
They have either forgotten why authorities are having to take wartime counter measures, or are ignoring that a V-shaped economic recovery is not in fact happening anywhere - including China where stress is mounting in the lending markets.
Friedmanites say money creation on a grand scale - central banks are financing the entire budget deficits of the US, eurozone, UK and Japan - must mechanically lead to an explosive surge of asset prices over the next two or three years. Consumer price inflation would follow with a lag.
The figures are certainly eye-watering. The M3 money supply has been rising at a 60 per cent rate in the US over the last three months (on an annualised basis), 20 per cent in the eurozone and 14 per cent in the UK. Monetarists argue that the stock of excess M3 will catch fire once people start spending again and "velocity" returns to normal. M3 is a measure of the entire money supply within an economy, including cash, savings deposits but also money in less-liquid financial products.
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This is not like post-Lehman quantitative easing (QE). That was needed to offset the contraction of money as crippled banks reduced lending. Pandemic QE is net monetary expansion. Ignore the monetarists at your peril, but with that cautionary warning I am going to do exactly that.
No herd immunity
Will velocity - the rate at which consumers and businesses in an economy collectively spend money - in fact return to normal as long as COVID-19 stalks the planet? The bullish case rests on the premise that the global lockdown is a "one-and-done" and we will rapidly return to business as usual. I think it will be messier than that, and, while this is not meant as investment advice, I suspect that we will see another stock market correction as the semi-slump drags on and government relief funds run dry.
The bullish case rests on the premise that the global lockdown is a 'one-and-done' and we will rapidly return to business as usual. I think it will be messier than that.
No country is close to herd immunity. The World Health Organisation says the global pandemic is getting worse, not better. Hans Kluge, the WHO's Europe chief, said this week that he fears a more deadly second wave this winter.
That is also the view of Lionel Roques at France's national research institute: "There is an extremely high risk of a second wave. Just 4 per cent of the French have been infected by COVID-19."
Antibody tests have not validated early claims that the case fatality rate is low enough to let the virus run its course. France at least has cut its reproduction rate to 0.47 before lifting its lockdown. Others have been more impatient. Britain is unwinding with an R rate at or above 1 in large regions.
Second wave
The American South is already in a second wave. The Texas Medical Center, a nexus of hospitals in the seven million-strong Houston region, says daily coronavirus admissions have been rising since mid-May. "Current COVID-19 caseload growth trajectory suggests base ICU capacity could be exceeded in two weeks," it warns. Arizona says it is close to the limit, three weeks after lifting its stay-at-home order. Los Angeles County in California says the R rate is back above 1 and has been climbing for several days.
My working assumption is that social and political COVID-19 fatigue will make it impossible for governments to lock us up a second time. But at the same time they do not have their "test-trace-isolate" regimes up and running, and they cannot endure the reproach of a soaring death toll. They are stymied. Even if they try to tough it out in Trumpian fashion, large numbers of people will retreat into hibernation and the economic recovery will founder.
Nor is it that recovery is securely under way in any case. China's import contraction deepened to minus 16.7 per cent in May. A full four months after the country suppressed the virus, a tenth of its migrant workers have yet to return from their villages and the economy has hit a plateau at around 90 per cent of pre-COVID output.
Nomura's weekly tracking index shows that shop visits are still down 20 per cent; passenger trips by road, rail and air are down 48 per cent; restaurant revenues (they are open but with social distancing) are down 38 per cent; the NO2 pollution index (an industrial proxy) is down 12.3 per cent; and home sales are down 8 per cent.
Even if [governments] try to tough it out in Trumpian fashion, large numbers of people will retreat into hibernation and the economic recovery will founder.
Some of these figures have weakened slightly since late May rather than strengthening. Beijing is rolling out fiscal stimulus and pushing the (augmented) budget deficit to 15 per cent of GDP but it is also having to grapple with a deflating credit bubble.
Patrick Perret-Green, from AdMacro, said China is hemorrhaging $US40 billion a month in capital outflows and is having to tighten liquidity to defend the currency. Hence the dramatic surge in Chinese short-term repo rates [rates at which the People's Bank of China lends money to the country's commercial banks]. Yields on three-year bonds have jumped by 100 basis points to 2.33 per cent over the last month. The rate spike is raising eyebrows in trading circles.
"We all know that China, with its mammoth debt level, cannot sustain higher rates," said Perret-Green. "It will have no choice but to ease significantly and move to some sort of QE."
That means letting the currency go and unleashing deflation on the world. Have your tin helmet to hand if that happens.
Massacre of small businesses
The outlook for Europe is getting worse. France has slashed its growth forecast from minus 8 per cent to minus 11 per cent this year. The Bundesbank has cut German growth to minus 7.1 per cent, pencilling in a rebound of just 3.2 per cent next year despite disaster relief measures amounting to 30 per cent of GDP. Even this assumes that a vaccine comes soon.
Once the economic fallout starts in earnest, we may have to brace for a "non-linear" rupture of the political status quo.
The EU's pandemic recovery fund is a distraction. It will not kick in until March 2021 at the earliest even if approved in its current form after the "frugals" - which now count Finland among their number - have had their say.
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The €400 billion ($652 billion) of actual fiscal stimulus will be spread over four years and will amount to 0.6 per cent of GDP annually. It is not going to save Italy. The eurozone is looking at a protracted slump that will fester long enough to metastasise. This means a massacre of small businesses and a fresh round of labour hysteresis, stretching the social contract to the limit.
The gilets jaunes in France have not gone away. Nor have the Left-Right protest movements in Germany - remember the Thuringia elections - or Vox in Spain? Italy's Lega-Fratelli alliance remains the government in waiting.
Once the economic fallout starts in earnest, we may have to brace for a "non-linear" rupture of the political status quo.
Governing elites will try to fend off political revolt with Peronist spending, and business will be made to pay for a lot of it. The profit share of GDP will diminish. So will the rentier return to the holders of capital.
That is what the current sharemarket premium is missing.
The Daily Telegraph, London
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