Great Depression 2.0 - The Cost of Over Manipulation

The Great Depression may soon be coming to a country near you!

The 2008 Financial Crisis was over the course of 517 days, The stock market dropped by more than 56%, millions of people lost their jobs, homes, and their life savings. Just as you think it was the worst time for the global economy since the great depression, here comes the 2020 Economic Collapse. In just 21 days, the market has dropped by roughly 20%, the world has seemingly shut down, and we just might be on the worst economic trajectory in history. So how did we get ourselves in this and what we should be expecting going forward? As most of you know, there is a global illness of COVID-19 that has been going around for more than 2 months now that many people are worried about it getting lockdown might lose their job and income stream. As job losses mount, a virtual spiral in the economy begins as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices until the cycle is complete.US initial jobless claims data just surged 17 million in only three weeks, an unprecedented level of lost employment. To put this into perspective, two-thirds of the jobs created over the entire expansion just evaporated. The unemployment rate is expected to continue to spike in the coming months to the highest level since the Great Depression and a recession followed with an average duration of 12 months. Earnings will be a decline for several quarters before we can see any type of recovery. Thus, forget about a V-shaped rally will even happen. While the virus may end, the disruption to the economy will last much longer, and be much deeper.

Catastrophic situation in manufacturing, retail, income and unemployment

When the disease had its first outbreak back in early January in China, it caused the Chinese Government to shut down its manufacturing sector to help prevent the spread of the virus. It shouldn't be a problem if 1/3 of all products in the world weren’t made in China. But since China is the global supply chain of the world, so when it experiences delays in production, the entire world's economy can quickly turn into a disaster. We have seen many large companies experience a slowdown in their sales and revenue. For example, the travel industry is very dependant on people's daily activities. During the virus hits, the city lockdown almost everyone to cancel their plans and switch from physical to virtual attendance.

Other industries are also experiencing 1 to 3-month delays because of the shutdown of the manufacturing sector, therefore, missing out on billions of dollars worth of sales. Because people are being asked to stay inside, social distancing, and work from home if possible, we have seen up to an 80% drop in relevant sales in some countries like China. And this effect keeps trickling down. it will affect radiates to all other companies that are connected to the industry. What happens when a company sees a drop in sales or revenue? Well, we tend to see things like layoffs, or even bankruptcies.

This would lead to a higher unemployment rate which would lead to fewer purchases being made by consumers, which would lead to fewer sales being made by businesses. And the cycle continues until the economy hits a low point like the great recession or the great depression. And keep in mind, this is just the transportation industry. This drop in sales will apply to virtually every other industry in the world except the toilet paper industry because that’s manufactured in a bunch of different countries around the world. Yet sales have increased for some companies like KP tissue by almost 50%. So, there is no toilet paper shortage, everyone just a bunch of hoarders buying 100 rolls at a time. Transcript out of room in the description.

Waiting for relief checks during the Great Depression in Calipatria, California. Photo: Courtesy Wikimedia Commons

The Great Depression 2.0 is coming!

4 things drive our economy and destiny in general. First, real productivity - organic and non-inflated growth which is usually about 1-2% growth annually and considered a healthy growth rate for the economy. Second, the Short-term debt cycle which follows a loop pattern in recession, expansion, and bloom. They roughly last about 8-10 years. Third, Politics - Both internal and external. Internal politics is including management of wealth gap, values gap, common social mission or fight over wealth with conflicts. External Politics means the relationship between countries. For instance, there is a rising power challenging the existing dominant and they compete with each other in various ways.

And lastly, the Long term debt cycle - every 50-75yrs, a total reset of our financial system where the new money will replace the old money. The first new world order started in 1945, right after the WorldWar II. As 2020 is the 75th year since the last reset, we are likely going to experience in the world order change. The internal politics will once again determine how we deal with each other in terms of social wealth distribution, who gets a bailout from debts and who will be left out unprotected. Corporate earnings and household consumption are plunging, government spending is skyrocketing, and economic activity plummeting. The US government deficit is set to explode in absolute and relative-to-GDP terms. When we look at the US government balance sheet, it is already bloated. Corporate balance sheets are stretched to record levels already as well. What kept them in the game was the ongoing economic expansion. The issue is that liquidity injections in such indebted environments don’t act as liquidity that translates into economic growth. Instead, new money only goes to service existing debt and roll existing loans.

While asset values and incomes plunge in recessions, the debt obligations will be more persist. During these times, households are forced to cut back spending and deplete their savings as businesses lay off workers to conserve cash that leads to a prolonged downturn. In deflationary recessions, the overall debt burden of an economy gets much worse before it can eventually get better. That was the case in the Great Depression before businesses ultimately fail and debt is expunged and replaced with equity and new debt in the bankruptcy process.

Federal Reserve: Total Assets, Balance Sheet

In fact, it already happened in late March 2020, when governments all over the world ordered to shut down their economic activity, put together gigantic “bailout” packages to support almost every assets class, corporate like the Hedge funds and Private Equity funds, extending loans and unemployment benefits to struggling businesses and consumers. The lasting effects from the bursting of asset bubbles in the market and economy will almost certainly play over many months and possibly a few years before the bear market finally hit bottom. And we are heading to this cycle right now just like back then where Central Banks drop the interest rate to hit nearly zero, printing infinite money supply to postpone the inevitable bust. If expanding the Fed's balance sheet or increase the size of the pie will make you think it will divide well among society, you will be very disappointed. Although this may indeed keep away the bust for quite some time, it will weaken productivities and employment gains. People living standard will no longer improve at an acceptable level or may even decline. If the free market is allowed to work while there are no other factors such as increases in productivity(value creation), changes in consumer tastes(behavior), etc., then the boom will turn eventually turn into a bust.

Wealth Gap is stretching and social unrest are coming

Ray Dalio, the famous hedge fund manager, and philanthropist who has served as co-chief investment officer of Bridgewater Associates since 1985 was once said, "There simply is too much faith that "someone is going to fix it" or "someone is responsible to fix this". The central banks have entered both the corporate and long-term bank credit markets. The cost of credit and capital, in general, are much lower now and the beneficiaries are big corporates, Wall Street and, highly leveraged investors, banks, and the financial institutes in general. The large US government balance sheet has worked historically only because it has the largest free-market economy, the most wealth, the largest military, one of the best systems of democracy on the planet which all these have given the USD the privilege of the global reserve fiat currency.

As seen from the 2008 crisis, the wealth gap has stretched further than ever in history which means declines in the middle classes, the wealthy become wealthier, poor remain desperate, the quality of life dropped to the bottom for 99% of the population.

"Globalism is dying and welcomes a new era of the deglobalized world!"

The time bomb of junk bonds are ticking

The Federal Reserve recently announced that it will include companies with the safest high-yield debt in its coronavirus stimulus plan. And according to Goldman Sachs, they now face an additional risk that the Fed may not be able to salvage. At issue is so-called refinancing risk: the possibility that these companies will not be able to finance the debt that is soon coming due, by tapping investors who provide new, longer-term credit. 

Time is quickly running out amid what's shaping up to be the worst economic recession since the Great Depression due to the share of high-yield debt that is due within the next two years is at its highest level since 2010, data compiled by Goldman Sachs showed. In dollar terms, the amount is at a high not seen since at least 2007.

The funding market for these lower-quality companies has essentially dried up because of widespread cash constraints and as investors reconsideration on how much risk they should be taking. Many companies that would have refinanced their debt early under normal circumstances now face no choice but to let it mature.

A Goldman strategist said, "While the Fed's facilities have reopened the primary market for investment-grade and the highest quality high yield borrowers, the primary market is still essentially shut for the lowest quality names." Many of these stressed sectors like airlines, with 46% of its debt maturing within the next two years, and will also have the largest refinancing needs during the months ahead as the crisis deepens. Thankfully, the Treasury's direct cash injection should provide some assistance here. However other industries face the double whammy of zero Fed support and being directly hit by the crisis. They include transportation & logistics (39% of debt is coming due), office/business equipment makers (39%), auto manufacturers (35%), and real estate (17%). The market experts are expecting defaults in the coming months to come from these industries and it will lead to even more layoffs and bankruptcy, deepening the market uncertainty further.

The banking system is collapsing

And when it happens, it will restructure the economy and so is the redistribution in wealth globally. We see this repeatedly in our history and I think we are in a long depression instead of just a quick V-shape rebound in just a few months. As the banking system comes under pressure with debt defaults and imploding asset prices together with the $2T derivatives going to vanish ass many countries suffer job losses and business shutdowns from the coronavirus. Two of the nation's biggest banks reported plummeting profits during the first quarter this year as they sought to prepare for an onslaught of defaults in debt that ranged from credit cards and mortgages to business loans. The country's largest bank, JPMorgan Chase, said its profit fell by 69% as it set aside $8.2 billion to prepare for defaults, the largest amount since 2010. The bank is adjusting to what JP Morgan's CEO Jamie Dimon called "a very tough and unique operating environment." Wells Fargo's profits plummet 89% for many of the same reasons. However, all this was not caused by COVID-19 in Wuhan but the historic high equity valuations, record corporate leverage, shrinking global trade, a repo liquidity crisis, and a recent breach of the critical 70% level for US Treasury yield curve inversions. The market confidence was on Fed money printing rather than the already mutating economic virus that the central bank liquidity was trying to alleviate.

Investors should be wary of the relief rally. Valuations are still historically high for the US stock market at large. Both US and the rest of the world will be looking at a chaotic situation both economically and socially. Further monetary easing will not remedy the situation and it will lead to a collapse of those major currencies and implosion of their debt, hyperinflation may start just like Argentina!

The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics about how business cycles occur. The theory views business cycles as the consequence of excessive growth in bank credit due to artificially low interest rates set by a central bank or fractional-reserve banks. According to ABCT, we know that a boom must result in a bust. But no one can forecast with certainly when it will happen, how the sudden demand shock and existential dread will affect business activity and consumer behavior (especially if the lockdown continues for an extended time.) One thing for sure is, it will all depend on the "Blackswan event" under which the fiat money regime operates.

The Fed can’t fix what’s broken

Everything bubble has finally only just burst from truly historic debt and valuation levels. The problem is there are far too many bullish investors believing that business cycles are irrelevant and that markets should not be timed accordingly. As a result, we see more financial and economic pain ahead before the final capitulation that is the ultimate sign of the bear market and recessionary lows. In physics, we describe an objective reality where energy is always constant within an enclosed system. It cannot grow or shrink. It can only change form and get pushed around. While we apply this theory in our economy, the way to end the pain from Policymakers' actions or the "Energy" is either to reset the system by letting it bust or allow it to further expand its credit by printing more money to extending the cycle. Eventually, it will be unsustainable because it's fundamentally impossible within the theory.