Global Economy in the 2020s

(These are not normal times)

Written Apr 15, 2021

2020 started a new decade with an unprecedented shocker. No, I am not referring to the Pandemic itself, — the world had seen quite a few pandemics before. I am referring to the orchestrated global shutdown, which had never happened before in history.

During the entire “year of Covid”, mainstream media had been scaring the bejesus out of us with daily bombardment of Fear, Uncertainty and Doubt (FUD) about our physical health. But virtually nothing had been reported about the impact of the unprecedented global shutdown on our financial health. Now in 2021, headline business “news” talk only of gangbusters growth and stimulus checks, with no mention of the difficulties in recovery.

Recall that even before Covid arrived on the scene, widespread angst was already palpable: Protests in Hong Kong were getting increasingly violent; the impeachment of President Donald Trump divided the country much more than the two previous presidential impeachments; natural disasters like wildfire devastated places like Australia and California; the George Floyd death flamed BLM movements everywhere; and tension with Iran was rising.

Then came the Covid global shutdown. It was as if the curtain dropped suddenly on the world stage and the play was abruptly interrupted by intermission.

Now, a year later, the curtain is starting to lift, and we can make out the orchestra warming up. But the next act is still a mystery. We know the stage-hands had been busy back stage during intermission. But what have they prepared to “wow” us with? Well, no program was handed out, so we have to figure out the plot by connecting dots.

For 11 years prior to Covid, the Federal Reserve Bank (“the Fed”) had been printing money with no limit with its Quantitative Easing (QE) policy, and keeping interest at near-zero with its Zero Interest Rate (ZIRP) Policy. This combination produced “dis-inflationary boom” in our economy. The very mechanics of QE is a “Liquidity Trap” (it traps the printed money within the banking sector and out of circulation in the general economy), thus forestalling general consumer price inflation. Banks in turn were loath to lend to small businesses on Main Street (thus keeping new money out of circulation in the general economy), but actively lent to large, public corporations which then used the borrowed money to buy back their own stocks and keep up generous dividend payouts, thus driving up their own stock prices and in aggregate fueled a rising stock market. Real estate prices followed suit (“wealth effect” spills over). Put simply, the financial “economy” grew but the physical economy did not. That is why for 11 years prior to Covid, we had consistent asset price inflation, but virtually no consumer price inflation.

Even before that, rampant financialization since the 1980s had created a global financial sector an order of magnitude larger than the global physical economy (which defies common sense). This is explained, by way of Exter’s Pyramid, in my other article “Investing” in the 2020s. Growth in the financial sector thus contributed to the GDP numbers, giving the optics of “growth”, even though there was no meaningful capital investment, capacity expansion, or job creation. There was only widening of the wealth gap: Those who participated in the financial markets enjoyed wealth growth from asset inflation, and those who owned no assets fell further behind in ever doing so (because asset prices kept getting further away from them). This is the “Matthew Effect”. Worse, “growth” fueled by printing of debt-based money (the world’s paper currencies are all debt-based today; that is, creation of money equals creation of debt) further enslaves debtors by creditors. So the wealth gap actually breeds inequality in freedom.

Then came the Covid global shutdown.

Just imagine, both demand and supply were shut down WORLDWIDE, which created a vicious circle that fed upon itself: Serial capacity shutdown caused scarcity and price rise, which reduced demand. In turn, this reduced supply caused more serial capacity shutdown. This vicious circle is clearly recessionary. What do you think a year of this would do to the global economy? Here in the U.S., brick and mortar retailers were all but wiped out. Those that remain carry less SKUs (Store Keep Units, or inventories items) today, and at higher prices. Countless bars and restaurants had permanently closed. Those that reopened now have more limited menus, and at higher prices. Shortages are noticeable even when you shop online.

So what’s the point? Whereas pre-Covid we only had asset price inflation from money printing and zero interest rate, now we have consumer price inflation from supply shortages introduced by the Covid shutdown (because demand is recovering faster, — thanks to stimulus checks, — than supply).

This means the economy is transitioning from “dis-inflationary boom” to an inflationary, or more accurately, “reflationary” period. I detailed this transition in my other article 2021 — The Year of Pivot from Deflation to Inflation. Whether boom can continue (per policy makers’ goal) or bust has begun remains unclear at the moment (because official narrative contradicts anecdotal evidence).

Why “reflationary”? Because after 11 years of dis-inflation, global economy was about to turn outright deflationary, which is by nature recessionary. When consumers anticipate future price drops, they defer purchases. Demand thus drops. As well, when prices drop, producers make less profit, and the marginally profitable start non profitable and go out of business. Recognizing this, the Fed wants to prolong the optics of “boom” via consumer price inflation (which is normally associated with economic growth). In other words, it wants to “reflate” (i.e. generate inflation) to imply growth.

In his most recent appearance on 60-Minutes, Fed Chair Jay Powell characterized the economy as being at a “pivotal point” ready to take off like gangbusters. Duh! The world was completely shut down in 2020. Coming from a zero base, any growth at all is gangbusters! That’s called the “Base Effect”. But the world is nowhere near pre-Covid levels. Thousands of factories closed around the world, taking with them millions of jobs. Even here in the U.S., which is doing better than the EU, millions of hospitality (cooks, waiters, bartenders, etc.) and retail jobs were lost during the shutdown. Only a fraction of people out of work are now returning to their old jobs. The official narrative counts them as “jobs created”. Not only is this fallacious, hundreds of thousands of initial unemployment claims are still being filed on a weekly basis. We’re not out of the woods by a long shot.

Meanwhile, supply shortage induced by global shutdown is very real. It increases input cost for a lot of companies. Some of them will immediately pass their increased costs on, and cause rapid CPI inflation. Others will experience profit squeeze and having difficulties surviving (with high outstanding debt). The Fed will find its “extend and pretend” job a lot tougher from here on out.

Truth is, global economic growth is below long-term trend and thus the world is in depression (persistent economic malaise), which is even worse than a short-lived recession (two consecutive quarters of GDP contraction). If accompanied by inflation, we will be in “stagflation” or “Inflationary bust” for the rest of this decade, in the fashion of the 1970s. If accompanied by deflation, we will be in “Deflationary bust”, in the fashion of the 1930s (following the 1929 stock market crash).

Which will it be? It depends on the Fed’s success at preventing long bond rates from rising. Of all rates, the ten-year Treasury rate is the most influential (hence called the “Benchmark” rate), in part because other rates (like mortgage rates) are pegged to it. This rate is not set by the Fed but determined by the bond market based on inflation expectation. Since reaching a 40-year low on 7/31/2020, the 10-Y Treasury yield has more than doubled from 0.528% to now 1.55%. Now it is taking a respite. All eyes are watching for a resurgence. If that happens, the “inflationary bust” scenario will take hold very quickly.

Rising 10-Y Treasury yield will make it more difficult for heavily indebted corporations to refinance their debt when due, and impose higher interest expense going forward. By some figures, nearly a third of large corporations are already “zombies” (i.e. don’t generate enough operating cash to pay interest on debt). Given this new headwind, some will go under, dragging their lenders (banks) with them. Unemployment will climb. Further, rising 10-Y Treasury yield will make it more difficult for our heavily indebted federal government to continue financing deficit spending with debt (i.e. by issuing more Treasury bonds).

The Fed has already started “Operation Twist”, aka Yield Curve Control, — i.e. selling short term Treasuries and buying long term Treasuries, — to prevent the 10-Y Treasury yield from rising further. The Fed is obviously aiming for the Goldilocks scenario, — keeping rates low enough to prevent business failures, but high enough to imply “growth”. We’ll soon see if the bond market plays along, given rising real inflation is more obvious by the day.

How did the Fed wind up in this predicament in the first place? The short answer is “You may find the monster of your own creation hard to control”. The monster is a multi-decade financial house of cards which requires ever more debt in ever larger quantities to keep propped up. Need some graphics?

The takeaways:

1. Debt relative to GDP (total money spent and received by the economy) is a more accurate portrayal of trend than just debt.
2. If corporate and household debt were included, the trend of this chart will be even more alarming, because of corporate debt growth since 2008.
3. The current level of 136% is not only the worst in history, but especially alarming because it is not even for financing a major war but just to fake economic growth (by fallacious proxy of rising financial markets). Worse, this debt is financed today primarily by the Fed printing money out of thin air, as opposed to China and Japan buying Treasuries, as in decades past.
4. Post war GDP growth (“The Roaring 20s”, — with the birth of the film, automotive and chemical industries; and the “Golden Age of Capitalism”, — with the U.S. devised Marshall Plan to rebuild Europe) was what drove Debt relative to GDP down after WW-I and WW-II. The “Great Reset” (mentioned in my other article Is “The Great Reset” the agenda of heroes or villains?) attempts to create the same “tear-down/rebuild” conditions, — without a kinetic war this time. We’ll have to see how that plays out.
5. The very last spike of Debt relative to GDP was in response to the Covid global shutdown. This spike is literally VERTICAL! Remember “a house of cards fueled by debt requires ever more debt in ever larger quantities to keep propped up” (currently, it takes $6 of debt growth to generated $1 of GDP growth, — and GDP is not even a good measurement of economic growth; job growth is!)? Can a jet plane vertically climb forever?

So here we are, waiting for the magic of the fourth in a series of money printing Fed maestros to show its stuff. Meanwhile, lack of organic economic growth is continually papered over with ever more “stimulus” (read: “subsidy”) checks. Think of the (grossly over-indebted) economy as a dope addict. Instead of helping the addict get “clean”, four dope pushers in succession kept shooting him up with ever more dope (debt). The patient is now lying there near dead, but the needles keep coming every time he stops twitching. When in this decade will he eventually die (from hyper-inflation induced hardships resulting from a currency debased to worthlessness)? This credible expert offers some sobering thoughts.