One of the bizarre aspects of the global depression resulting from the coordinated shutdown of most world economies due to the coronavius pandemic, is that we have experience a collapse in both aggregate supply and demand which, almost absurdly, has kept equilibrium prices relatively unchanged (except in the infamous case of oil where due to storage space limitations, the prompt WTI contract traded as far negative as -$40 on April 20. As a result, the biggest challenge facing economists is deciding if what comes next after the coronavirus pandemic is conquered, is inflation — as trillions in central bank and government stimulus lead to a far faster rebound in demand, or if the early surge in supply overwhelms demand and leads to a deflationary crash similar to what was seen in oil.
While the majority of economists and strategists, even contrarian types, are confident what comes next is even more deflation — and why not according to 10Y breakevens there will barely be any inflation for the next decade…
… one financial luminary who disagrees is David Einhorn who, when not feuding with Elon Musk on an almost daily basis now, believes that the economic shock from the coronavirus will turn out to be inflationary as he explains in his latest letter to investors.
A global pandemic. It’s just sad. It’s sad seeing people get sick. Some recover, others do not. It is sad to mourn friends who have passed, and sadder still for their families who are not able to say goodbye at the hospital or hold a proper funeral. It is sad seeing people lose their jobs or live with the uncertainty that they soon may. Some jobs will come back, but others won’t. As hard as it has been watching the virus cut a swath of suffering through our hometown of New York, we can only imagine how much worse it must be in countries that do not have a viable choice to shut down their economies to limit the spread of the disease.
Our leaders are faced with a menu of only bad options: allow the disease to spread, or ruin the economy. There is a continuum of trade-offs. On balance, the decision in the U.S. has been to slow the spread of the disease at the expense of the economy, but to try to socialize as much of the cost as possible. We don’t have an economic crisis because of the health crisis; the economic crisis is a product of how we have chosen to react to the pandemic. In the last crisis, we socialized the financial sector risk by bailing out the banks that were deemed too big to fail. The result from that intervention was more than a decade-long recovery, fueled by increasing financial leverage, with the expectation that the government would ultimately assume the risks. And the authorities did so confidently; in June 2017, then Fed Chair Yellen declared that she didn’t believe there would be another financial crisis “in our lifetimes.” We found it cringe-worthy when she said it.
We were told that the emergency measures were temporary. After a decade of easy monetary policy, the Fed, under Chairman Powell, delicately began to unwind some of the emergency measures. Wall Street responded to Chairman Powell’s first courageous steps negatively and President Trump criticized him vociferously.
President Trump is a businessman, and in business, the best credit gets the lowest interest rate. President Trump translated that principle to the sovereign debt market: in President Trump’s view, if the U.S. is the best credit, it should have the lowest rates. The President misapprehends how government debt works. High real interest rates are the sign of a strong economy. They reflect attractive investment opportunities that can earn attractive returns Zero (or negative) real interest rates reflect a weak economy with poor investment opportunities, and difficulty servicing its debts.
In late 2018, Chairman Powell caved to the pressure: he did not have the Volcker-like stomach to absorb blame for the economic slowdown that might have followed a normalization of monetary policy. Instead, he went back to Jelly Donut monetary policy, where the sugar rush drove a final burst of a stock market rally, which lasted until the pandemic — an exogenous event.
Even prior to this crisis, our leaders had reached bipartisan agreement that deficits do not matter. The only real debate had become who to tax and how much to spend. The arguments are generally politically-motivated: tax the other party’s constituents while cutting taxes for your own constituents, and spend money to benefit your own constituents, while trying to withhold money from the other party’s constituents. The outcome of this dynamic has amounted to both guns and butter — and low taxes. Pre-crisis, the Congressional Budget Office (CBO) projected a 2020 deficit of $1 trillion, or 4.6% of GDP, despite record low unemployment. Cyclically adjusted, this very loose fiscal policy matched the Jelly Donut monetary policy.
The pandemic is not anyone’s fault (outside of China). And it stands to reason that policymakers are now doing “whatever it takes” to shelter the population from both the health and economic fallout. Since it’s been agreed that deficits don’t matter, there really is no limit. Debts will be forborne or forgiven and money will shower from the sky. Similarly, monetary policy is in all-out crisis mode. Whatever the traditional rules were, each week we see new evidence that they were made to be broken. Creditors will be protected from losses and money will be printed in whatever quantities are needed to support the fiscal needs.
President Truman once quipped, “It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.” Every business is “essential” for the people who work there. Pausing the economy except for government-determined “essential” businesses has caused a recession/depression.
Having laid out where we are, Einhorn next takes a stab at what happens next. And since Einhorn has for years warned about the dire terminal consequences of what he dubbed the “jelly donut” policy a decade ago, it is hardly a surprise that he expects recent events to only accelerate the coming inflationary climax:
The economy is now faced with simultaneous supply and demand shocks. There is much debate as to whether the shocks are inflationary or deflationary. The deflationists point to the loss of income and the collapsing price of oil. The problem with using oil as a proxy for inflation is that the price of oil is suffering mostly from a demand shock, while the supply of oil is unaffected. Oil wells continue to flow, while demand for transportation has collapsed. Oil is not alone. For any good or service where the supply isn’t cut to the lower demand, prices will fall.
Even so, in a broader sense, we believe the economic shock will turn out to be inflationary. People (and businesses) who aren’t working are no longer supplying goods or services. The social response of replacing most or all of the lost income sustains demand (or, if temporarily hoarded as savings, creates pent-up demand). Although both supply and demand are falling, supply is falling more.
Source: Tyler Durden | ZeroHedge
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