What are the implications to the overall health of the economy.
In March 18, Canada PM Justin Trudeau imposes a $82 billion dollars in relief packages with interest rate adjustment from 1.75% to 0.25% with over 150 basis points. In March 27, Trump imposes at $2.2 trillion coronavirus relief in addition to the interest rate adjustment to zero. Many countries like with United Kingdom, Italy, Japan have respectively established different fiscal and monetary policies to support the economy in anyway possible.
From a retrospect perspective, government today is bearing much more responsibilities back then, not only because of the severity of COVID-19 but arising political conflicts and much higher expectations from the people. Back to the topic of inflation, what does these all mean for the economy, printing money three times than it used to print, debt-to-GDP ratio reaching above 1, and a market crash in the equity market.
The boom of the United States is pretty much a result of Trump’s growth-oriented vision, it has converted a normal business cycle into a boom or bust cycle. According to Raoul Pal, who created a concept of “doom loop”, which is referring to the transition of wealth is going to take place between the baby boomers and millennials.
The cause of a doom loop is because of various factors in the past who had made baby boomers such a successful demographic as they have benefited from industrial revolution and have become a steadily rich and yet huge population before financial crisis in 2003 and 2008. Most of their money is invested into pension plans, taking a huge role in the equity and bonds market. The arrival of COVID-19 has indicated a sign of recession and further pushed these baby boomers to withdraw their savings from pension plans.
The withdrawal will lead to higher interest rate as corporate bonds faced lessen demand (That’s one of the reason why the Fed lowered the interest rate to keep corporates alive), Public equities are not likely to recover from previous high in early 2020 despite all these fiscal stimulus (where millennials invested their stimulus pay cheque stock market instead of consumptions)
What does it mean to you? The doom loop is likely already taking place at the moment but the effect is not apparent because government is inject so much capital into the market. If a market correlation will have to occur in the future when government will eventually have to cut spendings, stop printing and pay interest on foreign debt, the market will have to reflect accordingly by bottoming.
According to Ray Dalio, his white paper on economics has a great portion reviling debt cycles. In Ray’s perspective, there are short-term and long-term debt cycle. Short-Term debt cycle refers to the interest adjustments according to consumption and borrowing. Lower interest rate leads to higher spending and investment with greater circulation in the market because one’s spending is another person’s income. When debt is accumulated, the central increases the bar to restrict borrowing in order to combat distressed situations. It takes place every 6–8 years for a full cycle and it is unavoidable and great for incentivizing productivity growth.
Long-term debt cycles refers to when debt is outpacing income in a national level, lenders are loosing their bars to send out loans because of the appreciation of assets, equities and income, which are substantially funded by debt. At the end, a bubble has shaped as the misconceptions of economic prosperity has blindfolded lenders, credit decreases, asset value vanishes and equity market crashes as a result of a long-term debt cycles. The frequency and length are determined by productivity stagnation, federal economic policy and trade management.
2021 is high likely to be a result of a trough in the long-term debt cycle, as default risk continues to rise, unemployment boosts and consumption remained low. Trump’s administration has lowered their capability to management economic crisis because he left himself with minimal room to introduce tax cutes and adjust interest rate to stimulate private consumptions. Printing a lot of cash could prevent small businesses going out of business and keep industries like airlines and services alive. However, the repercussion of printing all these money could lead to an ultra high inflation — which will be talked in the next section.
Gold has reached historical in April at $1700/Oz, it is an indicator of investors hedging inflation with gold and also the lost confidence towards the US dollars. The loser of the this pandemic reaction may not be their citizens as they receive pandemic cheques but the countries who have backed/stabilize their currencies with the U.S dollars.
In order to encounter and deflate the inflation of the US dollar, there 3 ways to deal with it, cut spendings, reduce debt by paying or defaulting and redistributing wealth. Which are all contractionary signs of an economy.
Private consumption and investment will remain low for an extended period of time before COVID19 vaccines are developed (not when economy opens). Government is expected reach a $4.2 trillion budget deficit accounting for all the relief packages and tax initiative. With doom loom scenario, wealth redistribution is going to slowly take place in the economy. Which it leaves us with debt.
National debt is going to be an interesting topic is uncover when Coronavirus begins to slow down. A study by World Bank suggested that economy begins to slow down when debt-to-GDP ratios exceeds 77%, after 77% every percentage point of debt above this level costs countries 1.7% in economic growth. In fact, despite of United States success in the financial market in the past few years, disruptive innovations and the number of start-ups have slowed down comparing to 4–5 years ago before Trump was elected.
For authorities and economists, the questions left behind were not how to remain as an economic superpower, but to mitigate the consequences of planting a bad seed 4 years ago of implementing a boom or burst economic policy. A market correlation is likely to be seen a dramatic recession and thus it will mark the end of American’s superpower when economic growth is not able to keep up after the health crisis.