Prediction 2 – The World's Biggest Ever Financial Crisis Occurs
All economic and financial predictions for 2020 were thrown in the air by the responses to COVID. Initially, financial markets sold off spectacularly, as the threat to profits was immediately apparent. But, then the speculators remembered that the high price of assets has nothing to do with the level of profits or the real economy, and everything to do with central banks printing money tokens to buy up worthless paper assets so as to boost their prices. As large parts of economies were closed down, and states pumped money directly into businesses to pay wages, and subsidise other costs, and printed even more money tokens to buy up even more of those worthless paper assets, so financial markets not only recovered their earlier losses, but went to even higher levels.
But, that simply shows what a fiction and how unsustainable those financial markets are. There are just two things that have kept them floating in the air at stratospheric levels. One is that central banks kept printing money tokens to buy up bonds and other assets, and two is that governments imposed austerity to reduce aggregate demand in the economy, so as to slow economic growth and the demand for additional money-capital, thereby, restraining both wages and interest rates. The demand for bonds from central banks was enough to inflate their prices, and reduce yields, given the limited supply of bonds issued by states to finance their spending in conditions of austerity. And, slow economic growth, in conditions of guaranteed capital gains on financial assets, was enough to get money and money-capital flowing into those financial and property markets rather than into the real economy, and real capital accumulation.
But, lockdowns have created a condition that reverses everything that has been in place for the last 30 years. Governments have paid out money on a vast scale to subsidise businesses in furlough and other such schemes. For many businesses, even that is not enough. They have other costs for rents and so on. Landlords already suffering as commercial property prices crash, as retail business moved online, were forced to give many of their tenants rent holidays, but eventually, businesses will have to pay up. Smaller businesses were given access to government backed loans, but the banks know that 90% of them will never be repaid, leaving them to try to get the money back from the government that guaranteed them. In September, not one single order for passenger aircraft was placed, anywhere in the world. When lockdowns end, governments will find that they are having to spend trillions of Dollars bailing out core and strategic industries. In Britain, Rolls Royce, seeing demand for its aero engines disappear, introduced a rights issue that saw it issue shares at just a third of the market price of its existing shares. On the one hand, firms will be forced to go to the market with share and bond offerings of that type, just to raise cash to pay their bills and stay in business, whilst governments will also be called on to bail them out, as all of this new issue of shares and bonds, will see their prices crater.
The kinds of money printing seen over the last thirty years worked to inflate asset prices, because there was no corresponding increase in supply of assets. But, now both businesses and governments will have to flood the market with new supply to raise funds to stay afloat. Unlike the money printing that financed speculation in assets, and caused a hyper inflation of asset prices, the majority of new spending is going to finance unproductive consumption. It is going to finance furlough and other such schemes to enable people without wages to continue to consume. It is going to finance the loss of tax revenues faced by governments as businesses are closed down, and no one gets incomes.
Huge levels of debt issuance to finance consumption is exactly the opposite of what has happened over the last thirty years, and as all this money goes into general circulation, so it will cause commodity price inflation to rise. It is already being seen in the COVID adjusted price indices that compensate for the changed nature of consumption, as many products were removed from possible consumption, but as also has been seen in the large price rises of those commodities, when they do again become available.
By the Spring of next year, most countries will have developed a sufficient level of herd immunity that, as already with Sweden, means that new deaths will have fallen significantly, and the argument for lockdowns will no longer be sustainable. As millions of people begin spending again, the demand for a wide range of goods and services will rise sharply. That has already been seen with the demand for cars after the first lockdown was removed. Within a matter of weeks, in 2020, after car production stopped, the existing stocks of cars disappeared. When lockdowns were lifted, large numbers of people, who no longer wanted to risk travel on public transport, bought new cars. The supply could not meet the demand, causing prices to rise. Similarly, reluctance to risk travel on commercial airlines led to a rise in the number of people joining together with friends and family to privately hire small jets to take them on holiday.
All of the liquidity pumped into circulation means that when people can once again spend there will be more monetary demand than potential supply causing prices to rise. Firms will seek to cash in on the higher money profits this creates, by rapidly expanding their own production. But, being already cash strapped, as a result of the lockdowns, they will have to seek assistance either from the state, or from additional debt issuance. Either way, the issuance of debt is going to rise rapidly relative to available supply of savings, which have been run down to finance expenses during the lockdown, which means that interest rates will rise sharply.
The prices of financial assets are determined by capitalised revenues. As interest rates rise sharply, so capitalised values of revenues fall sharply. The lower the existing level of interest rates, the bigger the proportional rise and so the larger the proportional fall in asset prices. That is essentially what caused the scale of the 2008 sell-off. But, interest rates today are not just even lower than in 2007-8, but many yields are even negative. Even the tiniest rise in interest rates today translates into a large proportional rise, and so large proportional fall in asset prices.
The combination of extremely low current interest rates with the huge rise in debt, and increase in inflation arising from huge levels of liquidity, makes a financial crash inevitable. A rise in interest rates alone means that, with the levels of debt, it becomes that much less sustainable, leading to increased levels of defaults. Higher levels of inflation not only leads lenders to seek corresponding returns, but the inflation causes costs to rise, leading to the need for even greater borrowing. As bond prices crash, as speculators sell bonds as quick as they can, some of that money goes into shares, or property. But, companies are also selling shares to raise money, so that share prices also crash. As interest rates rise so the capitalised value of land collapses too, and with many large landlords trying to escape a collapsing market, so property prices and rents crash.
This crash will make 2008 look like a sideshow. The extent of the crash will undoubtedly impact the real economy, but in the real economy, profits are high, there are untold new spheres available for profitable investment, thirsty for investment. With COVID on the run by mid year, and consumers demanding commodities, the crash in financial markets will open the door to money-capital once more being channelled into real capital accumulation, and expansion of the economy. That in itself will create the conditions in which a resurrection of the asset price bubbles is no longer possible, until the next cycle.
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