Unemployment

The Fed firemen are also the arsonists

Jim Grant of Grant’s Interest Rate Observer has a great article pointing out the irresponsibility of the US Fed. It criticises the very conditions that made the outcomes of coronavirus way worse than had they administered sensible monetary policies decades ago. FNF Media has been saying this for years. Now we are facing long overdue nemesis. It is true of the overwhelming majority of unimaginative MMT ‘me too’ central banks.

Grant wrote,

It took a viral invasion to unmask the weakness of American finance. Distortion in the cost of credit is the not-so-remote cause of the raging fires at which the Federal Reserve continues to train its gushing liquidity hoses…But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised the U.S. economy’s financial integrity.

FNF Media keeps on hearing tales about the failure of evil capitalism. When the actions of central banks stifle the free market from achieving price discovery, distorted capitalism will inevitably backfire.

From hereon, sharp pain will be the only effective – and quickest – way to resolve this mess. Governments need to ensure bad companies go bankrupt by rejecting bailout money to zombie companies that will just be a drag on the economy.

Instead of doling out tax dollars, the government should take equity in any business that receives money. Taxpayers deserve a return and by this methodology, it will enforce a mindset that always rejects propping up companies with failed business models. Instead of the government calling the shots, the expertise of commercial lenders should be tapped, a valid point made by Jonathan Rochford.

Unfortunately, this will cause huge short-term disruption and impact large swathes of the community but it will allow markets to clear and provide a platform for risk to be priced appropriately. It is like yanking off a Band-Aid. It stings at first but the recovery becomes far more sound, based on rational economics. Failure to do so will just lead to a protracted Frankenstein economy which will frustrate the majority.

The sad reality will be that Western governments will try to emulate Japan’s lost two decades by crawling on our belly making marginal inches forward. This is somehow seen as superior to hitting the giant “reset” button.

The only major difference being that the Japanese monoculture is experienced and better suited than any other nation to share grief. Western cultures are not remotely close to being able to tolerate such conformity. Japan is not capitalism with warts. It is socialism with beauty spots. It will pay to remember this. In the West, we will demand that others atone for our mistakes. Moral hazard will be the order of the day. This mentality must be stopped dead in its tracks.

Grant reinforced our long-held view on distorting capital markets with this,

The Fed commandeered investment values into the government’s service. It seeded bull markets in the public interest…But investment valuations don’t exist to serve a public-policy agenda. Their purpose is to allocate capital. Distort those values and you waste not only money but also timeLike a shark, credit must keep moving. Loans fall due and must be repaid or rolled over (or, in extremis, defaulted on). When the economy stops, as the world has effectively done, lenders are likely to demand the cash that not every borrower can produce.

We must not forget that post-GFC authorities have been asleep at the wheel even after the introduction of poorly thought out red tape designed to protect us.

Right before the regulators’ eyes, so many blue-chip corporations (e.g. Boeing, GE) binged on ultra-cheap debt to buy back their own shares just to chase short term performance incentives. In recent years, companies like Boeing and GE spent around $45 billion each aggressively buying back their own stock despite being in the midst of severe balance sheet deterioration. Both are trading in a state of negative equity today.

Ford Motor has a junk credit rating. GE & Boeing won’t be far behind them. Over 50% of US corporates are trading one-two notches above junk.

IMG_0523.PNG

The financial community has merely taken advantage of all of this short-termism. Where were the financial analysts doing forensic work on companies? All of this balance sheet deterioration was plain to see.  Why couldn’t they see the obvious long term deterioration in cash conversion cycles? How could they miss that aggregate corporate after-tax profitability has been trending sideways since 2012? Where were the biopsies? We will be witness to plenty of autopsies that were preventable.

Corp Profits After Tax

For Australia’s part, 28 years of unfettered economic growth has bred untold complacency. Only now will we realise the conceited arrogance of government and industry alike. One day we will realise that all of the onerous regulations dripping in ideology (e.g. climate/environment) to confound foreign investment will blow up in our faces. They will not have forgotten that Australia is an unfriendly place to conduct business.

Australia has behaved like a bloated drunk bishop looking down upon his destitute disciples climbing the stairs on hands and knees putting what is left of their pitiful savings into the collection tin. From now, the roles will be reversed at prices that will be highly unfavourable such will be our desperation. Not to mention our currency could well depreciate to a degree which makes us even more vulnerable to foreign predators. Setting our FIRB at $0 will be irrelevant if we fold to the whims of the first suitor that shows interest. The show will be on the other foot.

In press conference after press conference, we continue to be told that hibernating companies will spring back to life and it will all be a case of ‘keep calm and carry on!’We hate to sound negative here.

However, we believe that we are merely being realistic about what is to unfold. The coming depression will force us to become truly appreciative about just how well we have had it while governments have distorted our markets. Had we truly reflected on decades of prosperity instead of wailing about how life has never been worse, things might have turned out differently. We are about to get a true taste of the latter.

On reflection, some positives will come out of this tragedy because we will focus on things that matter rather than getting enmeshed in the theatre of the absurd – identity politics and the cancel culture.

Coronavirus might be a black swan event to the global economy but we have been complicit by allowing our lawmakers and regulators to play slalom with the icebergs. We all knew our overloaded ship was in danger of listing before we left the safe harbour but it was simpler to be suckered into the weather forecasts that predicted endless sunshine and eternal millponds. The engines have now stalled because the tanks are empty. We find ourselves in the middle of a pitch-black, stormy night with howling gale-force winds and a 40-foot swell. Some continue to cling on to the blind hope that the incumbent crew can bail fast enough to avoid the economy capsizing.

It will be all in vain because the ship’s crew left a tape recorder playing on a loop over the tannoy promising passengers to stay in their cabins while they secretly slipped away in the early hours on the only lifeboats available.

Central banks had one mission – create confidence. They have been complicit in the failure. They doubled down on all of the same policies that got them in trouble in the lead up to GFC. They had a simple task of telling governments to embark on structural and tax reform. Instead, they appeased their masters by endlessly cutting rates.

Never again must central banks be allowed to use QE to rescue the economy in a downturn. Central bank balance sheets should be forced to unwind all QE assets. Interest rates must be allowed to set at normalised rates which allow positive returns but avoid reckless borrowing.

While a lot of this piece might sound pessimistic we simply view it as being a realist with experience.

Pandeconomics & 32% unemployment?

Mobster Al Capone Ran a Soup Kitchen During the Great Depression ...

The Congressional Budget Office (CBO) has put forward its assessment of what the pandemic will do to the coming 2Q GDP number. It said,

  1. Gross domestic product is expected to decline by more than 7% during the second quarter. If that happened, the decline in the annualized growth rate reported by the Bureau of Economic Analysis would be about four times larger and would exceed 28%. Those declines could be much larger, however.
  2. The unemployment rate is expected to exceed 10% during the second quarter, in part reflecting the 3.3 million new unemployment insurance claims reported on March 26 and the 6.6 million new claims reported this morning. (The number of new claims was about 10 times larger this morning than it had been in any single week during the recession from 2007 to 2009.)
  3. Interest rates on 10-year Treasury notes are expected to be below 1% during the second quarter as a result of the Federal Reserve’s actions and market conditions.

That sounds pretty tame vs what the St Louis Federal Reserve has estimated.

According to the Bureau of Labor Statistics (via FRED), the civilian labour force consisted of 164.5 million people, and the unemployment rate was 3.5%. This means that there were approx 5.76 million unemployed in the U.S. in February. FRED has estimated on the back of an envelope that 47.05 million people being laid off during this period.

Summing to the initial number of unemployed in February, this resulted in a total number of unemployed persons of 52.81 million. Given the assumption of a constant labour force, this resulted in an unemployment rate of 32.1%

  1. Civilian labour force in February 2020 = 164.5 million (BLS via FRED)
  2. Unemployment rate in February 2020 = 3.5% (BLS via FRED)
  3. Unemployed persons in February 2020 = 5.76 million (#1 * #2)
  4. Workers in occupations with high risk of layoff = 66.8 million (Gascon blog post)
  5. Workers in high contact-intensive occupations = 27.3 million 
  6. Estimated layoffs in second quarter 2020 = 47.05 million (Average of #4 and #5)
  7. Unemployed persons in second quarter 2020 = 52.81 million (#3 + #6)
  8. Unemployment rate in second-quarter 2020 = 32.1% (#7 / #1)

If we backed out the more conservative figure of 27.3 million high contact occupations (#5) and added it to currently unemployed people (#3) we would get a 20% unemployment rate.

N.B. Great Depression unemployment peaked at 24.9%

Nothing to see here

We will get the US Auto sales figures out tonight for March. They will be dreadful. The US has run a 17m seasonally adjusted annualized rate (SAAR) for some time now. March will probably be in the 11-12m SAAR category. Post GFC car sales were in the 9-10m SAAR area.

The market will expect a smacking. It is just a case of whether it beats/misses expectations.

Note China’s car sales fell 79%YoY in February. The highest number on record. China’s car sales have been sliding for the last 2 years so the relative fall is meaningful.

Never let a good crisis go to waste

Never let a good crisis go to waste. Democrats have been doing their utmost to show partisanship during coronavirus. Instead of trying to help their fellow citizens, they see it better to throw in some irrelevant nice to haves which will do nothing to help Americans fight the economic impacts of coronavirus as bargaining chips.

Here are 20 examples.

  1. Corporate pay statistics by race and race statistics for all corporate boards at companies receiving assistance.
  2. Corporate board diversity targets
  3. Bailing out all current debt of postal service
  4. Required early voting
  5. Required same-day voter registration
  6. $10,000 bailout for student loans
  7. For companies accepting assistance, 1/3 of board members must be chosen by workers
  8. Provisions on official time for union collective bargaining
  9. Full offset of airline emissions by 2025
  10. Greenhouse gas statistics for individual flights
  11. Retirement plans for community newspaper employees
  12. $15 minimum wage at companies receiving assistance
  13. Permanent paid leave at companies receiving assistance
  14. hiding the citizenship status of College Students from the Census Bureau
  15. expanded wind & solar tax credits
  16. $100,000,000 for NASA’s environmental restoration group

While it is fair game to question the contents of a $1.8 trillion rescue package, none of the above will help Americans combat coronavirus. So the Dems have upped it to $2.5 trillion to include the above, including $1.5k in aid per individual; as much as $7.5k for a family of 5.

We suppose when the central bank has committed to endless QE, what does an extra $700bn on top of $1.8 trillion matter?

A gem on how to work our way out of the coming economic crisis

Image result for truck nitroglycerin movie

Jonathan Rochford of Narrow Road Capital has written a gem on the role of central banks in spawning this current crisis. An excerpt here:

The rapid and widespread sell-off over the last four weeks is a textbook systemic deleveraging. Whilst the culprits are many; hedge funds, risk parity strategies and investors using margin loans have all been caught out, the underlying cause is excessive leverage across the economy and particularly the financial system. The timing of the unwind and the economic damage from the Coronavirus wasn’t predictable, but such a highly leveraged system was like a truck loaded with nitroglycerin driving down a road dotted with landmines.

Frustratingly, this inevitable deleveraging was clearly predicted. Rather than act to reduce systemic risks central banks encouraged governments, businesses and investors to increase their risk tolerances and debt levels.

Naturally, it fits our own long-held view on central banks.

Jonathan adds some sensible actions which are contained in this link. The question remains whether governments will put principle ahead of expediency in the cleanup?

A reminder of where Aussies are employed

Graph 7: This graph shows the proportions of forms of employment, by industry. Construction has the highest proportion of independent contractors while agriculture has the highest proportion of other business operators

It is worth reflecting on which industries the bulk of Aussie jobs sit. This schematic is from the Australian Bureau of Statistics (ABS).

We have the heaviest tilt toward healthcare and social assistance at over 1.7 million jobs. Retail trade comes in at a shade over 1.2 million jobs. Construction at 1.15 million. Education 1.1 million. Accommodation/restaurants/bars etc at 900,000. Manufacturing another 900k.

There are 13.1 million Australians employed as of February 2020. Full-time employment amounted to 8,885,600 persons and part-time employment to 4,124,500 persons.

That means in the six aforementioned sectors, 53% of Australians in the workforce are employed.

Note that since 1978, Australia has had a 1.74x increase on Full-Time employment and a 4.6x jump in Part-Time in that time. That means the ratio of FT jobs has fallen from 84.9% to 68.3% and PT rose from 15.1% to 31.7% over the same period.

PT employment for men has surged by 6.9x to 1.31 million and female PT jobs have grown 3.9x to 2.8 million.

FT employment for men has increased 1.5x for men to 5.53 million jobs and for women, it has grown 2.8x to 3.35 million.

There are also 708,000 workers aged 40-64 who have multiple jobs. This is up from 646,000 in 2011/12. Total people working in multiple jobs has increased from 1.85 million in 2011/12 to 2.105 million in 2016/17.

We don’t think that the RBA’s latest 0.25% + QE, nor federal/state spending in the current climate can see off mass unemployment. We have written about this in previous posts. We wrote a larger tome on the dire straits facing central banks here.

Macron invites moral hazard

President Macron of France wants to suspend all utility and rent payments for 30 days. So what if Coronavirus lasts 6-9 months? Will landlords get special treatment from the banks to suspend loan payments on those properties forced into providing free rent?What about banks who have to pay for staff with reduced income because loan payments are frozen? Who pays? The very people the government is trying to help.

How long can a country subsidize employers and employees? What will happen when those French citizens who end up 6mths in arrears on rent? Should we expect that they have prudently set aside those payments to hand over as a lump sum to their generous landlords? Will the tenants claim that they had to spend it on other things and ask for the government to pay on their behalf? Of course they will.

These are the first steps to guaranteeing moral hazard. This misguided altruism will backfire big time. The vicious circle will mean the people he tried to help will end up in a worse place after it. Higher taxes, fewer jobs and more handouts with money that has been borrowed or printed.

What next? Bail out restaurants, bars and cafes that are affected by shutdowns?

We are staring at a Great Depression. No one likes to talk about it but we can’t just expect economies to shutdown for 2 months or more and then go back to business as usual once the whole pandemic has been defeated like nothing ever happened.

Take the example of a cafe. Most coffee shops buy in muffins and pastries. So if the coffee shop must cease trading for a while, it will tell its bakery to halt deliveries. Same for the coffee bean makers. And the coffee cup suppliers. They’ll tell their raw materials providers to stop until further notice. And so on and so on. The cafe will temporarily lay off staff. As will the baker, bean supplier and others.

Some staff or owners may have mortgages. Many won’t be able to meet monthly payments. They could default. Their homes could be repossessed by the banks which will then be faced with marking to market the value of the property on their loan books which could technically wipe out all their thin equity. Then the banks will be forced to ask for a bail out. Housing prices implode. Australia, are you listening?

Then home owners struggling to make payments cut back on non essentials. Out go gym memberships and cable TV subscriptions. Buying a latte becomes a luxury.

We are all going to have to realize we will have little choice but to click the big fat RESET button if the economy is to recover properly and soundly. It will be painful and bring out the worst in people but experience is a hard teacher. We’ll get the test first and the lesson afterwards.

And for Australia, which has experienced 28 years of non stop growth, the shock will be exacerbated because of so much complacency.

In a nutshell we all need to relearn the word “personal responsibility“. Governments are only doing everything in their power to remove us having to be accountable for anything.