#165. To catch a falling knife


Unless you’ve been in a dealing-room on Wall Street or in the City of London (or, as in my own case, in both) during a market crash, it’s almost impossible to imagine quite how febrile and frenetic the atmosphere becomes. Rumours flourish and wild theories proliferate, whilst facts are scarce. Analysts are expected to provide instant answers, perhaps on the principle that even an answer which turns out to be wrong is of more immediate use than no answer at all.

It’s a sobering thought that the only financial market participants with any prior crash experience at all are those who’ve been working there for at least twelve years – and even they may have been lulled into complacency by a decade and more in which the working assumption has been that, thanks to the omnipotence and the omniscience of central bankers, ‘stock prices only ever go up’.

This complacency, a dozen years in the making, is a resilient force, and showed signs of staging a come-back in the final trading minutes of a tumultuous week. The logic, if such it can be called, is that the Federal Reserve and the other major central banks will spend the weekend concocting a solution.

For once, this rumour is almost certainly founded in reality, and my strong hunch is that the central banks will have announced co-ordinated measures before the weekend is over. These measures are likely to include further rate cuts, a resumption of the Fed’s $400bn “not QE” programme that ended in December, and statements of intent by all of the central bankers. The likelihood of something along these lines, even if it achieves nothing of substance, will have raised expectations to fever pitch by the time that the markets reopen.

We should be in no doubt that this central bank intervention will be ultra-high-risk. For starters, there are plenty of reasons why it might not work. The Fed, for instance, cannot “print antibodies”, as someone remarked on the superb Wolf Street blog, in which Wolf Richter reminded us that “if you don’t want to get on a plane in order to avoid catching the virus, you’re not going to change your mind because T-bill yields dropped 50 basis points”.

Critically, if the central bankers try something and – beyond a brief “dead cat bounce” – it doesn’t work, then their collective credibility as supporters of equity markets will be shot to pieces, which would overturn market assumptions to such an extent that a correction could turn into a full-blown crash. Their only real chance of success will rest on persuading investors that whatever happens in the real economy has no relevance whatsoever for the markets.

My own preference would be for central bankers decide to do nothing, or, as they might express it themselves, ‘conserve their limited ammunition for a more apposite moment’. This, though, is a preference based almost wholly on hope rather than expectation. We might or might not over-estimate the powers of the central bankers, but we should never underestimate their capacity for getting things wrong.

The double dénouement      

From personal experience, analysts are pulled in two directions at once in circumstances like these. Whilst one part of you wants to provide the instant answers which everyone demands, the other wants to find a physically and mentally quiet space in which to think through the fundamentals. It’s fair to say that, at times like this, it’s enormously important to step back and produce a coldly objective interpretation.

Seen from this sort of ‘top-down’ perspective, current market turmoil is symptomatic of the uncertainty caused by the simultaneous ending of two eras, not one.

The first of these ‘ending eras’ is a chapter, four-decades long, that we might label ‘neoliberal’ or ‘globalist’.

The other, which we can trace right back to the invention of the first effective heat-engine in 1760, is the long age of growth powered by the enormous amount of energy contained in fossil fuels.

Whilst environmental issues are the catalyst bringing our attention to ‘the end of growth’, the Wuhan coronavirus is acting, similarly, to crystallise an understanding that ‘the chapter of globalist neoliberalism’, too, is drawing to a close.

The best way to understand and interpret these intersecting dénouements is to start with some principles, and then apply them to the narrative of how we got to where we are.

Here, with no apology for brief reiteration, are the three core principles of surplus energy economics.

First, the energy economy principle – all economic activity is a function of energy, since literally nothing of any economic utility whatsoever can be produced without it.

Second, the ECoE principle – whenever energy is accessed for our use, some of that energy is always consumed in the access process.

Third, the claim principle – having no intrinsic worth, money commands value only as a ‘claim’ on the output of the energy economy.

Together, these principles – previously described here as “the trilogy of the blindingly obvious” – provide the essential insights required if we’re to make sense of how the economy works, how it got to where it is now, and where it’s going to go in the future.

The ECoE trap

Critically, the energy cost component (known here as the Energy Cost of Energy, or ECoE) has been rising relentlessly since its nadir in the two decades after 1945. Since surplus energy, which is the quantity remaining after the deduction of ECoE, drives all economic activity other than the supply of energy itself, rising ECoEs necessarily compress the scope for prosperity.

The way in which we handle this situation in monetary terms determines the distribution of prosperity, and informs the economic narrative that we tell ourselves, but it doesn’t  – and can’t – change the fundamentals.

Where fossil fuels are concerned (and these still account for more than four-fifths of all energy supply), the factors determining trend ECoE are geographical reach, economies of scale, the effects of depletion and the application of technology.

These can usefully be expressed graphically as a parabola (see fig. 1). As you can see, the beneficial effects of geographical reach and economies of scale have long since been exhausted, making depletion the main driver of fossil fuel ECoEs. Technology, which hitherto accelerated the downwards trend, acts now as a mitigator of the rate at which ECoEs are rising. But we need to recognise that the scope for technology is bounded by the envelope of the physical properties of the primary resource.

Fig. 1

Fig. 4 parabola

Analysis undertaken using the Surplus Energy Economics Data System (SEEDS) indicates that, where the advanced economies of the West are concerned, prior growth in prosperity goes into reverse when ECoEs reach levels between 3.5% and 5.0%. Less complex emerging market (EM) economies are more ECoE-tolerant, and don’t encounter deteriorating prosperity until ECoEs are between 8% and 10%.

With these parameters understood, we’re in a position to interpret the true nature of the global economic predicament. The inflexion band of ECoEs for the West was reached between 1997 (when world trend ECoE reached 3.5%) and 2005 (5.0%). For EM countries, the lower bound of this inflexion range was reached in 2018 (7.9%), and it’s set to reach its upper limit of 10% in 2026-27, though prosperity in most EM countries is already at (or very close to) the point of reversal.

Desirable though their greater use undoubtedly is, renewable energy (RE) alternatives offer no ‘fix’ for the ECoE trap, since the best we can expect from them is likely to be ECoEs no lower than 10%. That’s better than where fossil fuels are heading, of course, but it remains far too high to reverse the trend towards “de-growth”.  In part, the limited scope for ECoE reduction reflects the essentially derivative nature of RE technologies, whose potential ECoEs are linked to those of fossil fuels by the role of the latter in supplying the resources required for the development of the former.

The energy-economic position is illustrated in fig. 2, in which American, Chinese and worldwide prosperity trends are plotted against trend ECoEs. Whilst the average American has been getting poorer for a long time, Chinese prosperity has reached its point of reversal and, globally, the ‘long plateau’ of prosperity has ended.

Fig. 2

Fig. 6a regional & world prosperity & ECoE

Response – going for broke

As well as explaining what we might call the ‘structural’ situation – where we are at the end of 250 years of growth powered by fossil fuels – the surplus energy interpretation also frames the context for the ending of a shorter chapter, that of ‘globalist neoliberalism’.

Regular readers will know (though they might not share) my view of this, which is that the combination of ‘neoliberalism’ with ‘globalization’ (in the form in which it has been pursued) has been a disaster.

Whilst there’s nothing wrong with spreading the benefits of economic development to emerging countries, this was never the aim of the ‘globalizers’. Rather, the process hinged around driving profitability by arbitraging the low production costs of the EM nations and the continuing purchasing power of Western consumers, the clear inference being that this purchasing power could only be sustained by an ever-expanding flow of credit.

The other, ‘neoliberal’ component of this axis was based on an extreme parody which presents the orderly and regulated market thesis as some kind of justification for a caveat emptor, rules-free, “law of the jungle” system which I’ve called “junglenomics”.

From where we are now, though, what we need is analysis, not condemnation. As we’ve seen from the foregoing energy-based overview of the economy, ‘neoliberalism’ was as much an inevitable reaction to circumstances as it was a malign and mistaken theory.

Essentially, and for reasons which energy-based interpretation can alone make clear, a process of “secular stagnation” had set in by the late 1990s, as the Western economies moved ever nearer to ECoE-induced barriers to further growth. At this juncture, policymakers were compelled to do something because, just as never-ending growth is demanded by voters, the very viability of the financial system is wholly predicated on perpetual growth. The contemporary penchant for ‘globalist neoliberalism’ simply determined the form that this intervention would take.

Since our interest here is in the present and the immediate future rather than the past, we can merely observe that, after the failure of ‘credit adventurism’ culminated in the 2008 global financial crisis (GFC), the subsequent adoption of ‘monetary adventurism’ simply upped the stakes in a gamble that couldn’t work. What this in turn means is that the probability of truly gargantuan value destruction is poised, like Damocles’ sword, over the financial system. If it hadn’t been the Wuhan coronavirus which acted as a catalyst, it would have been something else.

Conclusions and context

As we await the next twists in some gripping economic and financial dramas, it’s well worth reminding ourselves that stock markets, and the economy itself, are very different things. High equity indices are not hall-marks of a thriving economy, least of all at a time when market processes have been hijacked by monetary intervention.

In so far as there’s an economic case for propping up markets, that case rests on something economists call the “wealth effect”. What this means is that, whilst stock prices remain high, the accompanying optimistic psychology makes people relaxed about taking on more credit. The inverse of this is that, if prices slump, the propensity to borrow and spend can be expected to fall sharply.

The snag with this is straightforward – unless you believe that debt can expand to infinity, perpetual expansion in credit is a very dubious (and time-limited) plan on which to base economic policy. If the central banks do succeed in reversing recent market falls, the only real consequence is likely to be a deferral, to a not-much-later date, of the impact of the forces of disequilibrium which must, in due course, redress some of the enormous imbalances between asset prices, on the one hand, and, on the other, all forms of income.

Ultimately, we don’t yet know how serious and protracted the economic consequences of the coronavirus will turn out to be. My belief is that these consequences are still being under-estimated, even if, as we all hope, the virus itself falls well short of worst-case scenarios. It’s hard to see how, for example, Chinese companies can carry on paying workers, and servicing their debts, with so much of the volume-driven Chinese economy in lock-down.

Within the broader context, which includes environmental considerations in addition to the onset of “de-growth” in prosperity, we may well have reached ‘peak travel’, which alone would have profound consequences. Other parts of the financial system – most of which are far more important than equity markets – seem poised for a cascade. If it isn’t ‘Wuhan, and now’, the likelihood is that it will be ‘something else, and soon’.

47 thoughts on “#165. To catch a falling knife

    • Agreed. There is something of the Problem of the Tool here. If the only tool one has is a Hammer then sooner or later all problems turn into Nails.

    • The point I’m making here is that this has hit an already-weakened economy and an already-over-inflated financial system. Yes, it would be bad news under any economic and financial conditions, but conditions as they are have already elevated leveraged exposure to any adverse event.

    • But I think if you delve deeper into the article and this whole blog you will see that these complex supply chains are as a result of the rising cost of ECoE. The fact we need such globalised networks to try and sustain the growth we have had up until recently exposes the world to far greater consequences from nCov or soem other potentially much worse virus that could spread even more rapidly with more deaths. Yes, Spanish Flu and various plagues also spread and devastated populations with ease but if something equally nasty came along now it could be around the world within days – even nCov has gone to every continent in a matter of a couple of months. Spanish Flu of course was perhaps the first big pandemic after the invention of the internal combustion engine and powered flight

    • Thanks Paul, that’s exactly right.

      What I think we need to guard against is a narrative that ‘everything was fine, until the virus came along’, or ‘everything will be fine, once the virus goes away’. I may have put too much emphasis here on the energy fundamentals, but the aforesaid comforting narrative takes a lot of countering.

      I’m intrigued by what’s happening in China, where the rate of spread of infection seems to be tailing off. For those who believe the perpetual bullish arguments about the Chinese economy, this might be persuasive, i.e. that China is seeing the benefits of the robust actions taken as the virus started to spread.

      But my view is that the Chinese economy is now in such big trouble that Beijing simply had to find some way to get things moving again, even if that meant retreating from previous prudence on the outbreak. The spectre which stalks the nightmares of the CPC leadership is urban unrest, and that makes this situation especially hazardous – unemployment (because companies cannot afford to keep on paying laid off workers), food prices rising (which was already a problem because of the pork setback), and failing supply lines for the household essentials.

      This, at the least, inclines me to caution about reassuring data on virus trends seemingly emerging in China.

    • Hi Tim

      Does anyone know what’s going on in China with C – 19? I doubt if even the ruling class do.

      Which is worse; “getting things moving again” when you know things are worse than we are being told or when we don’t really know what’s going on? Frankly it seems one hell of a risk to me either way so do they really have a choice?

    • Bob

      Looking back to this article, I’ve been saying for a long time that things look bad in China.

      Obviously, this forms the context for what they can, must or choose to do. As mentioned in that article, the spectre that haunts the nightmares of the CCP is urban unrest. In practical terms this means employment, first and foremost, but supplies of essentials must be sustained, and price inflation (in categories like food) kept under control.

      I cannot see how meeting any of these imperative objectives can be consistent with continued lockdowns – though I take the point that doing the opposite hasn’t worked out well for Iran.

  1. Devils advocate here:

    Even if growth in prosperity has generally gone into reverse, I wonder if there isn’t still enough surplus energy in total for the current economic system to absorb the shock from COVID-19 and continue more or less in its current form. My statement assumes worse case Covid-19 pandemic scenarios do not materialize.

    It still astonishes me to contemplate the economic activity I see in the U.S. that represents the vast surplus of energy we have. People flying everywhere, driving everywhere, getting there take-out food delivered by money loosing companies, vast hours spent walking around talking on phones and watching cat videos. I have raised this point on this blog before.

    My bias is to see these activities and signs of the peak of the current system, and think that it could rapidly collapse downward from this point. But as long as fossil fuels continue more or less their current production levels, it may be that the system still has lots of surplus even-if-declining net energy to absorb shocks such as COVID-19 and continue forward. For now.

    (Yes, I know Shale production is vulnerable to a rapid collapse. )

    • Thanks Shawn.

      First, it isn’t just shales that are in a bad way – the fossil fuels industries more generally, and oil in particular, are already in a bad and worsening financial condition, whilst progress on renewables has stalled because we can’t scale-up earlier subsidy regimes.

      The way that we use energy is indeed extraordinarily wasteful. This, I think, reflects behaviours learned when ECoEs were low. But trends in many areas had turned down long before the virus event. We’re already buying a lot fewer cars, for example, and fewer smartphones.

  2. You may already be familiar with his work, but a couple of interesting papers by David Korowicz are especially relevant today – We Need to Talk About Catastrophic Global Risk and Catastrophic Shocks Through Complex Socio-Economic Systems — A pandemic perspective.
    They can be found at https://www.korowiczhumansystems.com/publications

  3. Governments should:
    1 implement local activities to provide necessities
    2 heavily tax unnecessary consumption
    3 un-tax local economic activity
    4 keep adjusting these levers, very carefully, until transport and travel is reduced by at least 80%
    5 use the higher tax out of unnecessary consumption to provide financing of all of this

    A dangerous path. But we will have to walk it, by choice or being forced to.

  4. I’m intrigued by what the effects – both immediate and lasting – on travel are likely to be. The folks stranded in Tenerife, for example, are likely to have further isolation required of them when they get home, on top of the quarantine period before they can even leave. Then there’s cruise liners, for which the publicity has been awful. People really don’t want to get on planes with the virus threat on their minds, plus the possibility of getting stuck in quarantine wherever they are going.

    Cancellation of everything from football matches to high-profile events may be sending a clear message. Video-conferencing may now seem more attractive than ever before.

    In this context, it’s noteworthy that global car sales were falling markedly, well before the virus issue emerged. So I wonder if there are trends now starting where people simply travel less than they have in the past?

    • I have been trying to travel less. I also do a lot of lift and coast to save fuel; surprisingly this doesn’t add much to journey times. I do this for the environmental benefit as much as the cost. One downside to this is that when it comes to MOT time my diesel van is often more choked up with soot so you then have to do a few blasts up and down the motorway at max revs to dislodge!

      I am due to do some sound engineering work in northern Italy about 50 miles from Milan in March. The two musicians I work with are coming from Scandinavia and are in their 70s and 80s. I worry more for their health than mine; for myself, the spectre of being stranded there for a few weeks or more is more worrying than catching the virus – all sorts of financial implications if I am not back home to work or oversee certain things.

      I think anyone who cares about the environment, the future or supply energy is no more aware than ever of the problems we have and this will result in less consumption. I look back on the fact that only 15 years ago I thought it was OK to buy a cheap vacuum cleaner for £10 knowing I could just buy another when it inevitably burned out. even then I cared but I was still not aware enough of the finiteness of energy, raw materials and, ultimately, our environment.

  5. I’ve have to admit finding this pretty funny…………..

    If you’ve not seen it, it’s a positive test on an – er, employee – at a brothel in Valencia. Over 100 people, including 86 customers, have been held in lock-down, with many no doubt scratching their heads in search of a plausible explanation when they do, eventually, go home………

    • #92: Pianists in a brothel
      There is a story (which may well be apocryphal) about an Italian politician who took a friend home to meet his mother. On the way, he warned his friend that his mother was a rather grand old lady, with high notions of decency and respectability. For this reason, he had not informed her that he was in politics, and asked his friend to keep his secret. “If she knew I was a minister in the government”, he said, “she would be appalled”.

      His friend asked him what his mother thought he did do for a living. “She thinks I play the piano in a brothel”, replied the politician. “That’s far more respectable”.

  6. A timely reminder from reality in this article from Zero Hedge: https://www.zerohedge.com/economics/global-demographic-fact-vs-central-bank-sorcery

    Those with most of the world’s wealth and therefore the power to decide the planet’s future, are entering a phase in which they facilitate the significant decline of demand, while preventing change as they live out the rest of their lives. In parallel with this inevitably will be the decline of energy usage as a consequence. The concurrent collapse of fiat currencies and the chaos that that brings to trade, economies and the socio-political-financial system dynamics should prevent sanity prevailing: https://www.zerohedge.com/markets/why-bear-market-will-lead-dollar-collapse.

    Another interesting factor entering play in this building perfect storm, is the unwinding of ultra-globalised trade that the virus of our day is going to precipitate. Thus far, it has allowed the universal elites to rule their respective masses by attritionally impoverishing them with the outsourcing of labour to the cheapest in a race to the bottom. The folly of putting all your eggs in one basket (most of the world’s manufacturing in China) has now become clear even to laypeople, adding to the pressure of ignorant nationalism in favour of isolation. This could for a while at least rebalance some of the raging inequality within countries as they have to produce their needs at least, if they still have that capacity.

  7. My own preference would be for central bankers decide to do nothing, or, as they might express it themselves, ‘conserve their limited ammunition for a more apposite moment’. This, though, is a preference based almost wholly on hope rather than expectation. We might or might not over-estimate the powers of the central bankers, but we should never underestimate their capacity for “getting things wrong.”

    As you say, for once i think the central banker should sit this one out and let the market settle at the current level. Shares are overly expensive due to;
    a] cheap money for some [speculators] and
    b] companies using cheap money to buy back shared and reduce their overall dividend payouts.
    c] if cheap money had been spent on infrastructure renewal, it would have created meaningful employment. But it is now too late, especially if % rates rise.

    If the central bankers wanted to do something, try going back to basics, state that %rates will rise to historic norms at 0.25% p 1/4 till this is achieved. If they do this collectively [in a similar manner to when they cut %rates] Down to negative levels.

    a] How can you cut %rates to stimulate growth when you are already at ZIRP levels.
    b] People at first borrowed to spend, but are now maxed out on credit, and are fearful when, not if, % rates do indeed rise. But in a panic measure the reverse of 5-6% down to 1% in 2008. It could be a panic rise of 0.5% to 5-6% in a similar time scale, which would trash the market for years.

    So signal that %rates will rise steadily to 5-6% over a period of say 5 years. [and mean it] This would allow consumers and business to deleverage. whilst creating sound money again.
    Use the KIS & KIT principle Keep It Simple & Keep IT Transparent. You may even create trust.

  8. Imho the virus is/will wake people up. The realization(s) that they are facing I don’t see them taking well at all. We have our first case of ‘in the wild’ virus locally not more than 20 miles from me. Announced on Friday night, people were rushing into Costco to stock up Saturday morning. Just people being prudently cautious is enough to cause contraction in my view. That contraction will self re-inforce over time perhaps more quickly than I had originally figured.
    I did see this virus coming to the US, and with an attitude toward reasonable civil preparedness has been labeled ‘prepper nutcase’. They announced on TV Friday that people should have 2 weeks worth of food to be able to shelter in place. The mad rush is on!
    I wonder what the drive up lines at McDonnalds look like today.

    • Thanks David.

      My understanding is that there is a lot more interest in ‘prepping’ – in general, not just in these circumstances – in the States than we have here in Europe, though I’ve never encountered this myself, as most of my travel in the US has been to big cities.

      I’m not a devotee of prepping, and I’ve written (though not published, yet) an article about why buying a bunker is no answer to anything. My ‘answer’, if there is one, is based on informed co-operation.

      Where I live, we’re a small island where most things have to be brought in by sea (though I think our food self-sufficiency is very high), and I’ve seen no signs of hoarding as yet. I’d be interested to know whether this is happening in European countries like France, the UK, Germany and – perhaps most of all – Italy.

      What’s likely to concern people here is whether the tourist season is impaired. My hunch is that that’s not going to turn out well.

    • We’re in Michigan (the US Midwest) and haven’t yet seen any rush at the local Costco or other markets. Some Whole Foods are out of grain, bean and rice, but that’s being blamed on last year’s horrific flooding in the plains states.

      We’re part of a citizen-based emergency response group and tend to keep track of such stuff and share discoveries among others in the group. Our community has been trying to create a local provisioning economy; it’s much too early to know if that is helping with this current event, but we have been promoting a “well fed neighbor” notion (where “fed” is used in the broadest sense of that word).

      Some might see what we’re doing as “prepping” and they might be right. But I’ve found that people use that word as too broad a brush.

      In New York Times today was a nuanced piece on prepping that was balanced between panic and denial. “How to Be a Smart Coronavirus Prepper” at https://nyti.ms/39aXbo1

      My lab recently got funded to study the creation of neighborhood “resilience hubs” (https://www.usdn.org/resilience-hubs.html). Below is an excerpt where we introduce “civic resilience,” which might be called by some s prepping.

      In reporting on Hurricane Dorian, The Guardian found that, “As aid agencies struggle to reach devastated areas, some residents take recovery efforts into their own hands” (Laughland 2019). Indeed, as the climate emergency overwhelms existing institutions, citizens frequently will have to act unaided. Notably, FEMA’s mission now supports citizens who already are on-site. This is a change from earlier approaches to disaster response, which were centrally staffed and managed. Previously it was assumed that financial resources, outside responders, centralized management, and level of damage were the key predictors of recovery. Recently, disaster response transitioned to encompass a strategy that follows the work of Aldrich (2018, Aldrich & Meyer 2014), who found that “disaster resilience comes from internal factors: How connected are we? How much trust do we have in each other? How often do we work together?” Resilience is being redefined in academic and public discourse (Meerow & Newell 2019, Meerow, Newell & Stults 2016). But on-the-ground planning and practice is running ahead of this theorizing. Civic resilience describes this pragmatic approach and developing this capacity in neighborhoods is the core of our newly started action-oriented initiative. Yet the premise outlined below is controversial enough to make securing external support unlikely, or much delayed.

      PREMISE – Dr. Missy Stults (City’s Office of Sustainability, hereafter City) succinctly states the premise underlying our research. In conversations with citizens, she asks how well a neighborhood could care for itself if a major event were to shut down an entire area for an extended period, gravely reducing the ability of city, county, and state services from providing immediate help. Just a few years ago, this premise would have seemed unrealistic. However, to San Jose, California residents, it is their new reality; PG&E cut power to nearly 800,000 citizens in Northern California starting October 9th. Consistent with the premise above, the mayor of San Jose told residents to prepare to be without power for as long as seven days, while another official asked citizens to “Prepare yourself, prepare your family, and help your neighbors” (CNN 2019). This situation is astonishing; intermittency of power and uncertainty about the duration of an outage is an almost unheard of combination in modern industrial society. Although plausible, the premise has proven difficult for many people to accept.”

      I’m reminded of what farmer’s around here say, “Hope for the best, prepare for the worst, endure what comes.”

    • Preping is quite a US thing. In France it is largely unknown, except in the sense of small communes trying to live off the grid. The whole bunker, amo and canned food is not really a thing. More like permaculture and degrowth.

      Switzerland is different though. Here preping was (is) pretty much institutional with retailers having the obligation of having months worth of stockpiles of a lot of stuff and fallout shelters under pretty much any building built from 1960’s to the 2000’s.

      The tourist season is getting a nasty beating, that’s for sure. Quite a lot of restauant and hostel have thin margins and large debts. This is going to get bloody. High tech manufacturing is also looking like it’s taken a sucker punch in the nose with the whole supply chain weakest link illustration taking place.

    • Thanks.

      On your final point, this coincides with where I think the real focus ought to be – my belief is that this is going to transition from a market slump into a banking crisis.

    • I think that glass jaw of our pumped muscle man banking system is at risk of shattering, and all the pumped up muscle will deflate right quick if the situation extends for say, more than 2-4 weeks. I don’t think the banks have the endurance to take one for the team here.

      And from the looks of it, the situation will not be brought under control within 2-4 weeks now that we got multiple clusters in the EU. The best we can hope for is 4 weeks (like in China) with strong measures, or a wider spread (so longer than 4 weeks) with weak measures. TBH Italy seems unable to deal with it. If Milano grinds to a halt (wither because of quarantine or a sick workforce), this will be very bad in terms of economic impact as it’s one of the largest EU manufacturing hubs.

      And thinking of it, it’s not like the EU countries have much room to manoeuvre in terms of economic relief measures. I hope that the CB will pick the right hill to die for.

      You know that things are bad when the head of the socialist party asks for business relief measures.

    • Thanks.

      Let me just reiterate that, fundamentally, what we’re seeing are cash flow problems, and these are far more pressing considerations than asset pricing. What the CBs need to watch for now – and I’m sure they are – is transmission to the banking system.

    • The notion that prepping is a US thing has to be put into context. I don’t know UK/EU history or practice on the matter (and benefit from your reports, especially the Swiss practices), but here in the US I can say that while it does happen it’s a very limited practice and nowhere near the level being suggested. Even away from the big coastal cities, it’s a very rare practice. Newspaper stories, sensational headlines, TV shows, and blogs may grab attention but it’s not a “US thing” to be into bunkers, ammo and canned-food-filled basements. Those latter make for great photos and podcasts.

      What doesn’t make for the same sensational coverage are transition towns, eco-villages, co-housing, housing co-ops, and now resilience hubs and other community-based efforts to respond to the climate emergency and increasing ECoE. Hollywood, newspapers, and blogs may like stories at the extremes (i.e., either apocalypse or techno-growth), but we shouldn’t let our view of human nature, or the nature of one country, be framed into such extremes.

      Prepping is a word, in my opinion, being used indiscriminately. We likely need another word for when a family and/or community decide to explore alternatives to a just-in-time, global-supply-chain, consumerist lifestyle. Calling small experiments focused on creating a sustainable life pattern the work of nutcases isn’t going to make the rest of our message here get a hearing.

  9. I think you underestimate the almost fanatical desire to travel of the average person in the UK whether for plain old sunbathing or to “improve” their minds. In only 50 years of constant advertising, glossy mags and even David Attenborough extolling the virtues of say the Galapagos I suspect it is one of the last things people will give up voluntarily. I hope this link works(I’m not much good at this stuff)
    The average citizen spends nearly as much on holidays as food and I suppose if you include the ones who can only afford food the difference is even less.
    Quite staggering how something once reserved for the rich (and the poor old Tommy) has become completely normalised in such a short period. Prices will have to sky rocket or Covid-19 prove to be worse than flu (on Friday a friend travelling to Abu Dhabi who said it was no worse than Flu and they needed the break) before this mad frenzy stops.

  10. Thanks for yet another post Tim – these are a couple if extracts from today’s post by Ambrose of the Telegraph with respect to the virus :

    Europe’s car industry is also in the sights. Moody’s downgraded Renault to junk last month. S&P has placed the company on creditwatch negative at BBB-, just one rung short of junk status and alongside GKN, IHO Verwaltungs, and ZF Friedrichshafen. The world’s number one car-maker VW is at BBB+ and no longer has much buffer.

    The US Treasury, the International Monetary Fund, and G20 Basel regulators have all warned that the underlying quality of high-yield debt and leveraged loans has deteriorated badly and is now more extreme than before the Lehman crisis.

    But what they are even more worried about is a fat tranche of BBB rated securities that has mushroom fivefold since 2008 to $3.4 trillion and is precariously perched on the cliff-edge. The slightest shock could lead to a cascade of downgrades.

    The US Treasury’s watchdog (OFR) said in its Stability Report that investment funds with strict mandates would be forced to sell these derated fallen angels, setting off firesales into a frozen market.

    It looks very bad


    • It does – especially in China, where bond ratings have seemed to get ever less credible as debt has soared, and where default rates have climbed rapidly over the last year.

      There is enormous scope for cross-contamination in the financial system. I’m still waiting – perhaps in vain – to see what the Fed and the other CBs might do. If the answer turns out to be ‘nothing’, I can see markets cratering.

  11. I am currently home educating my younger daughter so no problems if schools are closed except for attending exams in May/June. This then makes me wonder how the effect of delaying the whole exam season would have on universities, owners of student accommodation etc. Some of these universities are already on a knife edge. Lots to go wrong and lots to think about.

    • Indeed so – our systems have remarkably little resilience.

      Your comment adds to my thought that there could be a lot of collateral damage in the property sectors, both residential and commercial. What happens to houses bought up for tourist letting if the tourists don’t come – or commercial property where tenants’ income has dried up?

  12. Am I correct in my understanding that, during a stock market crash – and no buyers, if persistent stock market sellers sold £50billion value of shares it would be possible for the stock market index to fall by as much as 1000 points and register much higher order of magnitude in trading loss, perhaps as much 500billion?

    • First, you can’t sell – ‘execute a trade’ – if no-one is buying. What happens to stocks is that prices, both bid and offered, fall to a point at which a trade takes place.

      So, a stock that started at $100 is falling, I’m an owner and want to sell. Nobody offers me $90, or $80 – will I accept $70? And is there a buyer at that price anyway?

      In a thin market – i.e., very little buying and selling is taking place – it doesn’t need to be a huge transaction to have a big effect.

      Remember, also, algos – programmes which trigger sells automatically, sometimes on the stop-loss principle. These send “sell” orders, though these orders may not be able to be executed.

      Finally on this score, think about margin calls. I buy that stock for $100, but pay only, say, $10 down. Then it goes to $80, with me not only $10 out of pocket but owing $90….. Margin calls are huge in modern markets.

      Spread betting seems to be pointing at a 500-pt drop on the opening. CBs seem to be paralysed…….

  13. Thank you Dr Morgan, that explains the processes involved.

    I have always purchased long-dated Government backed Bonds – much safer, less gambling and I can sleep at night!

  14. We live in interesting times.

    The impact of ‘self imposed Isolation’ avoiding ‘public Gatherings’ – Cinema, Theater, Resturants, Shopping etc over the summer will be to say the least interesting.

    I dont see much demand for Cruises and Foreign Holidays this year

  15. Dr Tim,

    One thing that has changed since you and I were in London (well, I guess so, anyway) and selling analysis and, in my case, investments, has been the inexorable rise of index-tracking funds. We started with these, in the UK, in around 1990 as far as retail investors were concerned. Over the last 30 years, investment products have developed, with Exchange Traded Funds (ETFs) now beginning to dominate the investment landscape as far as index funds are concerned. ETFs purport to offer instant liquidity; I don’t believe a word of that, at least where “inefficient” sectors (small caps, high yield bonds, etc.) are concerned.

    With six or seven mutual fund companies utterly dominating shareholder registers in the USA, to whom can they sell stock? Each other, of course, and that will either significantly widen spreads, or, as you say, just not happen at all. Similar situations will now be found in almost every market.

    Sure, we know that “active” management only has about a 30% chance of outperforming a benchmark, and similar liquidity constraints apply, but I have said the only thing that I can reasonably say to my clients with their portfolios (mainly Victorian & Edwardian investment trust companies) – do nothing!

    The market must be allowed to find its own level; we have had enough interference, as you have also said.

    Here in the UK we are due a budget on 11 March. I would imagine the new Chancellor is going to be rather more constrained than he might have though a few days ago. And I haven’t even mentioned the coming pandemic (which I hope doesn’t happen).

    • Indeed, we certainly don’t need yet more interference with markets.

      From a broader financial perspective, equity markets are nowhere near the top of any list of what we should be concerned about.

      For a CEO, for example, ‘can we keep producing things?’, ‘can we keep paying our staff?’ and, biggest of the lot, ‘can we keep on servicing our debts?’ are all way more important than ‘where is our share price?’

      Governments and others have a legitimate concern with the prevention of shock market falls, but do not have a legitimate interest in keeping markets high.

      Rather, the focus now needs to be on liquidity – on supporting the banking system so that it can keep on supporting businesses. This is where, if something isn’t done, a market crunch could be the overture to a banking crunch.

      The emphasis might now shift towards fiscal rather than monetary support. Cutting rates is pretty ineffective in this situation. A drop in rates won’t get people spending again. But giving firms ‘tax holidays’ might save them from going under.

  16. @ Dr. Tim

    Re the 500 point drop in stocks (I assume US DJII), Marketwatch has the Futures up 300, and the SPY ETF up .9% There’s widespread belief that a rate cut is coming soon. I expect a dead cat bounce at best.

    • Well, the futures reversed downwards by around 1%. It’s anybody’s guess. I suspect the CBs will need got go all in on equities if they try to avoid a bear market. Even then, I doubt they have enough ammo.

    • It seems that Asian markets rose around 1%, with the BoJ following the Fed with vague-sounding promises to support markets. This vagueness probably makes more sense than going in ‘with all guns blazing’ when you’re out of ammunition.

  17. I’ve have to admit finding this pretty funny…………..

    If you’ve not seen it, it’s a positive test on an – er, employee – at a brothel in Valencia. Over 100 people, including 86 customers, have been held in lock-down, with many no doubt scratching their heads in search of a plausible explanation when they do, eventually, go home………

Comments are closed.