Ignore the Shutdown, the U.S. Was Already Depressed

Ignore the Shutdown, the U.S. Was Already Depressed
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Germany’s government was only just beginning to tackle the problem. Chancellor Angela Merkel had earlier advised German states to cancel any events where large groups might gather. Now, on March 16, she finally felt they had to go all the way. Even the brothels, she said, would have to close down.

Just a few days before, on March 13, the various economic and finance ministers in Merkel’s government did get together in close proximity. Not yet fully fearing what the virus models were advising, they did apparently fear the economic models forecasting none but darkness across the entire horizon. The European economy was, like America’s, already in serious trouble.

But unlike in the United States, the Europeans and especially the Germans weren’t in denial about it. Germany had, more than anyone save China, wrestled with the consequences of a global downturn begun two years earlier; more than a slowdown which no matter how much time had passed only squeezed their economy harder.

It would not let go. Worse, the longer the squeeze went on the more countries were sucked into the vortex of an increasingly global synchronized downturn officials were powerless to either stop or accurately identify (two years and all they came up with was “trade tensions”).

As 2019 was ending on what Jay Powell claimed was a hopeful note, Europe began 2020 with its three largest economies already at the doorstep of recession. Both France and Italy, numbers two and three, respectively, had posted slightly negative GDP over the final three months of last year. Germany, the largest European economy, while barely managing to avoid a minus sign in Q4 still had to reckon with how overall GDP during it was still less than it had been three quarters before.

Suffering no illusions, Peter Altmaier, Germany’s Economy and Energy Minister, declared, “No healthy company should go bankrupt because of corona, no job should be lost." To that end, the politicians would at first hand over their fiscal bazooka to Kreditanstalt für Wiederaufbau, or KfW, the country’s public-sector “development” bank.

About half a trillion euros were initially pledged from the federal government to KfW. The bank would lend to businesses suffering from economic interruption of one form or another. Within a week, the amount was being rethought and then within a few extra days the original KfW program was supplemented by a few hundred billion more while the Wirtschaftsstabilisierungsfonds (ESF) being hastily arranged to further rescue non-financial businesses with around €400 billion of its own.

Clemens Fuest, President of the IFO, a Germany-based economic think tank, soberly observed, “The costs will probably exceed everything known from economic crises or natural disasters in Germany in recent decades.” How quickly it all escalated.

Shutdowns, or market meltdowns?

While the ESF was being negotiated along with the KfW expansion, Germany’s Minister of Justice, Christine Lambrecht, responding to criticism announced, “If financially strong companies now simply stop paying their rents, this is obscene and unacceptable.”

The implication being that sound businesses were taking advantage of a crisis for either some “free money” or to escape their obligations.

Define financially strong, though.

While we await GDP estimates from deStatis for specifically the German economy, we do have them in hand for all of Europe (Eurostat compiles its own estimates). According to these figures, released yesterday, the European economy, encompassing the 19 members of the defined Euro Area, dropped by 3.83% in Q1 2020 from Q4 2019. It may not sound like all that much at first, but only until you realize that’s a quarterly rather than yearly rate.

It comes out to a bit over -14% in annualized fashion. Record contraction. Suddenly, “financially strong” is a much more difficult term to advise, perhaps stripped of all its former interpretations.

Europe’s worst quarter during its painful 2012-13 recession was the final one in 2012. Mario Draghi had felt moving toward it he had to promise to “do whatever it takes” including a massive monetary response, he claimed, the year before. EA19 real GDP fell by 0.42% Q/Q, or an annual rate of -1.67%.

Even during the first global financial crisis, GFC1 2007-09, the absolute lowest point in Q1 2009 saw real GDP in Europe collapse by less of an annual rate compared to now (-12%). Consecutive waves of global fire sales and across the Continent impending bank failures to go along with big name nationalizations.

The pandemic-model inspired shutdowns weren’t even imposed until right near the end of March 2020. There were various advisories and increasing restrictions, undoubtedly some coronavirus fear which leaked into populations, by and large, however, what happened in Q1 predated the heaviest restrictions and non-economic interference into each economy.

There was, however, from mid-February forward GFC2.

The US economy only looks good by comparison to Europe. Somewhere Ben Bernanke is smiling, having used this same standard to justify his QE’s; “at least we aren’t Europe” isn’t quite the standard for success rational people have in mind for these mythical designs.

On Wednesday, the US Bureau of Economic Analysis reported that the American economy suffered, too, albeit at a much lower rate of contraction than on the other side of the Atlantic. Real GDP: -4.9% quarter-over-quarter, this figure at an annual rate already.

The internals were worse, with a disaster in trade “contributing” 1.3 points to the final number. US imports fell by 15% after having dropped by more than 8% in Q4 – a collapse in domestic demand during a time when no one had heard of Wuhan. Real Private Non-residential Fixed Investment, GDP’s measure of capex, declined by almost 9%. And that was the fourth straight quarter of negatives.

As you can see, America was in trouble long before COVID-19, too, suffering under the same global downturn which had more severely impacted Germany and Europe. We weren’t different, just not as misfortunate, a gap from which Jay Powell like Bernanke used to bolster his own credit. The bond market, unlike Powell who was still hiking rates while whistling inflation, nailed it when the curve flipped way back in late 2018.

Understanding this point is the key to understanding what’s rapidly unfolding before our very eyes. Thirty million American workers have filed for unemployment benefits in a matter of a few months. It’s not all because of the model-inspired, misguided stay-at-home orders.

The surging ranks of the unemployed have only just begun to devastate the system. In Q1’s GDP estimates, the one for consumer spending, Personal Consumption Expenditures, or PCE, declined by a whopping 7.6%! And it wasn’t a lot worse if only because of the Toilet Paper Scare of 2020; spending on non-durable goods was up 5% during those three months.

How bad was this?

More than twice the negative of the worst quarter of the Great “Recession.” Real PCE declined by 3.7% in Q4 2008 from Q3. That was the one immediately following Lehman/AIG, the very one in which the hardest part of GFC1 was experienced for its entire length. A full quarter of bank panic, global dollar shortage, and mass unemployment. The same period when the labor force, according to the BLS, peaked and from which has since never recovered.

You have to go all the way back to the second quarter of 1980 to find PCE falling this far, this fast. In 1980, there was double-digit inflation and double-digit interest rates.

The reason inflation and interest rates were sky high was a monetary system in utter chaos and disarray, only the direction the dysfunction was taking had been the opposite of what we are familiar with today. Same principles, though.

In other words, underlying the severity of the short run problems in the 1980 economy was an undercurrent of largescale financial, really monetary, disturbance. While everyone who lived through the ’80 recession hoped for a quick end and even faster turnaround, President Jimmy Carter most of all, the “V” just wasn’t a realistic possibility with such fundamental uproar beneath.

The immediate recession itself was short; lasting from January 1980 to only July. But there was no real recovery from it; the monetary disaster taking up a lot more time to process and a lot more economic activity to burn through.

In fact, recovery would have to wait until December 1982. A second even nastier and protracted contraction would strike less than a year after the ’80 recession had ended.

I will argue that these Q1 2020 estimates are far more important to understanding our predicament, and how realistically we might get out of it, than those from Q2 2020 will be. This current three-month period will supply the worst economic statistics since the early 1930’s. But it’s the way in which we entered this quarter which should be disturbing.

As I wrote last week, the global economic system is right now exhibiting breath-taking fragility. Even in the US, counting on purported strength going in, the system has just collapsed. This isn’t all shutdown, and the parts that aren’t are those which tell us something important about what to expect on the other side of this thing.

Systemic weakness so thoroughly on display up front is no basis from which to build a recovery afterward. Equal the Great Inflation, the Great Depression, as well as the Great “Recession.”

Top to bottom, there were 8.7 million fewer payrolls by February 2010 compared to the peak in January 2008. If a year and a half from now we hear how the labor market has come roaring back, as it undoubtedly will, and how jobless claims have been reduced by 30 million it’ll sound very good as a soundbite. But if it does so from a peak near 40 million, that’s an epic disaster no matter how roaring the roar.

If the economy (GDP) drops by 30% in Q2 2020 but is up 45% in Q3, we’ll still be behind Q4 2019 but only barely and likely we won’t remember too much about the whole affair. Quickly forgotten as a bad memory.

If, however, it falls by 30% in Q2, manages only to get back to zero in Q3, and then rises by 30% in Q4 and another 5% in Q1 next year, that’s an epic disaster – especially so given how so much attention will disingenuously be drawn to that +30%.

A hypothetical scenario such as the one described above, beginning with the -4.9% already in the books, this would leave real GDP 3% behind where it had been in Q4 2019. Five quarters and a 3% reduction is all pretty close to the Great “Recession” with its six quarters in duration and 4% in depth.

What the mainstream models are all depending upon to approach even that rebound is, of course, “stimulus.” All kinds of it, from QE’s to KfW to the Fed buying equities directly from the NYSE (sorry, it’s coming). Econometrics, unlike the actual global economy, is flooded with monetary and fiscal stimulus.

The real world has been operating under a far different set of parameters. Starting with a (renewed) dollar shortage which showed up at the end of 2017. Economists’ models forget 2019 and its “stimulus” which still left that monetary shortfall more than one up on the expected outcomes. Europe at the brink of recession despite the ECB’s restarted QE and more negative rates (which somehow is coded as accommodation in the regressions).

The US like Germany was warned by the bond market, and Jay Powell eventually and partially heeded it by the end of July 2019. Rate cuts as insurance and aid, bolstered, he said, by “repo” operations and then not-QE QE. And yet, underlying was a deepening manufacturing recession all along and growing signs of contraction in the cyclical components of GDP by year’s end.

More than a year of global “stimulus” already prior to COVID-19 and entering the pandemic era we find only shocking fragility in all corners.

Especially monetary policies couldn’t even begin to adapt to a two-year long slump, but now they’re going to absolutely guarantee we get out of a 1930’s sort of collapse so as to have any chance of lessening it to a 2008-style experience? Jay Powell and Christine Lagarde, fresh off Argentina, they’re going to competently lead the world out of the abyss their gross incompetence had left it within?

It’s really not hard to imagine why the global bond market hasn’t much responded to all these political announcements and policy promises. The Fed has, many claim, “flooded” the world with dollars and yet every part of bond and money markets trade otherwise. No flood today, certainly none tomorrow, and the negative consequences continue to be mapped out by un-curved curves far into the future.

No one is downplaying the severity of the situation, even the worst offenders deserve some limited credit here. Where they’ve offended is in overplaying both the starting position and then their ability to limit the downside and pick everything back up on the other side. In between is not really the issue.

We’re only getting data on the first part of it, and already it’s enough to make you sick. They bungled 2008, badly. They botched everything about the last two years. And now the first steps into the current crisis couldn’t have gone worse.

Our long run potential, though, that still can.

Get rid of them all. Now. The clock is ticking. 

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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