Back on February 27, when it was still safe for New Yorkers to interact with each other in person, Guggenheim’s Scott Minerd sat across from Joe Weisenthal and delivered an almost apocalyptic coronavirus warning live on Bloomberg Television.
“You know, one thing Joe, I will tell you, that I’ve not said to anybody else in public”, Minerd began, clearing his throat to build suspense during a series of what, at the time anyway, sounded like comically overwrought remarks. “This is possibly the worst thing I’ve ever seen in my career”.
Weisenthal was taken aback, as was Scarlet Fu. “At what point did you have that realization?”, Fu wondered. Without missing a beat, Minerd said: “This morning”.
Some market observers (myself included) suggested that perhaps Minerd was overstating the case or, if he wasn’t, that there were more appropriate forums for him to make the point than on television, during market hours.
Fast forward a month and I’d be inclined to say Minerd had the “last laugh”, but that would be wholly inappropriate – nobody, Scott included I imagine, thinks what’s going on is funny.
Well, in his latest CIO outlook, Minerd argues that to the extent they’re over-leveraged after a decade of debt accumulation facilitated by artificially-suppressed borrowing costs, lending to the industries and companies the economy will need to lean on to provide employment when the pandemic ends “will only compound the long run problem… and make the companies even more vulnerable to failure” over the longer-haul.
“We are experiencing the end game of the great debt super cycle”, Minerd declares, adding that “the private sector has become increasingly over-levered [and] the baton is being passed to the public sector where resources are so strained that the printing press has become the last resort”.
He naturally references the US budget deficit being larger than it’s been outside of wartime or recession. Here’s a visual that underscores the anomalous nature of Donald Trump’s deficit spending at a time when the unemployment rate was already sitting at a five-decade nadir:
Obviously, the unemployment rate is set to skyrocket (see last week’s mind-boggling surge in jobless claims), but the chart gives you an idea of why many orthodox economists cautioned against the tax cuts and stimulus push when the economy was already performing well.
Minerd then tells you what he calls “the truth”, which, according to him, is that “the only policy solution short of socialism is to accomplish a great transfer of wealth from investors to debtors”.
He says reorganizations and debt haircuts are impractical for the current situation as “the sheer volume… would swamp the financial and legal systems and large defaults would be followed by asset liquidations that would depress the value of collateral backing other loans and likely set off a downward spiral”.
No argument there. Or at least not if you assume the economic damage from the pandemic will last long enough to make some manner of painful “adjustment” necessary.
As far as negative rates (another possible “solution” to the problem), Minerd says that won’t work because implementing an honest-to-goodness NIRP regime predicated in part on a cashless global society would be a logistical nightmare, and even if it could be done, it couldn’t be implemented expeditiously.
So, what’s the “solution”? Well, the following, according to Minerd:
There remains a tried and true method to achieve this policy: debasement. Many believe inflation is dead and such a policy would not work. The question of how to succeed in raising the price level is more a degree of commitment than ability.
By quickly turning up the printing presses, global central banks would need to provide reserves at a faster rate than the collapse in the velocity of money. This is a delicate exercise and one that would be difficult to execute successfully.
The risks on both sides is not moving quickly enough and overdoing it. If there is too little money made available, the prices of assets used as collateral backing loans will spiral downward. If there is too much, inflation will spiral out of control.
No doubt those words will resonate with many readers, and while he was correct to suggest the coronavirus epidemic would soon become a much bigger problem than many market participants thought possible just four weeks ago, I’m confident the US won’t see an outright “spiral downward” in the value of all collateral (physical or otherwise), and I’m even more confident that inflation in developed economies won’t “spiral out of control”.
As a kind of addendum, I would remind you that, as BofA’s Barnaby Martin discussed last year, one overlooked aspect of QE is the way in which it “‘transforms’ sovereign debt-to-GDP ratios by moving bonds from risk-averse investors towards more risk-tolerant central banks”.
“If QE is sizable enough, the transformation in debt-to-GDP ratios can be meaningful”, Martin wrote. You can see that clearly in the following two charts:
“QE helps ‘de-risk’ financial markets, by moving bonds from risk-averse investors towards more risk-tolerant central banks (buy and hold)”, Martin said, in the course of reiterating a handful of points he made previously. “This means that over the longer term, higher sovereign debt levels can be attainable, while keeping bond market ‘tantrum’ risks in check”.
That contention will drive some QE critics crazy. There’s more than a little evidence to support the notion that the further down the road we get towards central banks cornering government bond markets, the higher the risk of tantrums as liquidity disappears and those markets simply cease to function.
Intermittent flareups notwithstanding, Martin noted that although “Japan has one of the highest government debt-GDP ratios across the globe… volatility of JGBs has been relatively low since 2010”. That, he said, is “partly because” of BoJ ownership of JGBs.
The same dynamic can work for corporate bonds and other types of credit risk, and as of the implementation of the Fed’s hodgepodge of new facilities, we’re going down that road right now.
One last thing you should note about Minerd’s latest missive is that he kicks it off by quoting something he wrote more than seven years ago.
“Governments that have relied upon quantitative easing instead of undertaking necessary structural reforms have arguably entered into the grandest Faustian bargain in financial history”, he said, in 2012. Here are some additional quotes from that very same piece:
As interest rates rise, the market value of the Federal Reserve’s assets will fall. It could then become apparent that the face value of the Federal Reserve’s obligations had become greater than the market value of its assets. This could leave the Federal Reserve without enough liquid assets to sell to protect the purchasing power of the dollar, resulting in a downward spiral in its value.
To hedge against deterioration in the dollar’s purchasing power, investors have already begun migrating toward hard assets such as gold, commercial real estate, artwork, collectibles, and rare consumer products like fine wines.
The ongoing balance sheet expansion by the European Central Bank means European equity prices are likely to outperform U.S. equities over the coming years.
Long-duration, fixed-rate assets such as government bonds are likely to underperform.
That was on August 21, 2012.
Since then, the dollar index is up around 20%, gold is flat, US stocks are up 86% while their European counterparts are a mere 15% higher (that’s after the recent rout) and 10-year US Treasury yields are down 110bps.
I’m sure that “artwork” and “collectibles” call has done well, though.