It’s going to be a while before things get back to any semblance of normal.
That’s the message from Lacy Hunt, as delivered in Hoisington’s quarterly outlook, which strikes a predictably deflationary tone.
“Four economic considerations suggest that years will pass before the economy returns to its prior cyclical 2019 peak performance”, Hoisington says. Those considerations are:
- The synchronized nature of the global downturn;
- The remarkable slump in global trade;
- Surging debt levels associated with the pandemic response, and;
- The veritable collapse in global output
I’ll say a couple of things about each point, drawing on (and linking to) posts which offer more in-depth accounts. I’ll cite brief passages from Hunt.
Starting with the first, you’ll recall that in data back to 1871, the closest year to 2020 in terms of the proportion of economies expected to witness an annual contraction in per capita GDP, is 1931, at 83.7%. This is, in simple terms, poised to be the worst year ever.
1931 is followed closely by 1932 and 1930 on the list. The figure for 2020 is expected to be an astounding 92.9%.
“Recessions are either deeper or longer lasting when a very high percentage of the world’s economies are contracting rather than when they are centered on a limited number of countries”, Hoisington writes. “With over 90% of the world’s economies contracting, the present global recession has no precedent in terms of synchronization”.
On the second point, the Dutch government planning agency CPB publishes a World Trade Monitor each month on behalf of the European Commission. It comes on a two-month lag.
The latest figures show world trade by volume contracted at an epic pace in April. Specifically, the CPB’s monitor betrays a 12.1% MoM plunge. Exports fell by nearly a quarter (-23%) in the eurozone and the US, by -21% in Latin America, and by -14% in Japan.
On a YoY basis, the global decline was an astounding 16.2%.
“With so little of the world left untouched by the 2020 world-wide contraction, no countries appear able to provide a meaningful leadership role in moving the world economy forward by expanding trade relationships”, Hoisington laments. “In addition, it appears that present economic distrust might encourage efforts to erect trade barriers that aim to boost domestic growth”.
On the third point, JPMorgan’s estimates show fiscal support in the wake of the coronavirus crisis totals around $9 trillion, or 12% of global GDP.
When you take account of the assumed ~5% drop in output due to the effects of the crisis on economic activity, you’re left to ponder a global government debt-to-GDP ratio of around 105% by December, up sharply from under 90% late last year.
At the same time, private sector borrowing (which includes bank loans and net corporate debt issuance) summed to around $5 trillion in H1 and will likely total $7 trillion by year-end.
All told, that’s $16 trillion in new debt, according to JPMorgan.
“Total domestic nonfinancial debt, excluding off balance sheet liabilities such as leases and unfunded pension liabilities, surged to a record 259.7% of GDP in the first quarter of this year, 11.4 percentage points higher than the 2009 level when Lehman Brothers failed”, Hoisington writes, before reiterating what most readers likely already know — namely that we’ve reached the point of diminishing returns when it comes to debt and output.
As for corporate borrowing (which hit a record in the first half in the US), Hoisington chides corporate America: “The US business sector continues to ignore Benjamin Graham’s dictum for sound corporate financial management: sell company shares when stock prices are high and use the proceeds to pay off debt and buy shares when stock prices are low by issuing debt”.
They do not believe that central bank purchases of corporate bonds are likely to be a boon to growth.
“The BOJ, ECB, and the People’s Bank of China have all been buying corporate debt of failing entities for more than a decade with the BOJ doing so for more than 25 years”, Hoisington reminds you, noting that “these operations have provided a fleeting lift to economic activity, but at the end of the day they resulted in misallocation of credit, poor economic growth and disinflation/deflation”.
Although regular readers know I have a more benign take on central bank purchases of corporate bonds, the figure (above) is a rough illustration of how accommodative policies aimed at generating inflation can actually be deflationary to the extent they forestall creative destruction and prevent the purging of misallocated capital.
On the fourth point, global economic growth is set to plunge for the full year. Although the outlook may improve, it may just as easily not (e.g., if lockdown/containment measures are reinstated in large economies to help cope with new virus outbreaks).
The IMF’s latest projections show the global economy contracting 4.9% in 2020, down sharply from the 3% seen in the April update. In addition, the rebound is expected to be less robust, with growth running at 5.4% in 2021, down from 5.8%.
The fund calls this “a crisis like no other”. Estimates for advanced economies were slashed across the board in the June update, with only Japan escaping relatively unscathed.
“2020 global per capita GDP is in the process of registering one of the largest yearly declines in the last century and a half and the largest decline since 1945”, Hoisington writes. “The lasting destruction of wealth and income will take time to repair”.
Ultimately, Hunt’s conclusion is straightforward. “Assuming a large percentage gain in economic activity in the second half of this year, the Fed, the World Bank and many economists project that there will still be a substantial gap between potential and real GDP”, he writes.
I’ll leave you with one, final key passage which, incidentally, is also the last paragraph from Hoisington.
At the end of the three worst recessions since the 1940s, the output gap was 4.8% in 1974, 7.9% in 1982 and 6.4% in 2009. The gap that existed after the recession of 2008-09 took nine years to close. This was the longest amount of time to eliminate a deflationary gap. Even when the gap was closing over the last decade, the inflation rate continued to trend downward, remaining near or below 2%. This indicates that there were even more unutilized/underutilized resources than was captured by the magnitude of the gap. Considering the depth of the decline in global GDP, the massive debt accumulation by all countries, the collapse in world trade and the synchronous nature of the contracting world economies the task of closing this output gap will be extremely difficult and time consuming. This situation could easily cause aggregate prices to fall, thus putting persistent downward pressure on inflation which will be reflected in declining long-dated U.S. government bond yields.