First a hint of what is going on.
Japan stimulus.
What will likely unfold, fiscal policy blow outs.
Most countries will engage in 2–3 rounds of this stuff, including the US as new fires, appear in credit, asset and flow markets (short term paper).
The price impact immediate, medium, long term.
As each country expands balance sheets, the effect on the currency will be a bit like an impulse shock https://en.wikipedia.org/wiki/Impulse_response. The initial decline at the announcement (1–2 days). Background impacts of demand for local currency and dollars as loans fail to roll, margin calls, greater margin requirements due to volatility, and this will last 1–2 months.
Longer-term >2–3 months policymakers will look to export markets and competitive currency dynamics. Most currencies may stay (relatively) similar at parity with each other, but aggregate real inflation will unfold in many countries as inefficiencies and balkanized trade flows emerge.
Inflation a crude metric of value flow
Interestingly the aggregate inflation metric will mask huge variance among product/service components with some goods and services collapsing in demand/price while others rocket up as a mix of network instability due to supply chain breaks etc. uncertainty unfolds. This will increase working capital costs etc. across the networks of supply chains and payments making some business models (long cycle >8 months) non-viable short term without intervention.
This limitation in inflation to accurately reflect GDP (value flow) will justify new central bank policies and tools.
Real GDP contraction
All of this means 6–18 months of contracting real GDP, while govt’s move to target nominal GDP with fiscal and monetary policy as the big new thing. Targetting nominal GDP allows for a loosening of the typical inflation positioning and tools.
Gold functionally useless but still universally appealing.
Gold will become appealing as it “looks” interesting relative to other short term assets and appears to increase in value as the aggregate speculative network of holders grows and price spikes feed into demand. (see network capital thesis Johnson/gogerty). Broad money from the private sector shrinks in both volume and increases significantly in cost, while short term money M0 grows dramatically due to desperate fiscal policy.
2008 was relatively simple to fix as the challenge was financial and required narrow purchasing of a few key assets types (MBS/CDO) etc. by Maiden lane type facilities. Covid Crisis is real demand destruction combined with fiscal contraction across broad spectrum of sectors and classes of services fiscal and real, combined with potential real or perceived competitive currency devaluations.
Equity PE disaster: disappearing E, overpriced P.
Earnings will be challenged or go negative as real demand for goods shrink 10–30% in some sectors.
Equities and high yield credit markets are seriously overpriced with real yields based on old E’s still at 5–6%. (PE of 20) https://www.longtermtrends.net/price-earnings-ratio/
50% real declines over 6 months could unfold as risk premia expand to at least 8–12% and the earnings side of the equation collapses.
Useless, but shiny appeal
Gold price momentum will accelerate in the 6–18 month period. For gold in real terms $3–4k/oz. is valid in 12–18 months, with huge error bars on the upside as large country reserve policies and domestic demand could skyrocket. India, China, gulf region etc.
The spread between physical and paper gold (ETF’s, swaps etc.)will expand then normalize.
Lastly: political wildcards
It is important to note political instability will increase dramatically as national leaders seek “answers” and solutions. Tarriffs/competitive devaluations etc. and an acceleration of anti-globalization and “flawed” but popular inward-looking economic policies will accelerate and potentially feed on each other.
Full Disclosure: (long gold, short equities)
Author: The Nature of Value
