The world is being shaken by the pandemic caused by the new coronavirus, and Japan is
not an exception.
Schools closed, events cancelled, travel restricted – the virus has drastically re-shaped our
everyday lives.
The virus has not only infected many individual persons, but it has also managed to infect
the economy.
It is crucial to understand how the virus spreads and how we can protect ourselves against it
but it is equally crucial to understand the economic consequences that often are the
catalysts that move history.
A large portion that I will talk about in this video don’t only concern Japan but
applies around the globe, as the way many developed country economies operate are from
the same playbook.
Let’s get into it.
First, let’s get one thing clear.
The economic chaos we are seeing is not happening exclusively due to the coronavirus.
It is a much more truthful representation to think that the structure and the practices
of our economic system has been accumulating risks for many years now and the coronavirus
was only the match that exploded this barrel full of gunpowder
The previous financial crisis that happened in 2008 was resolved by central bank stimulus
This was like slapping a piece of duct tape on the bottom of a sinking ship.
This time the nature of the crisis is a little different but the actions of the central banks
around the world are almost identical to the last one.
Unlike last time however, the pin that pricked the bubble attacked directly the so called real
economy.
As people take precautions not to go outside and spend, the direct result is that many
local businesses – mostly small can’t withstand the loss of cashflow.
Our economies are largely dependent on domestic consumption, so when this economic activity
is hindered the consequences quickly multiply.
I compared our economies to a barrel full of gunpowder.
This gunpowder represents the debts of individuals, corporations, municipalities and governments.
It is the fractional banking system that only holds a few percent of reserves compared to
our deposits.
Or no reserves at all, as the regulation was revised.
In essence, the banks are insolvent and are able to keep operating only due to central
banks pumping more cash into them and on the condition that the majority of people won’t
take notice to this.
The gunpowder is also our underfunded liabilities, for example our pension funds.
It also represents the over-levered investors and institutions that have acquired assets
on debt, and should these assets fall, so will they.
A prime example of this kind of domino effect leveraging is happening around the SoftBank
Vision Fund.
As a venture capital they have invested about 100 billion dollars into various start-up
companies, the most famous being WeWork.
WeWork in itself has enormous debt loads as it has not managed to occupy a sufficient
portion of its office space and we can assume that the coronavirus will make the
situation even worse.
SoftBank on the other hand has received financing from many banks and individuals with Mizuho bank
Mitsui Sumitomo bank and Mitsubishi UFJ bank being the top lenders in Japan.
To receive this lending SoftBank Group has pledged SoftBank corporation stock as collateral.
Meaning that if the stock price falls, the banks will ask SoftBank Group to put in more
collateral or they will liquidate these stocks.
Now we can see how all of these entities are linked to each other and how a failure for
one can cause problems for the whole chain.
And this is only a simplification of the entire structure which most likely has more
moving parts and connections.
So this is the system we have created through many years and the spark to ignite the proverbial
gunpowder barrel could have been anything.
So why are the central banks and governments fighting this crisis as if their life depended
on it?
To answer that question, let’s see what would happen if they failed.
As you may have heard, the central banks are considered to be the lender of last resort.
Whenever a bank or a company that is deemed “too-big-to-fail” is on the verge of bankruptcy,
the central banks activate and lend them money, kind of like using a cheat code in a game.
The central banks have the ability to magically create currency from nothing which they can
then push to the markets to keep the economy going.
If you are interested in how this process works in the detail, please go and watch the
“Hidden Secrets of Money – episode 4” by Mike Maloney.
So should the central banks fail to keep our bubble economy inflated, we could fall in
to something called the deflation spiral.
In this scenario everything deflates.
Stocks, bonds, real-estate, wages, consumer prices - everything goes down
Resulting in asset holders facing a reality check, as their paper wealth evaporates before their eyes.
Remember that asset holders are not only those top-hat and monocle wearing elites, but workers
that are participating in pension funds, insurance companies and normal households.
This deflation spiral is like experiencing the withdrawal symptoms from drug use.
Suddenly everyone is poorer, which leads to them cutting spending, and when spending decreases
more companies go bankrupt, people lose their jobs and so a feedback loop is created.
The deflation spiral is an opposite reaction to the inflationary policies that have been
taken by central banks.
The traditional Keynesian economics recommend that the deflation should be fought by all means
through government intervention such as public spending projects and central bank stimulus
This can seem like a good idea at first but when we consider that the government has to
first siphon the capital from someone in order to spend it, the net effect is usually negative.
As the government don’t face the same difficulties in raising production capital as private entrepreneurs,
it is much easier to start public projects that are economically not viable – producing
malinvestments that are exposed in the future.
The capital the government uses for these projects are taken from taxes, reducing the
available capital of the public – or the capital can be procured from the central bank
printer, in which case the existing currency is devalued, thus forcing the public to pay
through inflation.
The whole point is that, the more the government intervenes by launching public projects,
forcing companies to keep wages high,
forcing banks to extend credit
The longer and more severe the healing process ends up being.
The deflation happens because of the excess that was created during the inflationary,
so called “good times” and it is impossible to have a recovery without first letting the
economy adjust.
In the next video we will take a look at the Bank of Japan and Government to see how they
are intervening in the markets and ultimately creating the biggest economical crash in our lifetimes
See you in the next video