So 2019 really was the ideal time to start a youtube channel focused on economics because
the months since this channel has taken off have not exactly had many dry news days.
The economic impacts of the coronavirus have been felt far and wide and we have
covered these problems in-depth in a handful of videos on this channel.
But the logical question that most people are asking is what comes next?
Disasters happen and they are never pleasant but part of being a nation,
a business or even an individual is being able to deal with adversity and come out the other side.
Because of this people are expecting a recovery of sorts, and it seems like the
only point of contention will be what letter of the alphabet this recovery will represent.
You have likely heard of a v-shaped recovery, so-called because it would reflect a sharp
decline in the financial markets and then a sharp recovery making the shape of a V.
Other speculations include a w shaped recovery where we will see 1 recovery
then another decline as the effects of government stimulus and relief
packages wear off only to be followed by another genuine recovery later on.
Pretty much at this point, if a letter has some kind of topography,
alphabet obsessed economists have used it in a prediction.
Of course, the big issue with this is that nobody can really predict the future
so that means until this whole thing plays out we really won’t know for certain.
But that doesn’t mean that these predictions are simply the result of economists desperately
trying to justify their existence in an increasingly thin difficult job market either.
In fact policies and procedures should be put in place by governments to appropriately
deal with any one of these types of recoveries, if and when they happen.
But amongst all of this, there is one type of recovery that we should all be very afraid of,
one that is not getting nearly as much airtime and one that is actually being
hurt by a lot of current policies and that is a K shaped recovery.
What’s more, is that this type of recovery is not a hypothetical or a speculation,
it is happening right now before our eyes, and that shouldn’t come as a surprise.
It was actually the same type of recovery we experienced after 2008,
so perhaps predicting anything different is the real farfetched reality here.
But as always we need to look at a few things
to really understand what this K shaped recovery looks like.
So what even is a K shaped recovery?
What are the forces that are driving it?
How should governments, businesses, and individuals plan for it?
And while we are having fun speculating
What will the K mean for our economies in the future?
ADD INTRO
Now a v or u or w shaper recovery is pretty easy to understand. Just put the letter over
the top of the dow jones industrial average price chart and hey presto predictions made.
But the eagle-eyed amongst you might have realized that
K doesn’t really work for this its got too many lil squiggly bits. Sooo
What is a K shaped recovery?
A k shaped recovery starts out the save as
any other recovery profile. With some kind of economic decline.
The largest quarterly drop in GDP growth in recorded history
and swelling unemployment figures should fill in for that pretty nicely.
Now as for the actual recovery part of a K shaped recovery that splits into two
just like the letter, with one portion of the economy going back to or even exceeding
past prosperity and another portion of the economy continuing to fall behind.
Now in this case the divide between these two portions of the economy
are wealthy asset owners and big businesses in one category,
and then regular wage earners and small business owners in the second category. Shocking I know.
This is already starting to happen and the results are clear. The S&P 500 grew to its highest level
ever in the same month that the overall economy recorded those record losses.
American billionaires have added a staggering 637 billion dollars to their collective net worth,
while unemployment has spiked into double digits.
Now the reason this is happening is that financial markets that drive the wealth
of most American billionaires are planning for the long term.
Investors know that eventually, this health crisis will have to come to an end and at
that time the businesses that they own will be there and ready to start turning a profit again.
So long as their companies survive through a year or so of slower business
they will come out the other end all the same.
The chances of them actually making it though have been massively improved by generous
government stimulus and record low-interest rates, which means even businesses whose core
operations may have been impacted are feeling pretty flush with cash.
What’s more is that this is the worst-case scenario.
for a lot of businesses like Amazon, and Uber, the idea of a world avoiding
shopping centers and public transport has been a massive short term win.
Now unfortunately the average world citizen does not have the luxury of
making financial plays over the years or decades
they have to put food on the table today, which without a job can be extremely hard.
Sure government support is there but for most households, it will not come
fast enough or provide enough income to support their day to day living expenses.
This means that those families will have to do one of two things.
One cut back on living expenses, and no
we are not talking about giving up a morning Starbucks, and Disney plus subscription,
we are talking about deciding whether or not to pay for electricity bills or groceries.
Now the second option is that they can start to dig into their assets.
Now given that more than 70% of American adults have less than $1,000
in savings these might not be the assets you think of.
People will have to sell homes, cars, and other personal belongings. In the off chance that
they have retirement savings it might mean smashing open that piggy bank prematurely.
The Australian government has allowed its
citizen’s early access to their retirement savings.
This policy allowed people economically impacted to access up to 20 thousand dollar
that would have otherwise been locked away from them until the age of 65.
Now in the short term this was fine,
it allowed people to make their next mortgage or rent payment.
But a majority of people accessing this cash were younger families
that had decades left of potential compounding over the course of their working lives.
20 thousand dollars today may keep food on the table a roof over the head and the lights on,
but it means forgoing hundreds of thousands of dollars at retirement.
Now it’s difficult to comment on this being a good policy or a bad policy.
Even the cushiest retirement probably doesn’t mean much if your young family is out on the streets.
But what this does show is that a downturn hurts everybody,
but the true devastation is not felt in weeks or months of scary headlines,
it is felt, compounded over a lifetime by those who couldn’t weather the storm.
Now the Australian example looks at people who were fortunate
enough to actually have retirement savings.
For some people, the solution will be accruing debt. Racking up credit cards,
personal loans and maybe refinancing their home, if they are lucky enough to own one.
For these families, they will wish they were missing out on compound
interest because it is going to be hurting them in the other direction,
with loan payments that might go on for years after crisis.
One other thing to keep in mind amongst all of this, is that this will not simply
be those with means riding things out while everybody else gets pushed under.
This chaos will actually present a great opportunity for those
in the top part of this K shaped recovery.
The 2008 financial crisis presented a very similar situation to the one we are in now,
all be it far more watered down.
In the wake of that crisis,
people were able to capitalize by buying up distressed properties and companies.
Blackstone is a private equity company that today is one of the largest residential landlord in
the united states thanks to the 30,000 homes they purchased out of foreclosure in the wake of 2008.
Blackstone in a recent letter to their shareholders detailing their 2020 Q2
performance they made note of the fact that they had $156 billion dollars in “Dry Powder”.
Dry powder is a fancy finance term for cash or cash equivalents that is ready to be invested.
What this means is that they are poised ready to snap up some bargains as soon as they go on sale,
be that in the form of cheap houses from forced sales, loans to households trying
to stay afloat or simply shares in a market that seems oblivious to the wider economy.
Blackstone is just one example of this, lots of seriously wealthy institutions
and individuals have been hoarding alot of cash for exactly this reason.
Now capitalizing on economic misfortune feels bad, but realistically businesses do this all the time,
they are entities designed to run an efficient market. If they see a asset
priced below value they but it, if they see an asset priced above value they sell it.
It’s just that in the midst of an economic downturn this mechanical
process can seem a bit hmmm scrooge mcducky.
But for the businesses that can do it, good on em, it’s a sign of solid asset management.
What is also solid company management are the plans that are not so secretly being worked on
for after the recovery.
We will actually do a video on this topic in much more detail in the next few weeks
but for now, there are billions of people around the world who are now working from home full time.
This has been a big technical challenge for a lot of businesses
but necessity is the mother of invention and a lot of companies have made that leap.
With the realization that almost all professional office-based work can be
done from home comes the realization that almost
all professional office-based work can be done from Manilla or Mumbai.
Ok, doom and gloom aside big picture it sounds like there should be some steps to take to avoid
the special k becoming a regular occurrence that hits developed nations every 10 years.
So how do we
Avoid the K
This is something that is ultimately going to come down to governments and individuals.
If businesses can make money off misfortune they are going to make that money, but it
should be the role of governments to avoid this as much as possible,
and to be honest, for people to take a bit of personal responsibility as well.
On a national or even a global level downturns see a peak in inequality.
Now regardless of your opinions on wealth inequality, even the most hardcore fat cats
would probably agree that this divide should be driven by some people getting
richer during the good times, rather than most people becoming poorer during the bad times.
So something needs to be put in place to account for this.
Now countercyclical fiscal stimulus in the form of government grants,
welfare cheques, business loans and tax cuts are great.
But its actually only half of the solution and if anything it is the least important half.
Fiscal policy has two modes, expansionary and contractionary.
Exapnsionary fiscal policy is what we are seeing now.
The government trying to prop up the economy by pumping money into it,
but they almost always fail at flipping the switch back over to contractionary fiscal policy.
Contractionary fiscal policy involves taxing more and giving less government money away.
Which are not exactly wining campaign slogans,
so governments are often times alot slower to adopt this.
Now despite what even most economists think,
contractionary fiscal policy isn’t used to save up a pool of money during the good times.
Sure it certainly can that buuuuttt I mean a lot of developed governments
have completely given up on the dream of a surplus in the next million years or so…
No the real motivation of contractionary fiscal policy
is to get people used to living in a world where cash doesn’t necessarily come easy.
Taxes are high and less government spending means that on average
people will be bringing in less money.
Of course since this is only done during times of economic prosperity,
the overall health of the economy will more than makeup for this, but nobody,
not businesses, municipalities nor individuals will be lulled into a sense of complacency.
This might just sound like it is starving the economy of oxygen, and it kind of is in a sense.
To really stretch the analogy, world-class athletes will often train in high altitude
environments to get used to exercising with thinner oxygen. That means when game day comes
the thick air of see level gives them a new boost of energy beyond what they have trained with.
Contractionary fiscal policy is training the economy for tough times.
But cmon, welcome to the modern western world, nobody want’s to put effort in anymore. So
if you want to prepare for this you are going to have to do it yourself.
Now on an individual level everybody knows the solution. Live below your means and save.
There is a great adage is that a healthy economy is like high tide,
everybody gets to frolic in the ocean and have fun.
But as soon as that tide goes out you get to see who wasn’t wearing any pants, or
put basically who was living beyond their means.
People can get away with living paycheque to paycheque for a long time during economic booms,
but if they find themselves pantless at low tide, it is already too late for them. They
have lived beyond their means and now they are going to pay for it.
Now one of the issues here is that the means of the average American household
doesn’t pay for the lifestyle that people expect of the average American household.
If you think of middle america you will probably think of a 4 bedroom 3 bathroom house, 2 cars,
a holiday every year, and maybe a few toys paid for by 1 and a half working adults.
The thing is though, even two average full-time jobs
don’t pay for that kind of lifestyle in most areas of America anymore.
But since that standard of living is the assumption people continue to fall into it.
The Overspent American is a book by the economist Juliet School that chronicles
the way that the American dream has increasingly moved upscale
while simultaneously everyday costs of living have risen and wages have remained stagnant.
This isn’t a uniquely american problem either,
most developed western nations are dealing with a very similar predicament.
So even though everybody knows the solution deep down.
Live below your means and have an emergency fund, not a lot of people are willing to do it.
Compare this reality to nations that actually do have a high savings rate, china, korea, signapore.
In these countries, you will find things like multigenerational housing
is commonplace, where families will have up to 4 generations living in the same household,
with parents working and grandparents looking after the children.
Now this is obviously hugely financially beneficial because not only are housing
costs reduced but so too are things like utilities, spending on furniture,
land rates, and household upkeep all while having childcare built into the package.
All of this said living with your parents past the age of 25
in most western nations still carries a bit of a stigma with it.
Final Thoughts
The K is coming and it is going to be more devastating to a lot
of households than a response by the same name in a text…
The shape of the recovery on average might not matter much for a majority of people,
if they are already sunk.
Times of crisis are times of opportunity but its important to have the discussion about whether
this opportunity should come in the form of taking advantage of distressed households.
Now it is easy to shrug this distress off as the result people living beyond their means
but as we have seen that has become increasingly easy to do.
Outside of everything it should go without saying that you probably want to be
on the right side of that K, and to be there you need to make good investments.