Rare Supply-Demand Shocks
Bloomberg has an excellent article on how the Global Economy Is Gripped by Rare Twin Supply-Demand Shock.
The coronavirus is delivering a one-two punch to the world economy, laying it low for months to come and forcing investors to reprice equities and bonds to account for lower company earnings.
From one side, the epidemic is hammering the capacity to produce goods as swathes of Chinese factories remain shuttered and workers housebound. That’s stopping production of goods there and depriving companies elsewhere of the materials they need for their own businesses.
With the virus no longer contained to China, increasingly worried consumers everywhere are reluctant to shop, travel or eat out. As a result, companies are likely not only to send workers home, but to cease hiring or investing — worsening the hit to spending.
How the two shocks will reverberate has sparked some debate among economists, with Harvard University Professor Kenneth Rogoff writing this week that a 1970s style supply-shortage-induced inflation jolt can’t be ruled out. Others contend another round of weakening inflation is pending.
Some economists argue that what’s happened is mostly a supply side shock, others have highlighted the wallop to demand as well, to the degree that the distinction matters.
Slowest Since the Financial Crisis
Inflationary or Deflationary?
In terms of prices it’s a bit of both but mostly the latter.
There’s a run on sanitizers, face masks, toilet paper ect. Prices on face masks, if you can find them, have gone up.
But that is dwarfed by the demand shock coming from lack of wages for not working, not traveling, not eating out etc.
The lost wages for 60 million people in China locked in will be a staggering hit alone.
That has also hit Italy. It will soon hit the US.
Next add in the fear from falling markets. People, especially boomers proud of their accounts (and buying cars like mad) will stop doing so.
It will be sudden.
Bad Timing
COVID-19 comes at a tricky time for the global economy. Take Japan. The Oct sales tax hike saw GDP fall 1.6% q/q in Q4, taking year-over-year growth negative (black). That’s a weak base even before factoring in Q1 deterioration in the manufacturing (blue) & services (red) PMIs… pic.twitter.com/iUZwQ1U2LA
— Robin Brooks (@robin_j_brooks) March 4, 2020
Stockpiling
‘The stockpiling crisis that has hit supermarkets across Asia has spread to Europe as consumers start hoarding groceries and hygiene products amid fears of a coronavirus pandemic.’ https://t.co/uV5OK1zLJj
— Jesse Felder (@jessefelder) March 5, 2020
Deflation Risk Rising
Like in many other places, Euro zone is vulnerable to COVID-19 because its starting point is so weak. Growth in Q4 was just 0.1% q/q and it’s hard to see how 2020 will be much better than 0.5% overall, far below the ECB forecast of 1.1% (as of Dec). Deflation risk is rising… pic.twitter.com/oLUbIKwHLg
— Robin Brooks (@robin_j_brooks) March 5, 2020
Another Reason to Avoid Stores – Deflationary
The COVID-19 shock is likely to accelerate the structural shift away from brick & mortar retail in the US. Growth in core retail sales was already weak through Jan, even before virus anxiety built (top lhs). COVID-19 is, unfortunately, another reason to order online (top rhs)… pic.twitter.com/feu30pC4pW
— Robin Brooks (@robin_j_brooks) March 4, 2020
Hugely Deflationary – Weak Demand
There’s a debate if COVID-19 is a supply or demand shock. There’s evidence of supply disruption in longer delivery times in manufacturing. But we don’t for a second worry that prices will rise, because weak demand swamps all that. Net net: negative demand shock dominates by far. pic.twitter.com/OtyMoJHTDT
— Robin Brooks (@robin_j_brooks) March 3, 2020
This was the subject of a Twitter thread last week. I agreed with Robin Brooks’ take and did so in advance but I cannot find the thread.
I did find this.
Well – Not Me
I have been calling for lower and lower yieldsPeople do not understand debt deflation https://t.co/lzrOAq3BPl
— Mike “Mish” Shedlock (@MishGEA) February 27, 2020
Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.
That is what the Fed fears. It takes lower and lower yields to prevent a debt crash. But it is entirely counterproductive and it does not help the consumer, only the asset holders. Fed (global central bank) policy is to blame.
These are the important point all the inflationistas miss.
Mike “Mish” Shedlock
China buys oil from Iran – in violation of US sanctions – and does not pay in Dollars.
Two big No-No’s, which Uncle Scam does not like. Not one bit.
Both countries have massive, deadly outbreaks.
Just a co-incidence, I’m sure.
Considering the close economic ties between China and Iran, it’s certainly to be expected that there was a lot of travel back and forth between the two countries, and the fact that the disease spread between the two is no coincidence. The one thing Trump did right was to be “mean” and shut down all travel to China early on.
I would buy your theory but for the fact of a lack of a vaccine in the US which they would presumably have stashed away in advance of unleashing this monster in the target countries.
Case in point, via ANSA web traslate
“Athens announces 21 new cases of Coronavirus, of passengers who were all inside the same bus from Israel.
The Israeli ministry of health confirmed that it had learned that members of a group of Greek tourists who visited Israel between 19 and 27 February were found to be positive for coronavirus once they returned home. The ministry added that those tourists also visited the Palestinian territories. According to Palestinian press sources, they also passed through Bethlehem, where a medical emergency has been declared today. Israel and the Palestinian National Authority – the ministry specified – are exchanging information to reconstruct in detail all the movements of that group that will be announced in the next few hours to determine who – having met her – must now enter quarantine.”
A viral bioweapon is probably too unpredictable to be used in this way, that is assuming that any country that released it cares about own population enough to reject own casualties.
My feeling is that, fault of having a remedy, we have not seen anything yet. Confinement measures are still very weak over here in Europe (as in US)
On the one hand we assist to an endemic lack of testing which allow case discovery numbers to explode suddenly because the severe cases needing hospitalisation draw the attention of the authorities when it is too late like in Wuhan, Italy, Iran, Korea.
On the other hand the measures to be taken for the confinement to have a strong damping effect on the speed of infection are economy and financial bubbles killers.
China is starting to reduce the confinement measures and the
results start coming the infection rate seem to flip back up.
Think it was tough for Hop Sing toiling away at the Apple factory for $1.50hr. 12hrs a day 7 days a week,think what it’s like now when everybody in the plant is got pneumonia ,or can barely breath from a collapsed lung.I’m sure instead of suicide nets,Apple will have crews to cart of the dead so as not to slow production!
Not to sound uncaring, but as a retired US history teacher this whole coronavirus pandemic and the subsequent economic impact are history in the making. Both of these events have the potential to be generation-defining, like the Spanish Flu and (not to sound extreme) the Great Depression. Fascinating. I stated this before, but it bears repeating: this is a slow-motion train wreck.
your opinion is fit for toilet bowl
I couldn’t agree with you more MiTurn. I also can’t help but wonder how far away we are from the financial Big Reset that will be another defining moment in U.S. history. My guess was closer to the end of the 2020’s but perhaps sooner? At any rate, as a fellow history buff, it’s fun to watch it all unfold.
Indeed, we are watching history in the making. Once every generation or so, there is something going on that defines that period, and defines the legacy of the leaders involved. The Spanish Flu, the Great Depression, the Cuban Missile Crisis, the Gulf War, and 9/11 are some others from the last 100 years that come to mind.
What will Trump’s legacy of leadership in time of crisis be? Will he rebound, and take charge, and be re-elected? Or will he continue to ignore and diminish it’s importance, and leave a legacy of an unresponsive government, and lose in a landslide?
What will Trump’s legacy of leadership in time of crisis be? Will he rebound, and take charge, and be re-elected?
He may well be reelected if Sanders is nominated, but his so called leadership is not in question, he is clinically insane and will destroy what is left of America.
To be followed by a global currency crisis.
Which of the majors “goes to money heaven” first?
Indian Rupee is a good candidate.
Problem is all major currencies are in the same boat so how does that work
Some will fail quicker than others. They are all intrinsically worthless, but will not revert to that value in unison.
Exactly. Currencies priced in the open market against one another. ALL central banks are allowing The Crazy, so I just don’t see it happening anytime soon.
If one were to fail, I would pick China … as they are (loosely) pegged to $US. Yes, they have $3 trillion of foreign reserves to defend … but with exports that will crash and a big mess of bad debt to clean up on horizon? Will there be a run on yuan?
For DECADES betting against yen has been a widow maker trade. Currently, very strong to dollar @ 106. Kyle Bass and John Mauldin both (years ago) had it going to 250. Mauldin SO SURE that he claimed he was going to buy his condo in yen. Hope he did not take his own advice.
The problem for Mauldin is that the Yen may go to 60 on its way to 250 such is the scale of its use in carry trades.
When some disagree with the others and fall out. Political realities under times of stress more than not being able to find arrangement – they always back each other (at a price) otherwise.
Also, when local currency becomes unwelcome because the economy that backs it is seen as unstable, people shun that currency, at which point if the circumstance is severe, foreign buyers won’t step in to support it if they think there is nothing they can gain from doing so.
Yeah but…. Gresham’s Law, bad money drives out good. If a currency starts to tank because the underlying economy and or government is seen as unstable people will spend it like there is no tomorrow, they will see hyperinflation in that currency as buyers offer any price in terms of that money just to get rid of it while they can. nobody sits on cash that is losing value relative to the cost of goods in such a scenario. It was the cycle that spelled doom for Wiemar. Where the wheelbarrows people needed to carry cash to buy dinner were worth more than the cash they carried.
2.2 million people told to stay home in Washington.
I cannot read the story because I am not about to disable my ad blocker, but I am wondering if the story is accurate in that Washington County OREGON was the fisrt in the state to have a confirmed case of Cov19, and schools were closed to deep clean them. Does the story say that the county in question is a WASHINGTON county? Or, is it Washington COUNTY?
Wonder when the FED will cut rates to 0 and open the discount window to everyone.
The EU already has negative rate mortgages in some places like Denmark, and so in a way that is the same thing as opening the Fed window to everyone. Would be nice to refi at a negative rate where you not only have principal only to pay each month but the bank pays part of that principal for you. It is one of the reasons I close on a house in Florida April 6. All the powers that be are going to do whatever it takes to prevent a recurrence of the loss of home equity we saw in the GFC. Even if that means paying your mortgage for you. Refundable tax credits (as Bush did in 2008) there will be no limits to what they will do because if there is another foreclosure crisis as in 2008/09 half the banks with window access will fail on the spot. And please remember that most of the “assets” the Fed has on it’s books are mortgage backed securities.
So the kicking the can down the road will stop.
And when that happens we will see major deflation.
Just look a the natural gas industry if you want to see commodity deflation. Natural gas prices are so low in the U.S. that virtually all natural gas drillers and producers are running a negative cash flow. Gas prices are lower than the cost of production. Factor into this equation that many natural gas drillers and producers can no longer borrow money to continue operating AND they will soon have to refinance their debt but almosty nobody wants their debt. Another example of debt deflation.
I read yesterday that 200,000 flights had already been cancelled. Probably mostly overseas, so big plans. Trying to quantify that, if you estimate 200 passengers/flight at $500/ticket (probably low) that’s $100,000 lost revenue per flight. Multiply by 200,000 is $20 billion dollars lost, just by the airlines industry, globally, in February.
Just like hotels, you can not make up for lost nights / flights.
Yup, and those who are looking for flights, know the planes are empty, and will delay their purchase until airlines rationalize their asking prices.
That’s how we get deflation. Inflation in an economy pickled in debt is basically impossible.
The bond market is right. The (US) stock market, which implies a substantial rise in prices (and hence profits) is wrong.
When your income decreases to where you cannot afford , even deflation seems like inflation if it does not drop fast enough.
There are some freaky effects that can take off in circumstances like this, you might end up with rationing, or loss of faith in the currency, at which point all bets are off. Weimar germany was said to have been starving while its barns were full – people hoarded and suppliers waited as currency became rejected for being unstable to the point of being unusable.
Initially mostly deflation though, unless there is mad panic and severe supply reduction and/or large public stimulus spending – as a whole there is access to a lot of money in a lot of people’s accounts that might be spent quickly if the mood is that tomorrow there will be nothing to buy.
Volatility is that you cannot guess, because the metrics change outside of normal perception or understanding.
Good points from Tony, Mark, and SHOfan
I booked a one way flight from Tampa to Oregon last month before there was an American case of virus, and for the first time in my life I made it a first class ticket just because I am not willing to sit in economy class for 5 hours at a time. Usually I have a layover in a mid continent place like Denver so only half that time packed into economy before getting out to stretch. But this time the stop is in San Francisco a full five hours from Tampa.
I have to fly because I am driving a moving van from Oregon to Florida and must return to get my car, I can’t drive both at once. I am now very concerned that I will be stranded in Florida in the new house with no way to get back to Oregon to get my vehicle. The place I am moving to has no public transportration at all. All this talk about cancelled flights, I will be pissed off if they do fly at a loss and the plane is nearly empty because the economy class ticket was only $174 where the first class was $630, if I am sitting there and have paid over 600 while some bloke who paid 174 gets to sit in first class with me because they upgraded him – just because they do not want to walk all the way to economy to serve him a drink.
That is one reason why I never bought a first class ticket, just knowing how mad it would make me to see someone that paid for an economy ticket get upgraded while I had to pay full price for mine. Oh well, as long as it is not someone with a baby.
I do remember that I had to fly on Thanksgiving at the very last minute from JFK to California because my mother was in a coma and thought to be near death, in 2001 just after 911, as well as another crash that came down shortly after takeoff from JFK, crashed into some houses the just the other side of Jamaica Bay, I was one of about 12 passengers on the entire plane. Those cows STILL did not upgrade me. I did practically have my own stewardess though.
Good post.
Deflation in the cards. Falling asset prices + falling demand = “uh oh” for Federal Reserve.
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“will stop doing so It will be sudden.”
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All along I felt when “it” finally happened, it would be a “light switch” moment. Business will pile on as CFOs have waited YEARS for a “kitchen sink” quarter … or three … to clean up the books.
Deflation for assets and certain goods. Inflation for other goods.
Absolutely certain to be met with Fed money creation on an epic scale to counterbalance the impact – same dynamic as GFC only orders of magnitude larger.
I actually think it will be the other way around, asset prices, especially residential real estate, and equities, will be propped up most unnaturally, no matter what it takes the central banks are not going to run the risk of another foreclosure crisis ala the GFC, the Fed cannot when most of the 4.5 trillion on their own balance sheet consists of sketchy mortgage backed securities, and there is a looming auto loan crisis. And we already have a couple banks with Fed window access that are teetering on the brink, Deutsche and HSBC are both the very definition of zombie banks. They will do absolutely anything to prop up home prices to prevent another loss of home equity. Even if that means huge tax incentives and negative motgage rates with automatic refis.
On the other hand, simple consumer goods will face massive deflation as there will be way too few (no) dollars chasing way too many goods. I was in the suprmarket yesterday and prices were crazy, $5 per pound for tomatoes? Two bucks for an unripe avocado? And the whole time I felt my skin crawl at the thought of all that viral load all around me. First time I seriously did not want to be where I was while shopping for food. The government will keep stores supplied even if they have to use the national guard to do it. And if prices do go insane from hoarding I expect they will just put limits on how much you can buy at one time. As well as price controls, such as the Florida law that made it illegal to gouge on gasoline prices when there is a declared emergency. Gas stations were changing their prices charging as much as $10 per gallon which people who were being evacuated from the path of hurricanes were forced to pay, so the state made that illegal. Now you cannot raise your price in the event of a declared emergency. So far several states have declared emergencies, California. Florida, Washington, Utah just did 16 hours ago and half of all states now report virus. Emergency declarations in Indiana, Maryland, and of course a federal declaration as well.
That might cause a crisis in pricing for certain things like hand sanitizers and bottled water, masks, but it is grossly deflationary for most other things once the initial panic buying stops and people hunker down.
Will firing up the Fed Printers actually solve this though. Maybe the shot in the arm to the economy would be the forgiveness of all the student loan debt. That would certainly jump start housing, auto, durable goods, etc…