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Anatomy of a Meltdown VI – Perhaps I Was Correct in 2013

Garrett Fisher
May 6, 2020

In my original article in 2013, I articulated fears of a future recession that would dwarf the experience of 2008. At the time, I felt that the circumstances leading up to the next “big one” would be market conventional: a bubble in prices somewhere, followed by a pop, an inability or unwillingness for governments to do much, deflation, government money printing, and then inflation, followed by a repeat of the Volcker maneuvers in the late 70s: smashing inflation by jacking interest rates, creating another recession, although tampering inflation.

Recently in early spring of 2020, I wrote a five-article series revisiting my original predictions. By and large, the ethos of my argument was that I got the timing and magnitude of the expansion incorrect, followed by assuming that the recession induced by coronavirus, while magnitudinous, would not create the exact situation that I had described, as central banks had shown that they are clearly willing to function as trading desks, intervening in relatively robust fashions. My new prediction, aside from a bloody recession from the pandemic, was a middle ground, positing that the next recession might be the thing where the tools of today do not work, though massaging my prediction to accommodate current central bank proclivities.

Now, roughly a month later, I am finding myself questioning if my article in 2013 was correct after all. Perhaps I am correct in assessing the ingredients of a wicked recession: some sort of unsustainable price and activity bubble, a trigger that ends it, and a reverse of the same forces that created the bubble in the first place where prices crash far and hard. That situation tends to tie the hands of government. Who wants to bail out 2007 house, commodity, or subprime mortgage prices? When staring at stratospheric valuations for assets which are fundamentally not valuable, there is no logic coming to the rescue for such nonsense. It is only after the collapse in those prices starts knocking other dominoes that sentiment turns toward intervention. That waiting period poses a form of trap where, by the time intuition and political sentiment favors intervention, deflationary forces have already begun.

Deflation is worse than inflation. The Great Depression was marred by gory consumer price index deflation, ending the entire decade of the 30s without any price inflation whatsoever, with a particularly harsh period before the New Deal where annual deflation topped out at 10%. The problem with deflation is that debt remains at the same nominal value (as does cash), yet economic activity contracts, prices contract (and therefore business earnings and wages), asset prices decline (including collateral) and the entire economic system still demands payment of debt denominated in higher amounts, expected to be repaid with depreciated collateral and reduced or non-existent income. As bank deposits are lent out on credit, loan losses wipe out banks, which wipes out cash, and the cycle of despair accelerates with a crushing and powerful intensity.

The 1930s were a series of mistakes that compounded upon themselves. The government did not stop the banking system from failing, so economics took its purest form, which was to enforce an outlandish contraction in response to the growth period of the 1920s, in many definitions disproportionately inverse. One might call it the reverse of an irrational bubble, where the economy irrationally eats itself into oblivion. FDR and the New Deal prevented us from understanding how far it would have gone unabated.

March of 2020 would have been the “day the music died” if central banks hadn’t prevented the system from entirely imploding in a 1930s fashion. From there, stimulus money has been hurled left, right, and center, with unheard of amounts (that received enough press in my articles, worrying about their effect). Yet, despite historic money supply increases, inclusive of outright helicopter money, oil prices went negative for the first time in history. While an aberration of delivery mechanisms and commodities contracts, the headline is reflective of something that is beginning to gain steam in early CPI measurements: elimination of inflation or light deflation.

That in and of itself is not cause for alarm, as some periodic bounces with nominal price contraction is not the end of the world. However, the original template for my 2013 financial apocalypse article noted a situation that created deflation, a belated government reaction, and inflation, with damage along the way. I assumed then that the reason for deflation would be the inability of the government to use stimulus to get out of the problem, at that point due to the assumption that US Treasuries were somehow at the mercy of bond market dynamics. Since the government “couldn’t” generate the money through borrowing or tax, deflation and a wicked recession/depression would be the only outcome, and only when that cake splattered in our faces would the government resort to the financial printing press.

As we know, 2020 is a time when the markets for US Treasuries started malfunctioning. Should we call it the market punishment that I had predicted? I am not certain that the world decided that US government debt was worthless, though it definitely was the time when there were not buyers for the amount of sellers of Treasuries, which would have had some interesting outcomes had intervention not taken place. Within a short period of time, the Fed jumped in and started printing money, without having resorted to my cycle of deflation despair.

Nobody could have imagined a pandemic unfolding the way it did. It’s the perfect kind of disease to catch us unawares, to divide humanity, to confuse government response, to create lockdowns and protests against lockdowns (at the same time). I had a conversation in late February about the disease with a scientist, and he pointed out that the rate of spread is so high due to the virus subverting our natural intuition. We act when we feel sick or others appear symptomatic, which allows it to spread so clandestinely with variable mortality rates.

That reality is making it increasingly harder to keep an economy stitched together. No amount of money printing will make people buy things they do not feel they need or spend money on experiences that they cannot or are too afraid to have. The inevitable outcome is price deflation in the immediate term if buyers are not present.

The trillion-dollar question is how much price deflation and how long it will last. A modest decline in consumer prices with cyclical declines in asset prices wouldn’t hurt anyone. In fact, recessions can have, I wouldn’t say “healing” properties, it would be better to note how they tune the economy to remove ineffective activity and crystallize profitable and innovative businesses. However, should deflation become significant owing to the reality that the virus may have us on our knees, lockdown or not, until billions of vaccine doses are administered, then we may have the very situation that I described in 2013: the government cannot stop price deflation.

I would suppose the blueprint I wrote about would happen as I said: financial implosion of varying gradation (30,000,000 Americans out of work so far….?) leading to elements of political and social upheaval (prospect of food shortages is one). Once the virus is out of the way, stimulus would likely be hurled in an almost overreaction, creating the inflationary impact as previously noted.

This is not a situation where I would relish being correct; however, I think there is a reasonable chance that we are facing a version of my original apocalypse hypothesis. I note, with great caution, that a month ago, I wasn’t thinking it would happen, and I can only imagine what things will look like a month from now.