Corona crisis: the cost of the response – Part I

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Claudio Grass
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The absolutely unprecedented wave of shutdowns, new restrictions and regulations that the coronavirus epidemic has triggered on a global scale is truly hard to quantify. We’ve simply never seen anything like it before. Never in the history of mankind have countries all over the globe intentionally hit the kill switch on their own economies and simultaneously pulled the brakes on anything even remotely resembling productive activity. 

Some of the consequences of these radical policies are plain to see – in fact, they are already materializing. Unemployment is just beginning its upward trajectory, while entire industries have already been decimated, with hugely important service sectors like travel and hospitality on the brink of collapse. The impact of the governments’ actions in these cases was obvious from the start. They have however also triggered even deeper and much more dangerous shifts that are not as easy to spot at first glance. 

Debt implosion

As most readers will recall, this is something that I’ve been writing and warning about for a very long time. The mountains of debt on every level of the economy, public, corporate and even in households, has been clearly unsustainable for years already. However, the excesses of central bankers, their “whatever it takes” measures and their forcibly low-interest rates had managed to paper over this problem, at least for those who didn’t bother to look any closer at the true extent of the debt issue. 

Companies were borrowing like there was no tomorrow and using the money to buy back their own stocks and thus artificially prop up the price. Consumers were loading up on debt, mostly out of necessity rather than an appetite for luxury, as their own income failed to keep up with Wall Street gains over the last decade. Student debt, especially in the US, reached all-time highs, while medical debt also skyrocketed. All the while, the illusion of growth and all the loose money that central bankers pumped into the system meant that asset price inflation went through the roof. Rents exploded and millions struggled to keep up with the payments, as their own paychecks didn’t mirror that same growth.

And now, all this is coming together to create the perfect storm: As millions of people have already lost their jobs, and there are millions more to follow, their ability to meet their rent obligations is seriously diminished. According to the latest figures, a record 6.6 million people filed claims for unemployment in the US, the highest figure ever reported and way ahead of the previous record of 695,000 back in 1982. Of course, scary as this may sound, it is only the beginning. Due to the forced shutdown of countless businesses, the Fed predicts that 47 million jobs could be lost next quarter, translating to an unemployment rate of 32.1%. Just for context, the same rate was 24.9% during the Great Depression.

This massive destruction in the labor market is quickly transforming into real systemic risk. As veteran real-estate investor Tom Barrack put it, what happens next is a catastrophic “domino effect”: As tenants fail to pay rent because of a lack of cash, property owners get squeezed and default on their own mortgage payments. Homeowners also face an uphill battle and as they lose their jobs and struggle, their payments also get delayed and the notices pile up. This delinquency accumulates, on an enormous scale, and it’s the banking sector that ends up holding this gargantuan bag of bad debt. This is the same sector that has been severely weakened by the decade of zero and negative rates. It is also the same sector whose deep, fundamental struggles became obvious way before the coronavirus even emerged, during the first shock in the repo markets that caused the Fed to intervene with multi-billion cash injections.

When the “worst-case scenario” becomes today’s headlines

I have repeatedly highlighted the serious risks of the banking sector and the unreliability of the current system, especially for those investors who are interested in the long-term preservation of their wealth and who want to be protected in a harsh-crisis scenario. Of course, during the artificial equities boom of the past years, mainstream interest was turned in the exact opposite direction, with most investors chasing profits and trying to make a quick buck from ridiculously overvalued companies. Very few were willing to consider what this rally was actually based on and even fewer were prepared for it to stop abruptly and for markets to collapse almost overnight. Now, however, that the tables have turned, it is clear that what seemed like a far-fetched “worst-case scenario” only a few weeks ago, is the reality that is unfolding before our eyes. 

The debt avalanche is no longer a thought exercise. The unemployment spike has already given birth to a growing movement of tenants vowing to go on a “rent strike” in the US, demanding their rent obligations be waived entirely, not just delayed, while over in Europe multinational corporations have already refused to pay rent for their commercial locations. At the same time, many European nations and major US cities have already enacted an evictions ban, that aims to avoid massive homelessness but also increases the pressure on owners. Mortgage delinquencies, that up until recently stood at a multi-year low, are now set to skyrocket and exceed the rates we saw during the subprime crisis. Under the new rules, borrowers of US government-backed mortgages (which constitute 62% of the total market of first-lien mortgages), are now allowed to miss up to one year of payments, without even having to prove any financial hardship.

At the same time, there’s added pressure from the very high consumer debt levels. According to the Institute of International Finance, today households around the world have $12 trillion more debt than they did at the start of the 2008 crisis. Household debt-to-GDP ratios in many major economies like France and Switzerland are at all-time record levels. Of course, no country can compete with China, that saw an incredible surge in household debt last year to a record 55 trillion yuan, a figure that has doubled since 2015. According to Atlantis Financial Research, even at this early stage, consumer default rates at some banks have already spiked up to 4% from about 1% before the outbreak of the disease. As UBS projected in March, Chinese banks could be confronted with a 5.2 trillion yuan jump in nonperforming loans and a record 39% drop in profits in 2020.

As for the corporate sector, the picture there is even more ominous: After a decade of extremely low-interest rates, US non-financial corporate debt has exploded to $6.6 trillion as of the end of 2019, a 78% jump since mid-2009. The scale of overall credit deterioration and the upcoming surge in defaults has already caused Moody’s to downgrade its outlook on the corporate bond market from stable to negative, while according to Goldman Sachs estimates, $765 billion worth of investment- and high-yield bonds have already experienced rating downgrades this year.

Overall, these preliminary figures are expected to get significantly worse, as the effects of the shutdown set in and over the next weeks and months, we’re bound to have a much clearer picture. What we can tell for sure, however, is that we’re about to find out what happens when the music stops and the lights go out on a 10-year long party, all paid for with borrowed money. 

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In the upcoming second part, we look at the wider consequences of the shutdown, not just on the economy but also on a political and social level and we examine the implications for precious metals investors. 

Claudio Grass, Hünenberg See, Switzerland

This article has been published in the Newsroom of pro aurum, the leading precious metals company in Europe with an independent subsidiary in Switzerland.

This work is licensed under a Creative Commons Attribution 4.0 International License.