Corona crisis: the cost of the response

The absolutely unprecedented wave of shutdowns, new restrictions and regulations that the coronavirus epidemic has triggered on a global scale is truly hard to…


Editor’s Note: This is a combined Part I and Part II


by Claudio Grass via

Corona crisis: the cost of the response

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. 

Responding to the response

This time around, both central banks and governments have gone “all-in” in their response packages and the scale of the support and liquidity provided dwarf the measures that we saw in the 2008 crisis. Of course, the question remains whether this will all be enough to help save the economy from these massive self-inflicted wounds. 

However, one thing is clear so far and that is the uniformity of the political handling of the economic crisis. All officials and representatives appear to be on the same page and using the same type of language to describe their interventions. They all present said packages and measures as a direct and essential response to the coronavirus, as though they are meant to provide relief from the effects of the disease itself. 

At this point, it is really important to get one thing straight: SARS-CoV-2 did not cause bars and restaurants to close, it did not ground entire fleets of airplanes and it most assuredly didn’t fire 6.6 million Americans from their jobs. The virus itself is responsible for leading to, contributing to or accelerating the death of 43,500 people globally so far and for sickening a lot more, but it did not cause trillions of losses to the global economy, nor is it responsible for the deep recession we’ve just entered. Governments did that all by themselves, and their central bankers set the stage. 

A cure that is far worse that the disease

There is no denying that the coronavirus is dangerous and by no means do I intend to dismiss the many thousands of deaths that have been associated with it. In my mind, there is no such thing as an “acceptable” number of deaths and human lives are not mere statistics, to be weighed in a cost-benefit analysis to optimize some imaginary bottom line. But that doesn’t change the fact that tragedy, death and suffering are all part of the human experience. Of course, some can be prevented and we should absolutely do our best to do that, but with a rational and clear mind, with a solid plan and with precision, lest we end up causing a lot more suffering to a lot more people. 

In this case, at the very least, one would have expected a targeted, science-backed approach to control the epidemic. Focusing on the isolation and protection of the most vulnerable groups, informing people about the actual risks that they and their loved ones may face, in a calm and collected manner, and encouraging self-quarantine where medically advisable would be the rational direction. Personal responsibility would make a lot more sense as a basis for a state’s response, while adopting a rational, consistent and cool-headed tone to avoid mass panic and confusion would be the mature thing to do.

And yet, the approach that most governments have chosen to deal with this crisis seems to be entirely devoid of such reason and clarity. Perhaps driven by panic at the thought of the collapse of their poorly designed and disastrously mismanaged public healthcare systems, or perhaps driven by pure incompetence and a bureaucratic rigidity that only has an ON and OFF setting, they have decided to kill the entire economy, to freeze the lives of their citizens, and allow fear to triumph over reason. 

Unfortunately, the damage that they have already inflicted goes well beyond the death of any kind of economic growth. The political and social implications are, arguably, even more terrifying. For one thing, the lines that have been crossed with the sudden and far-reaching implementation of the new rules and restrictions can never be uncrossed. The unilateral enforcement of these measures, that in most cases went undebated and unvoted for, showed just how far a state can go and just how many of its citizens rights it can “temporarily suspend”, if it has a good enough excuse. It can force them into virtual house arrest, it can scrap their basic right to free movement and peaceful assembly, it can take away their livelihood and their businesses and it can certainly fine them or even lock them up if they fail to comply with the new rules. All that and more it can do, even during peacetime, and even without ever having discussed such scenarios, put them to the vote and receive a mandate in an election. 

It’s also interesting to note that there’s hardly any difference between political lines and “convictions”. So-called “conservative” leaders and parties, that are meant to safeguard the rights of the individual and the constitutions of their countries are enforcing the same measures with the same gusto that their left-leaning peers do elsewhere. Thus, even if there ever was a vote on these matters and even if the citizens were actually asked for their opinion, it probably wouldn’t be much of a choice.

At this stage, it is still very early to spot the political consequences of these actions. Most people are still paralyzed by fear, which is pumped at great doses into their homes by the media. At the same time, the “gifts” and the “relief” that the governments have promised them are still enough to keep them for realizing the real extent financial distress that most households are set to face over the coming months. However, once the dust settles and the virus panic subsides, once the “free money” stops being enough to cover basic needs and once the mass bankruptcies start piling up, another fear is bound to spread and this one will be a lot better justified. Financial hardship has always manifested in political division and social strife and it can be argued that we’re already seeing the first cracks appear in many Western nations. 

Investment strategy for a harsh crisis

I’ve been talking and writing about the possibility of a “harsh crisis” for a very long time. Even though I’ve never seen one in my own lifetime, I’ve been taught a great deal about the importance of being prepared by the countless lessons provided by history. I’ve found most of these lessons in books and historical analyses, but I’ve also learned a lot by listening to those who carry living history with them, the actual survivors of such scenarios.

Obviously, we are not in such a crisis yet and I sincerely hope we won’t get there either, but hoping alone is not a great investment strategy. I do expect this economic downturn to get worse and depending on how long it lasts and how deep the damage is, it could also have serious socio-pollical consequences. This could take many different forms and at this point it is impossible to predict the direction it could take. While it is, clearly, hard to prepare for such “unknown unknowns”, we can prepare for what we do know and for what we’ve seen before. 

As we outlined before, the banking system is simply not fit for purpose when it comes to storing one’s assets and preserving value. The risks are far too great and the credibility of all major banks in times of crisis is so deeply eroded, by their own record, that no sane investor would trust them to safeguard their wealth, especially in times like these. As for mainstream investments in general, the mayhem in the markets over the last month should have convinced even the most optimistic investor that the times of easy money in stocks are over, irreversibly so, probably for a long time. Both these factors paint a dark picture for speculators and for stock gamblers, but they do offer solid support to the case for physical precious metals and for other real, tangible and directly owned assets that can be safely stored outside the banking system.

If there ever was a time to rely on physical gold to get us through this storm, this is it. Those who had already headed the warnings and prepared for exactly this scenario that we’re facing right now are reaping the benefits. However, I sincerely believe that this is only the beginning. No matter how paper gold prices might move from day to day, and irrespectively of the short-term gains or losses some might book in a week, for the long-term investor, the only way is up. 

Claudio Grass, Hünenberg See, Switzerland