Tuesday, March 31, 2020

Is it that 'Cash is King' or 'Cash is Trash'?

If we understand what “depression” is, and if we understand what “galloping inflation” is, we'll have a better grasp of what's happening to the world today.

Depression is the expression of lost confidence in the prevailing economic system. What happened in the United States of America in the late 1920s and early 1930s, is that the people who were overconfident in the soundness of the economy and abused it to the breaking point, saw their mood swing to the other extreme when the economy began to falter.

Fearing what tomorrow will bring, they sold at give-away prices, the hard assets they owned, and hoarded the cash waiting for the situation to clear up. Hard assets –– from tools to instruments to buildings –– being what's used to produce goods and services, it was the idling of these assets that reduced the production of those goods and services. In the end, that's what defined the word depression. In practical terms, it was like the economy had gone into a coma.

As to the expression, galloping inflation, it is a phenomenon that usually begins when shortages in one or more vital staples become chronic. Prices rise and people ask for raises. If the economy is otherwise sound and has the export potential to attract foreign currencies, the jurisdiction will import what it needs, pays for it and the problem is solved there and then.

But if the economy develops shortages and has no means to pay for imports, an internal leapfrogging effect develops. That is, when a segment of society –– such as the private sector, for example –– gets a raise and causes prices to go higher still, the public sector will want to leapfrog ahead of the private. It asks for, and gets a raise, which causes the private sector to ask for still more money. The two sectors begin the process of leapfrogging ahead of each other, causing inflation to gallop, and the value of the currency to diminish to near zero.

What's happening in the world today, is that most economies were hit by a virus named Corona. It forced governments to take measures that save lives. The measures entailed telling people to stay home and not go to work or any place where they might have conducted economic activity. And so, whereas depression resulted from the economy going into a coma because of loss of confidence, today's coronavirus forced the governments to send the economies into a coma to save lives. Whether or not the economies will tailspin into a real depression will depend on how long the pandemic lasts.

Having learned the lesson of the twentieth century depression, the central banks and the treasuries rushed to flood their economies with cash instead of tightening their monetary and fiscal policies, the way they did nearly a century ago. Today's move is meant to maintain a semblance of economic activity, thus raise the level of confidence before people start selling their hard assets cheaply, and cause a real depression.

In the wake of two trillion inflation-inducing dollars being injected into the economy, what will happen when the pandemic will have been defeated? Upon reopening their doors, the companies will do what they always do, which is to recall only some of their laid-off employees, keeping the others out, and causing unemployment in the country to rise. It is that the companies will find ways to produce as much if not more than before using a smaller workforce, which is good for business. But will the rise in both inflation and unemployment result in consequences we cannot foresee at this time?

Richard Phillips sees some very real changes coming. He wrote an article to that effect under the title: “The Sad State of US and Global Affairs,” and the subtitle: “If –– or is it already when –– the current crisis ends with the United States of America fiscally and monetarily bankrupt, the idea of a full-blown depression becomes all too real.” It was published on March 27, 2020 in The Globalist.

Here is some of what Richard Phillips has said:

“It is safe to assume that the federal budget deficit in the current fiscal year will zoom past the $4 trillion mark –– and approach $5 trillion before it's all over. Assuming there is a 15% decline in fiscal 2020 due to the pandemic, GDP looks like it will come in at around $18 trillion. It would put the projected US budget deficit at around 28% of GDP! That would translate into a potentially massive expansion of the Fed balance sheet. Just don't forget about the massive US corporate debt. It stands today at over $10 trillion. If the crisis ends with the US fiscally and monetarily bankrupt, the idea of a full-blown depression becomes all too real”.

And this is the advice that Richard Phillips is giving out:

“The wiser solution now might be to judiciously provide limited financial support to the needy and encourage forbearance in both the public and private sectors for the next 60 days”.

But not everyone in the private sector will listen to him. A good many, especially in the crowd of stockholders, will want to sell now, and perhaps buy back later.

And this raises an interesting question: Is cash king under these circumstances, or is it trash?