Stumped by coronavirus: market can’t reprice for a depression full of unknowns

Jim Rickards says the market does not know how to reprice.

Jim Rickards is prepared for COVID-19.

The man who has warned for years of a new crisis that could freeze markets and finance is bunkered down at his mountain farm in New England where he has built the state’s largest private array of solar power panels.

“We have solar power, we have our own wells, we grow our own food, so we are in a fortunate position,” he says.

The Cassandra with a hotline to central bank advisers sees the Federal Reserve balance sheet heading to $US6 trillion ($9.7 trillion), three to four million unemployed in the US at the next jobs report in early April, a painful L shaped recovery, a Trump re-election at 50/50 and a stockmarket that has a whole lot further to fall.

“This is a depression, that’s baked in the pocket,” he stresses. “Here are the relevant issues: No 1, how long will it last, and No 2, are the ultimate losses permanent or temporary?”

The pandemic, he explains, has taken the market way out of its depth.

“Markets are pretty good at repricing, so if there is a shock, a natural disaster, or maybe when Trump got elected in 2016 — that came as a shock to a lot of people; the market can reprice for that.

“The problem now is that the market is trying to reprice, but they are repricing against an unknown. Market participants don’t know how bad the market will be, don’t know how far it will spread, how many will die, how long the economy will be shut. You are repricing to a moving target.”

Rickards believes the market has unfinished business.

“We are down about 30 per cent, but bear in mind from 1929 to 1933 the US market fell 89 per cent. In 2000-01 the Nasdaq fell 67 per cent: that’s a real bear market.

“There will be these little, they call them ‘sucker’ rallies in the middle of a bear market, but the bear market is far from the bottom and that is because no one knows quite how bad this will be.”

The $US2 trillion passed by US congress on Friday may be spending but it is not stimulus, according to Rickards.

“The idea that it is going to stimulate anything — I don’t think the evidence supports that. The famous Keynesian multiplier is that you borrow a dollar and spend a dollar, you get $1.20 of GDP, but that only works to a point. We are well past that point.

“Now, we borrow a dollar, spend a dollar and only get maybe 90 cents of GDP so we’re just digging a deeper hole for ourselves. This is the greatest economic collapse since the Great Depression, and we’re going to have to dig our way out of it. A lot of this is necessary,” he adds, “but I wouldn’t count on this as stimulus.”

Equally, QE is no cure for a disease, he warns. Fed governor Jerome Powell is really just keeping the lights on, keeping the plumbing free with guarantees of markets from municipal bonds to being prepared to make direct loans to companies.

Rickards says about $US500bn from congress’s fiscal package will go to the central bank as capital.

“They’ll leverage to perhaps $US4 trillion or more, so you are going to see the Fed’s balance sheet go well past $US5 trillion and perhaps $US6 trillion by the time we are done.”

Rickards’ bestsellers from the last decade are selling well, he says — titles like The Road to Ruin, Aftermath, the Death of Money and Currency Wars.

The Road to Ruin is especially topical. In it Rickards took an idea from Kurt Vonnegut’s 1960s novel Cat’s Cradle, when a scientist discovered a new isotope of water. It had a property that if you poured it into water, however, that water froze and any water it came into contact with also froze.

“So if a small vial were poured into a stream the stream could freeze but then the oceans and life on earth would die, so it was a kind of a doomsday machine,” explains Rickards. “So I applied it to international markets. I was thinking about what happens when you close a market under stress. The problem is the demand for liquidity. People still want their money back; that’s what a financial panic is. So if you close the stockmarket, they’ll sell their money market funds, then you have to close the money market, then they’ll redeem commercial paper and you have to close that market, and finally they go to the banks and you end up closing the banks, which did happen in 1933.”

Rickards feels we are dangerously close to a seizing up of markets, pointing to many close calls, form the LTCM Russia fiasco, the 2008 bailouts, bank closures in Cyprus in 2013, to Greece in 2015 when people flew from Athens to Frankfurt with empty suitcases loading up on euros because the ATMs back home were closed. Today of course, there are no flights. And no one, least of all the market, he points out — is grappling with the risk of social unrest.

Long road back

Back to the real economy, Rickards believes that once COVID-19 sweeps through, it will be a long slow clawback.

“GDP is going to drop, order of magnitude 20 to 30 per cent annualised in the second quarter. Our March unemployment report on the first Friday in April is going to show perhaps three to four million unemployed. The tip for the number is 200,000 new jobs, now we’re going to see three to four million job losses.”

He gives short shrift to White House economic Adviser Larry Kudlow’s prediction that the outbreak is a near-term hurdle and there will be “tremendous pent-up demand” both in the stockmarket and the economy for recovery.

“You lived through 2009, 2010 as did I. Remember green shoots?” Rickards says incredulously. “All we heard about for years was green shoots. There were no green shoots. What we got was 11 years of 2.2 per cent growth, at least in the US, a full percentage point below the average recovery since 1980.

‘All we heard about for years was green shoots. There were no green shoots.’

“Pent-up demand is phony and here’s why. My wife and I go out to dinner on a Friday. We didn’t go out last Friday, we’re not going out this Friday. But let’s say three months from now things are better. We are not going to have two dinners, or three dinners. The dinners we skipped are a permanent loss.

“The US economy is 70 per cent consumption, and about 70 per cent of that are services, not goods, so most of these losses are going to be permanent. Do you have the famous V shaped recovery where it goes down sharply and up sharply? If you have pent-up demand that’s what you get. That’s not what we have. This will be more like an L.”

Just what all this does to the political landscape is another preoccupation for market watchers. In 2016 he confidently predicted the shock Trump victory and until about a month ago, he had another one predicted, based on the inverse of the probability of a recession.

“The recession odds were say, below 20 per cent, so you’ve got to put Trump’s re-election odds at around 80 per cent. Now of course since then, forget recession — we’re in a depression.”

That does not make Trump’s chances zero however. Rickards now has him at 50/50. “Nobody blames this on Trump, but he will be judged by his response, by the way he handles it and how quickly we come back. But this is important because the market has not priced for a president Biden. They’re trying to price for coronavirus, they’re trying to price for how bad this depression could be, but they haven’t even started to think about ‘oh gee what if Biden wins’, whereas now that is a real possibility.”

Surrounded by his apple orchard, lime trees, vegies including a sizeable potato crop and wild peppers for a touch of spice, Jim Rickards muses over the letters he is receiving about his book.

“These are written one, three, five, even nine years ago to warn people. Some people took the warning, but a lot didn’t and they are running around now trying to buy gold. You can’t buy gold. It’s not a question of price.”

As a cheer-on to his 130,000 twitter followers, a recent @JamesGRickards post pictured the Queen inspecting gold bars in the deep vaults of the Bank of England with the tag, ‘‘Teaser for Season 4 of The Crown’’

Teaser for Season 4 of "The Crown." pic.twitter.com/r7P5NpOPKP

— Jim Rickards (@JamesGRickards) March 28, 2020