Beyond the virus: it’s the recession

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The dramatic decisions taken by the Federal Reserve are not aimed at the the corona virus but at the economic consequences of the measures taken to prevent its contagion. As the Fed stated a few days ago: “The Federal Reserve is prepared to use its full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals.”

The decisions taken to ‘protect America’ have already been proved to be an accelerator of the recession and they had no positive impact on the market correction. On Friday, JP Morgan Chase announced that the recession would happen by July. The bank now estimates that the nation’s economy is likely to shrink by 2 percent in the first quarter and another 3 percent in the second quarter. Goldman Sachs concurs. It means that we already are seeing an abrupt slowdown of the economy. Don’t count on the Central Banks to solve it. They have already bought $ 15 trillion of assets since the 2008 financial crisis to no avail.

The recession is not limited to the United States. The OECD has announced a halving of the growth due to the consequences of the virus. Since then, the situation worsened, and a number of countries have decided to close their borders, even within the European Union. For all practical intent and purposes, we are already in recession and the stimulus programs show it clearly. The real question is whether stimulus policies will manage to correct the over leverage of the entire financial system.

The measures that slowdown key activities will have to be assessed carefully going forward. They will increase the social pain and put more companies in bankruptcy and households in deep trouble. The 2007–2008 crisis will look like a minor event compared to what we can expect. It took two weeks to wash out 80% of the S&P 500 growth since Donald Trump as elected.

With a recession comes a cohort of unemployment and bankruptcy. For countries like the United States, where the employment is at an all-time high, it might be less painful than for Europe. Japan is in a different situation: its workforce is insufficient to develop its businesses, especially engineers.

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Source: FT (see this excellent article)

The indebtedness of the corporate world in the United States continues to increase and is now reaching 75% of the GDP, while the government debt reaches 105%, a level it only reached after World War II.

One of the reasons is that the buyback of corporate equity as well as the dividend distribution exceed their operating earnings. This weakens companies’ ability to face an increase of interest rates, or a decrease of their operating earnings. Should taxpayers support airlines who spent their entire cash flow to buyback their shares and are now over-leveraged?

Source: MarketWatch

But the real question is whether the US government, even with the help of the Federal Reserve, is capable to finance a stimulus package when the recession will be serious without provoking a weakening of its rating and an increase in its interest rates.

There is no doubt that the evolution of the US federal debt is the result of a least 20 years budgetary policy that spans through political parties. In this context initiatives such a repaying student debt (Sanders), purchasing 77 million barrels of oil or paying directly $1,000 to the American people (Trump)seem imprudent as they are politically motivated.

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The corporate debt, the government debt or the interest rates will trigger the next financial crisis is less important than to tell our citizens that the recession is there, a financial crisis is unavoidable and while the corona virus triggered the current Wall Street collapse, it is not the cause.

We are now entering a severe and long recession, with its cortege of unemployment, bankruptcies and miseries, in a position of eminent financial fragility.

Written by

CEO at Galileo Global Advisors and Adjunct professor Columbia Law School.

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