Something from ex-PIMCO economist Mohamed El Erian caught my eye this week as his recent post perfectly articulated some of the points I was blogging about previously about the changes taking place around us.
Thanks to the Covid event trigger, the world is moving into a brave new world with no historical precedence or past experience to look back upon for guidance. We will remember history from now as pre-Covid or post-Covid reference points. It is either before 2020 or after 2021. Even watching youtube videos dating from 2019 days look so dated by now. And it’s only 3 years ago.
El Erian said the following: “The world isn’t just teetering on the brink of another recession. It is in the midst of a profound economic and financial shift. The first transformational trend is the shift from insufficient demand to insufficient supply. The second is the end of boundless liquidity from central banks. And the third is the growing fragility of financial markets.” https://finance.yahoo.com/news/top-economist-mohamed-el-erian-193236736.html
Starting from early 2020 when Covid struck, world demand collapsed as countries implemented lockdowns to close their borders in a desperate attempt to protect their population from the virus. Within months, we see ships stacked full of cargo stuck in harbours with nowhere to go. Everyone was told to stay at home and not step outside. It affected every living human being on the planet, something that has never happened before in our lifetimes.
Supply chains were crippled and we had to scramble for toilet paper and stock up on food. Days turned to months without anyone knowing what would happen the next day. Alpha came, then Beta before Delta, the most deadly of them all, flooded the morgues with bodies. It was a terrifying time when we all watch helplessly and wondered if the world was ending. It felt like we were taking one step forward and then having to take 2 steps backwards. And it happened multiple times.
Thankfully, the vaccines were ready by the beginning of 2021. It took months for countries to do national vaccination rollouts as supplies were tight and had to be ramped up. Working within the unknowns, this process turned political as governments worked in the dark to battle against individual rights to protect the wider community. It was a discovery journey even as the virus mutants ever so often.
By the end of 2021, Omicron finally arrived. Everyone sighed with relief that the virus had finally evolved to a milder form with lower mortality rates even though it became more contagious. It seems that the virus is determined to survive by not killing its host. Finally, the world was moving from a pandemic to an endemic stage.
This is where El Erain’s first transformational trend started to happen, a shift from insufficient demand to insufficient supply. Supply chains broke down as logistics became chaotic due to a huge surge in demand. The world started to open for business again after shutting down for almost a year. Countries were bidding against each other to secure precious resources for their citizens. Everything was out of stock and prices began to rise, causing inflation.
Coming from a lower base due to lockdowns in 2020/21, demand for most things rose a few hundred percent within weeks as one country after another relaxed their borders in early 2022. Inflation immediately went up to levels not seen in many years since the oil shocks in the 1970s. The central banks had to react with aggressive rate hikes to counter rising inflation.
Because of the 2008 GFC, central banks had supressed interest rates at a historically low level for too long. It provided cheap money for the last 14 years for investors to leverage to their eyeballs. This created asset bubbles everywhere.
El Erain’s second transformation shift was the end of boundless liquidity from central banks. The aggressive rate hikes in 2022 to counter runaway inflation burst the party bubbles. The Fed did 4 consecutive 75 basis points (0.75%) hikes that equate to a total of 3%. It had hiked rates at six straight meetings, something it hasn’t done since 2005. Not since the 1980s has the Fed raised rates by 3.75 percentage points in a single year.
Stocks started to collapse from the Covid-induced rallies of 2020. Tech names dropping 70-80% from their recent historical highs became common. Zoom, Shopify and even the big boys like Meta suffered. The 2021 “diamond hands to the moon” hype of crypto and NFT markets started to crack by early 2022.
El Erain’s third and final transformation trend is the growing fragility of financial markets which we are experiencing now. There is a domino effect that is affecting institutions we thought were robust but actually look like a deck of cards now. In a rising tide, all boats are naturally pushed higher. By the same token, a receding tide also grounds many ships. We also discover who was swimming naked as frauds surfaced.
Crypto fiasco disasters like Terra Luna and FTX are happening with increasing frequency and taking on more victims. Their interconnectivity to each other becomes a huge liability when assumed values vanished overnight with a big drop in a token’s price. Yield farming and lending out your coins suddenly became unsafe when one can totally lose your principal overnight. Counterparty risk became untenable as even the top exchanges get hammered.
We are starting to see a re-evaluation of value thanks to the post-Covid induced inflation. This led to aggressive rate hikes which trigger the reverse of loose monetary policies. Falling dominoes are starting to impact more asset classes and the growing fragility of financial markets is being sorely tested.
As we head into the end of 2022, we face an uncertain 2023. Will there be a mild recession or would we see another horrible year for investment again? Will the central banks reverse course and exercise their printing machine to “save” the economy? One thing for certain now is that China, the sleeping giant, is awakening from its zero Covid slumber. It is a double-edged sword that can re-invigorate the global economy or create a new round of inflationary upside pressure.
The optimist in me tends to see the positive side of things as we move away from the Covid years and return to a new normal. It is time to relook at everything from a different light now as a profound and fundamental economic and financial shift is happening.
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