Labelling COVID-19 as a one in 100-year event has invited comparisons with the 1918 Spanish flu.
A century ago, the world was faced with a pandemic on a truly epic scale. The Spanish flu was the deadliest in history. Estimates indicate around one-third of people worldwide — 500 million — were infected.
The fatalities numbered somewhere between 20 million and 50 million.
Obviously, there were economic consequences.
‘The flu took a heavy human toll, wiping out entire families and leaving countless widows and orphans in its wake. Funeral parlors were overwhelmed and bodies piled up. Many people had to dig graves for their own family members.
‘The flu was also detrimental to the economy. In the United States, businesses were forced to shut down because so many employees were sick. Basic services such as mail delivery and garbage collection were hindered due to flu-stricken workers.
‘In some places there weren’t enough farm workers to harvest crops. Even state and local health departments closed for business, hampering efforts to chronicle the spread of the 1918 flu and provide the public with answers about it.’
Bodies piling up. Businesses forced to shut down. Inability to harvest crops.
The fatality rate today is much lower, but the economic impact has a familiar ring about it.
Eventually the world did recover.
And it’s this post-Spanish flu period that has some seeing a bright light at the end of the tunnel.
From the ashes of the Spanish flu rose the phoenix of the Roaring Twenties.
This was a decade of great prosperity. Admittedly it didn’t end well, with the Great Depression. But let’s not focus on that.
Could we be on the cusp of another Roaring Twenties?
Not so sure about that.
While there are echoes of what happened a century ago, not everything is the same.
For a little background, this from Ray Dalio’s latest book, The Changing World Order.
The book was written in response to the economic upheaval caused by COVID-19 (emphasis added):
‘These [expansion and contraction] moves typically come in the form of short-term debt cycles and long-term debt cycles… Over long periods of time these short-term debt cycles add up to long-term debt cycles that typically last about 50 to 75 years.
‘…the long-term debt cycle runs from…
‘1) low debt and debt burdens (which gives those who control money and credit growth plenty of capacity to create debt and with it to create buying power for borrowers and a high likelihood that the lender who is holding debt assets will get repaid with good real returns) to
‘2) high debt and debt burdens with little capacity to create buying power for borrowers and a low likelihood that the lender will be repaid with good returns.
‘At the end of the long-term debt cycle there is essentially no more stimulant in the bottle (i.e., no more ability of central bankers to extend the debt cycle) so there needs to be a debt restructuring or debt devaluation to reduce the debt burdens and start this cycle over again.’
In 1920, the long-term debt cycle in the US was gathering momentum.
Total US debt (as a % of GDP) was around 160%.
As the decade progressed, debt to GDP rose (in the Panic Year of 1929) to 200%.
With hindsight, we know the Roaring Twenties was the final decade in a long-term debt cycle that began almost 50 years earlier.
Source: Hoisington Investment Management
Note that in the years immediately after the Panic Year, the ratio spiked to 300%.
Did people take on more debt? No. GDP shrank.
According to The Balance:
‘During the first five years of the depression, the economy shrank 50%.’
In addition to this, debts were defaulted on.
Here’s the math on how two negatives create a spike in the chart.
|Debt||GDP||Debt to GDP Ratio|
The long-term debt cycle…
The Great Depression rang the bell on the previous long-term debt cycle.
There was no more stimulant left to create the same level of desire for credit that existed in 1920.
The US (and the rest of the world) went through a painful and prolonged period of debt restructuring and forgiveness.
When sufficient debt is purged from the system, the low debt base is the starting point for the next long-term debt cycle.
According to Ray Dalio…
‘The last big long-term debt cycle, which is the one that we are now in, was designed in 1944 in Bretton Woods, New Hampshire, and was put in place in 1945 when World War II ended and we began the dollar/US-dominated world order.’
The long-term debt cycle we’re in has been rolling along for more than 70 years.
The current US debt-to-GDP ratio is 347%…more than double the ratio that existed in 1920.
Source: Federal Reserve Economic Data
While the health crisis has parallels with 1918/19, the wealth crisis is more like 1929, only worse.
In 1929, the Debt to GDP ratio was 200%, much less than 347% we have today.
Central banks will do their utmost to keep the debt bubble inflated, but there is no way they can match the (earning and spending and borrowing) leakage on a dollar for dollar basis.
Just not possible.
And here’s another fact that very few people realise.
The US (and global) economy was slowing down before anyone knew about COVID-19.
This is an extract from the excellent Hoisington Investment Management ‘4th Quarter 2019’ report (emphasis added):
‘Substantial excess manufacturing capacity developed last year in the face of the slower growth and will serve to put downward pressure on inflation.
‘Total industrial capacity of the nation’s manufacturing, mining and utility companies was 77.3% in November, 2.3 percentage points less than the peak reached about a year earlier and at a lower level than when the economy entered all of the recessions since 1970.
‘Manufacturing firms were operating at even a lower rate, 75.2% late last year, compared to the post-1950 average of 79.9%.
‘The Organization for Economic Cooperation and Development (OECD) indicates that the industrial sector capacity use has moved steadily lower for all OECD countries over the past five years.’
The long-term debt cycle had reached maturity.
The slowdown in manufacturing was due to…‘high debt and debt burdens with little capacity to create buying power for borrowers’.
More and more income was being diverted to servicing debt burdens and less going to consumption.
And, as I mentioned, this was happening BEFORE the global economy was shuttered.
What is next?
Since March 2020, do you think things have gotten better or worse for an already slowing manufacturing sector?
That was a rhetorical question.
We are now entering a period that you and I have only read about in the history books.
A period where ‘there needs to be a debt restructuring or debt devaluation to reduce the debt burdens and start this cycle over again.’
None of us have experienced this in our adult lives. All we’ve ever known is the long-term debt cycle.
The abrupt change in the functioning of the economic model is not something people and markets have factored into their thinking.
The breather on Wall Street has instilled a sense of calm. Pulses have slowed a little in recent weeks.
Which is why the next leg down is going to be a doozy, a real head spinner.
The ‘there, there it’s OK rally’ is going to transform into the ‘take that and take some more for good measure plunge’.
The pandemic might be a one in 100-year event, but this financial crisis has the look and feel of a one in a 90-year experience.
Oh, and here’s one final difference. The US share market (Dow Jones Index) action leading up to 1920 was more subdued compared to the decade-long boom we’ve just experienced.
Source: Macro Trends
Source: Macro Trends
Record debt level. Record market high. Slowing demand.
Is this the set up for the Roaring Twenties or depression thirties?
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