Expecting the Unexpected: This Isn’t a Normal Crisis

Dear Reader,

Well, some things are changing fast.

Virus cases in Melbourne are spiking…

…the border between Victoria and New South Wales is closed, with no indication of when it will reopen….

…and Melbourne is going back into lockdown tonight.

Then again, other things haven’t changed.

The Reserve Bank of Australia (RBA) left interest rates unchanged at a low 0.25% yesterday. The indication is that they are likely to stay low for a long time.

I’m not so sure about that.

I mean, for now, everything is pointing to this being the case. Oil prices are low. People have high debt, they are stuck at home and aren’t spending. Unemployment is increasing.

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This isn’t a normal crisis

But this isn’t a normal crisis. We’ve been dealt a tough hand with this pandemic.

So far, it’s prompted a huge response from governments around the globe. They’ve flooded the system with money to maintain liquidity and increase debt. But, as my native country Argentina learned the hard way, increasing the money supply has consequences.

Governments around the globe are taking on a lot of debt. How will all this new debt be paid for?

At some point, it will need to be repaid with either more taxes and/or inflation.

We are already hearing comparisons of this crisis and the higher government debt to times of war. Often, the aftermath of war has resulted in higher inflation.

We are now in the middle of a huge experiment, one that began during the last crisis.

I mean, low for long interest rates, quantitative easing, it’s all things that we tried already to fight off the 2008 crisis, and they seemed to do the trick. Except for the fact that these brought inflation to asset prices.

Things weren’t great before the pandemic hit, and the virus is now acting as the perfect scapegoat for the crisis we were likely heading into already.

In fact, Jim thinks COVID-19 could be a ‘trojan horse’. One hiding something big and highly unexpected underneath.

Many are dismissing the idea that all these measures will bring consequences. But a couple of points on this economic experiment…

For one, this one is taking place in a completely higher and new scale. We have no idea where this experiment will lead us.

Second, last time it was households that were in trouble through the subprime crisis. This time it’s everyone. And it’s governments who are taking on more risk.

As I write this, though, the old global system is changing.

Inflation happens when demand increases faster than supply. This pushes prices higher. This push can come from either an increase in demand but also from a decrease in supply.

But as I’ve said, this isn’t a normal crisis.

The crisis is pushing demand lower

The crisis is pushing demand lower, which will mean that in response manufacturing will produce less. Less production will decrease the supply of goods available, which could spur inflation.

And there is also the risk of disruption of supply chains from the virus. We could see shortages as cases spike in certain areas.

At the same time, the pandemic and the lockdowns are increasing the cost of doing business and the cost of supplying things.

At some point, these costs will get passed on to consumers which will push inflation higher. It’s likely that things like travel, restaurants…they will all get more expensive to cover the higher costs of doing business.

Market expert Shae Russell predicts five knock-on effects of the recent market crash that could be even bigger threats to the average investor’s wealth than the crash itself.

And, countries around the world have realised with this crisis that they need to take some control over their supply chains to secure them. Globalisation over the years has brought in less inflation, through cheap labour. Localising some of the supply chains will definitely bring more inflation at some point.

I’m not trying to alarm you, but my point is, don’t discount about of inflation coming our way at some point just yet.

In the short term, inflation doesn’t look likely. But there’s a lot of uncertainty out there.

Yes, demand looks like it will stay subdued as people repay debt, hunker down, and decrease spending…

But it’s the supply side that’s in question here. How will the pandemic and the change in supply chains affect the goods that we consume? Especially as tensions keep increasing between countries and cases spike?

While it may not seem so now, the pandemic won’t last forever.

Remember, things never stay the same. The only constant is change.

Best,

Selva Freigedo, For The Daily Reckoning Australia