The underwritten is a summary of the Economic scene facing us for the next 2 to 12 months. I apologise for the cut and paste but when reading this I thought it was an excellent summary and takes us away from the hyped up tripe we tend to get from mainstream media. This is the type of summary you may want to read if you have economic decisions to make in business or investment or if you are a self managed super fund...... Aside from all is the general reader may or could go to the bottom of the summary where you may find the consumer behaviour interesting.

8 April 2020 ... This written by a major fund manager and is relayed in a format of choices and scenarios.

As the world battles with the COVID-19 pandemic, our assessment of the economic and investment implications depends upon three fundamental issues. These are the duration of the output gap, the policy responses to mitigate the output gap, and whether or not the crisis will result in fundamental and lasting changes in consumer behaviour.

Let’s take each issue in turn.

Issue 1: The duration of the output gap

The output gap is the lost economic output a country will experience during a period in which the economy is effectively shut down. The longer the output gap, the deeper the economic damage. The duration of the output gap will largely depend on the effectiveness of the health response taken by governments.
There are two health responses that are being pursued. One is a hard suppression strategy, where authorities implement a total shutdown of the economy for, say, six to eight weeks. This is likely to be the most effective strategy to minimise the duration of the output gap. Following a period of total shutdown, growth in new cases should be near zero. Officials should be able to reopen the economy provided they have strong testing, contact tracing and monitoring to stop the spread of new cases. For many countries, this might prove to be hard to do comprehensively and effectively. External borders would have to remain closed to stop imported cases.

China appears to be on this path.

The other strategy is a mitigation strategy where authorities implement a controlled social-distancing strategy and keep parts of the economy open as long as possible. This is likely to lengthen the duration of the output gap compared with a hard-suppression strategy.
Many countries are now pursuing courses in between these two bookends.

Our best guess is that the duration of the output gap ranges from two months to six months depending on the effectiveness of the various health responses. Based on the measures being pursued by various countries, we would put China at the low end of this range, the US and Australia in the middle and many emerging markets at the other end.
The one area that could shorten the output gap is an effective therapeutic being found that reduced the mortality rate in the most severe cases. This would enable countries to reopen with less fear. We would be surprised if an effective therapeutic could be found and scaled globally within six months. There is enormous work being undertaken on testing therapeutics with trials underway with little red tape. We note Johnson & Johnson has announced it will commence trialling a vaccine in September. At best, it would only be available for small-scale deployment in early 2021. This is unlikely to truncate the duration of the output gap.

Issue 2: The policy response
The policy responses cover those by central banks and governments. Central banks appear to be taking two courses. The first is to reduce interest rates as far as practicable; that is, making money effectively free. The other is to ensure the financial system has sufficient liquidity to ensure it doesn’t freeze. We are seeing massive injections of liquidity by central banks via a scaling up of quantitative easing, providing liquidity-support facilities to businesses, liquidity support to other central banks (currency swaps) and liquidity to critical areas of the economy such as the repo markets and money-market funds.
We have been impressed with the actions taken by the major central banks to date; they are acting nimbly, and with scale and speed. They appear to be winning the fight to head off a liquidity crisis, and will tailor responses as issues emerge. At the same time, some difficult issues haven’t yet been addressed that are likely to put further strains on the financial system. One unresolved issue is the support to be given to sub-investment-grade companies that have borrowed in the high-yield and leverage-loan markets.

Another area to be resolved is what happens when many companies have their credit ratings downgraded from investment grade to sub-investment grade. Solving these issues is difficult and might require a co-ordinated response from governments and central banks.

With fiscal policy, we are seeing governments implement four possible packages of fiscal responses. One is to compensate all businesses for 100% of their lost revenue. This would keep balance sheets intact and enable businesses to pay all their employees and key suppliers; for example, landlords, lenders and so on. Businesses could furlough workers and restart when the economy reopens. In this instance, there would be a limited rise in unemployment, despite a hit to GDP, and activity would resume when the economy reopens. The output gap would be transferred to governments and to central-bank balance sheets via quantitative easing. This would be a V-shaped economic recovery. Singapore and Denmark come closest to adopting this strategy.

The second strategy is to compensate businesses for some of their revenue loss and allow them to meet permitted expenses such as wages, interest on loans, rent and utilities. Employees would be furloughed. The US has a program to lend up to US$10 million to companies employing fewer than 500 people. Under this strategy, a large part of the output gap would be transferred to governments and central-bank balance sheets and the remainder would be shared by society. This would save many businesses and enable them to restart. This combined with an effective mitigation strategy would be the best chance of a U-shaped economic recovery. Germany is following this strategy.

The third strategy is to compensate workers for 70% to 100% of lost wages (typically capped at the median wage). This strategy preserves personal balance sheets, but not businesses that have to manage fixed costs. The issue here is that, outside of wages, the remainder of the output gap would fall on businesses, landlords, utilities and banks. This is also likely to hit property prices. Even if many businesses survive, they would emerge with additional debt or balance sheets that were damaged. This would impede their ability to invest and employ as many people as before. They would cut costs to survive even when the economy restarted. This strategy would head off the most dire of economic outcomes but it is unlikely to prevent a deep and prolonged recession and a significant jump in unemployment. Many western governments are pursuing this strategy. These governments might well provide additional fiscal support to preserve businesses’ balance sheets that could be expected to support a stronger economic recovery.

The last strategy is zero compensation. A country loses 17% to 50% of annual output (depending on the duration of the blow to the economy). Many businesses would not survive, particularly small businesses. The property market would crash. Banks would face severe loses. This is the depression scenario. Fortunately, almost no developed country is following this strategy. We fear many emerging markets will not have effective mitigation strategies and be unable to fill a meaningful part of the output gap. We are particularly concerned about Africa, Latin America, India and emerging countries in Southeast Asia.

Issue 3: Changes in consumer behaviour

In thinking about the economic and investment implications, investors need to assess the effect that the health and economic crisis is likely to have on consumer behaviour. This will determine the speed of any economic recovery and create winners and losers in a relative sense.
We know that significant events such as the Great Depression of the 1930s and the world wars had lasting effects on behaviour; so too will today’s crisis. There are areas such as the cruise industry where there is likely to be a lasting effect on consumer behaviour. It is possible that the travel industry will experience a fundamental and lasting reduction in demand

Retirees will probably not travel overseas like they did previously. Businesses might determine much business travel is inefficient and discretionary and that meetings can be held just as effectively via video conference.

Other questions investors must ask themselves include: Will there be a fundamental shift in consumption patterns? Will people dine out in restaurants less frequently? Will there be less conspicuous consumption? Will people change their hygiene habits enough to lead to higher demand for cleaning and hygiene products? Will there be a change to how people work? Will this lead to increased demand for software like video conferencing? What will happen to the savings rate? Will people delay renovations to their homes?
The extent of change in consumer behaviour will depend upon many factors. These include the duration of the output gap, the effectiveness of the policy response and the speed and shape of the economic recovery.


The situation remains fluid. It is difficult to predict how the next two to 12 months will play out.
We think there is a range of outcomes for the economic recovery, from a V-shaped recovery (a fleeting recession) to a U-shaped recovery (a mild recession), a prolonged and deep recession and, at the pessimistic end, a depression.
We believe that for many major economies, a V-shaped recovery and a depression appear the least likely scenarios. Outside of a few countries, a recession (a U-shaped recovery) to a deep and prolonged recession appear the most likely outcomes at this point in time. The good news is that governments and central banks are calibrating their responses to attempt to mitigate the economic fallout.

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  • Very interesting piece Poppa.

    Two things for me - retirees and heading o/seas will probably take a hit. Will this mean more stay and travel around Australia? Or NZ?

    Secondly i have said it for ages, the age of travel o/seas when some if not most can be done through video conferencing at a fraction of the cost. It has always amazed me at a local level about this but i guess there has always been the chance to talk it up and get on the drink etc. My work has only taken this on board recently and i know it has reduced travel time and minmised costs in many areas and yes there has been a flow on in terms of not using local / interstate venues etc. but it as been done and quite effective too.

    • Thanks Mitchy, I didn't think I would get any comments.

      Just to add to that....have a look at this may surprise you and yes I would wary about anything travel related but internally within Australia we may have a boom in local holidays and destinations. I think we will also be looked upon favourably as a destination to the "daredevil international holiday seekers" who want to remain in a relative comfort zone...... LOL Cruise ships/ cruises..... I have only ever been on one but I suspect I will be dead before number 2 takes place.

      One trillion and counting: is government debt a problem?
      Hans Kunnen 8 April 2020 5
      Some stories bear repeating. Back in 2013, Chris Cuffe wrote an article in Firstlinks (then Cuffelinks) entitled Until debt do us part, Act 1.
      Its basic premise was that concerns and commentary about government, national and household debt were often off the mark. It pointed out, from an accountant’s perspective, that 'debt to GDP' ratios were a mix of stock and flow numbers. The level of debt is a stock item while GDP or national income is a flow item.
      Can we service our rapidly-rising debt?
      This mix of accounting concepts distracts us from the primary issue that debt creates, namely capacity to service. The article suggests that debt servicing ratios are more helpful in determining our level of concern and should be the focus of commentary.
      With Australia’s household debt at record levels , our general government debt about to reach levels not seen since WWII (due to the Covid-19 response) and foreign debt now in excess of $1 trillion, it’s time to remember Chris Cuffe’s basic accounting principle. Undoubtedly, we will soon start reading horror stories about debt. Be prepared.
      As shown below, government bonds on issue have already risen rapidly since 2010, and will exceed $1 trillion within six months after funding the stimuls packages.

      The current economic policy response to Covid-19 continues to unfold. Its economic aim is to cushion the economy from the impact of its policies to control the health crisis (lockdowns).
      The scale of the economic response is lifting debt to the point where previously agreed up debt ceilings are being lifted. While in the United States, this has caused political grandstanding and generated market uncertainty, in Australia it has passed by with little comment.
      Economy is still functioning
      On whatever measures you chose to use (and, debt to GDP, sadly, is the most common) Australia’s government debt is low by world standards. It is set to rise, but even if it were to double, it would still sit below the debt to GDP ratios of nations with comparable standards of living.
      What about our ability to service this new debt? This depends primarily on two things, our income and the interest costs.
      Without doubt our income will take a hit this year. It may well be subdued for a few years to come. No one really knows the endgame of Covid-19 but a vaccine does seem probable, but with considerable delay. That said, the economy has not stopped in its tracks. Income will be down but not out.
      An unemployment rate of 10 or 15% is an economic and social disaster but it also says that 85-90% of the economy is still operational. There will be wages earned, profits made, and taxes paid. There will still be a flow of income to the government from which debt payments can be made.
      And what about the cost? Today interest rates are at historical lows. Low borrowing costs can be locked in for a decade. Rates will rise but not soon. In the meantime, we have the capacity to rebuild our economy, reduce unemployment, rethink our ways of doing business and adjust our priorities.
      I don’t wish to underplay the risks associated with taking on debt. It’s never a riskless exercise, but likewise, I want us to understand the metrics that matter.
      What are the metrics that matter?
      GDP or national income in 2019 was almost $2,000 billion. Government debt outstanding was almost $600 billion in the latest Reserve Bank chart shown above (released on 4 March 2020). According to the budget papers, government debt in 2018-19 was estimated at $373 billion with interest costs of $14.1 billion while government revenue was $485 billion.
      At the time of writing the government had announced some $350 billion in new spending. The largest items are the JobKeeper, business support and JobSeeker programmes. The exact timing and magnitude is not known and further programmes may be required.
      Taking the estimate of $350 billion as a base number for new debt due to spending programs, this adds $0.9 billion per year in interest costs. However, if government revenue falls by say 20% or $100 billion new debt could rise to $450 billion and total new interest costs of $1.1 billion.


      The government is already paying $14.1 billion per year in interest costs. Total annual interest costs would rise to around $15.2 billion under this new scenario. Is this manageable? Yes. A resulting debt service ratio of 3.9% is well above that of recent years but is on par with levels seen during the 1980s and 1990s.
      In a nutshell, the increase in debt resulting from new government spending programmes and a decline in government revenue is manageable. While we would prefer not to be in this position, from a debt financing position it is not a crisis.
      We have been here before and we will come out the other side.

      Hans Kunnen is the Principal at Compass Economics and was formerly an economist with Colonial First State and St George Bank.

      • Hans seems to know his data and sums Poppa....

        Yes this is all v concerning and for novices like me i am grateful to have a permanent gig in this time.

        What i do know is that these times are somewhat unpredented again when compared to some prior pandemics (SARS etc.) and i guess govt is attempting to get the mix right.

        I read today (unsure how accurate) that Japan is looking at withdrawing some investment / companies in China to further minimise future potenital risk. I think the main jist was to encourage local business to invest elsewhere out of China.


  • Thanks for posting pops. Enlightening reading. 

  • Good read Pop.

    I think one thing is for sure - and that is that no one knows for sure how this is going to play out, and how long it's going to be before we can start the recovery. There's no guarantee there will ever be a vaccine, let alone how long it will take. I agree that our countries govt. debt level isn't an issue and there's plenty of room for more stimulus if needed.

    QE is doing a great job for the markets but I reckon that once we get on top of the virus and start recovery we need to then also start focusing this MMT on what it was originally intended for -  productivity increases -  quality public works and infrastructure to create jobs and quality public assets. I reckon an official unemployment rate of 15% means a real rate of 25% and that's a disaster that we need to fight and fight hard. 25% unemployment means noone will be spending money on anything let alone anything even remotely discretionary.

    I dunno what your thoughts are on this but i like alot of what Ray Dalio has said over many years and I subscribe to the 75-100 year debt cycle and believe we were right at the end of a cycle before all this happened - and as a result this pandemic is in essence speeding up the inevitable contraction and ironically helping central banks etc. to focus and deal with it without distraction. Every cloud!

    On a micro level I hold genuine fears for highly leveraged households whose "wealth" is entirely tied up in property that I reckon is still around 40% overpriced. If they can't hold the housing market alot of punters with hearts of gold will be caught in the crossfire. For me, that's the tragedy and the real cost of it all.

    Of course - the banks, big corporates and elites will be just fine - as per normal. 

    Hope you and the family have had a relaxing Easter mate :)

  • No issue with what they are saying here, however, you should know better about referencing the author.

    Stating this is written by a major fund manager doesn't pass the pub test.

    Not referencing this opinion piece is akin to plagiarism DH.

    • I accept that criticism Vince, I thought it out and wasn't sure that I was allowed to, as it comes as a private newsletter addressed to me......just wasn't sure.....hopefully by saying it was a major fund manager it excluded me from plagiarism which i wanted to also be clear on.

      • Kram, back to you on your comments, I believe we are quite realistic (between us) in terms of the unknown and volatility that still confronts us.

        As you know I am a optimist by nature and as such I will stay that way.....that said I have gone very liquid (cash) with my Super (self managed) , just keeping my gold stocks and a couple of my favourite biotechs.

        I do not see for one minute think that the current bear market rally we are witnessing is for real.....I expect that we have not have seen the bottom yet. This is a market you need to stay focussed on and there is no need to put everything in the same bag and you have every right to change your opinion very regularly.

        One note of caution with properrty prices, there will be bargains out there but the fundamental is land and it  will prove to be a very good investment for the future....IF YOU CAN AFFORD IT....most people won't. So you may see some savage falls in the very short term but if you are not a forced seller, don't panic.....if the world comes back, so will property prices. Little anecdote is my son is a builder and one of his clients in the legal profession went with him yesterday to look at a property (they are building) which is under construction. The investor said to him, I can borrow money at 1.50% at the moment, any bargains you see (meaning land and much of this opportunity is old existing housing that can be split into two properties) then we should not miss the opportunity.

        These properties will be coming on to the market as finished products in say 18/24 months time once purchased.

        If we had extreme deflation then we would have a different ball would mean everything falling in value with the US Dollar collapsing....... the Gold Price can still fall in such a situation but only  in a relative sense.

        The alternative is high inflation, hyperinflation being different again.... I would like to think we will have a brief and segregated (through industry type) deflationary experience (happening now) followed by controlled inflation. This effectively over time dilutes the debt but adds value to things like the property market and industrial development.

        Finally and this is REALLY putting on my optimistic hat! If Australia starts to reindustrialise and becomes less reliant on imports from single countries then there will be a huge change in the people demographic with less emphasis on the service industry and much more on trade driven occupations.

        Australia becomes a very attractive alternative for migration and again we need to look back at post war type booms that can surface in this time......we need therefore to make sure our migration is culturally acceptable to the people that can help build a nation, rather than political correctness of just taking refugees that simply want to destroy our way of living by importing their domestic politics and religions.

        • Kram just reread your post and whilst I dont know Ray Dalio, I'm a great believer in Cycles and have been a regular receiver of newsletters from Phil Anderson in a publication called Cycles and Trends.

          He personally has stopped doing it and it has been taken over a couple of his underlings who I dont have as much confidence in. Their bottom line is that property will present the buying opportunity of a lifetime in the next 12 months.

          That said it will be a couple of years after that to know if the proof is in the pudding.

          • Just looked up Ray Dalio, feel a bit stupid, knew his company  but not him.....he is very impressive Kram and is a much bigger "big picture man"  than my comparison to Phil Anderson who is more a tech.

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