7 minute read
Economic Downturn
DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.” Daniel Lacalle
Recession Is Already Here
The debate about recession risk is pointless. We’re already in a recession. Real gross domestic product (GDP) in the United States declined at an annual rate of 1.6 percent in the first quarter. The Atlanta Fed’s GDPNow model shows a 1.5 percent contraction in the second quarter. But the underlying figures are scarier.
Investment is collapsing, consumption is being barely kept alive, and if we look at other components, imports are soaring while exports are rising less than expected.
This is the backlash against massive stimulus packages. An artificial boost to GDP in one year from $2 trillion of excessive spending generated a non-structural rise in GDP that immediately led to a contraction. However, the debt increase remains, and the structural problems are evident.
The labor market is only strong in the headlines. In June, the number of longterm unemployed was unchanged at 1.3 million, which is 215,000 higher than in February 2020. The labor force participation rate was 62.2 percent, and the employment-population ratio was 59.9 percent. Both remain below February 2020 levels (63.4 percent and 61.2 percent, respectively) according to the Bureau of Labor Statistics (BLS). Meanwhile, inflation is eating away any wage rises, and real median wage increases are negative in 2022.
Negative real wage growth, weakening consumption, decade-low consumer confidence, and collapsing investment mean we’re already in a recession, and the massive stimulus plans have created nothing but debt.
Inflation expectations are moderating for the wrong reason: a recession. Although these expectations remain above the levels that we would consider normal (3.4 percent median over three years compared to 2 percent that we would call “normal”), this moderation comes from the correction in those commodities most linked to industrial activity.
Oil and natural gas remain at elevated levels, but have corrected massively in one month, far from the prices reached in March. However, both are maintaining an extraordinarily strong rise so far this year, and the winter effect is clear in the futures curves that continue in backwardation (a positive medium-term price signal).
Furthermore, copper, aluminum, and iron ore are down on the year, showing that industrial activity isn’t improving as many expected. The Baltic Dry Index has also corrected rapidly, a signal of cooling in freight rates. The Chinese slowdown is relevant, but domestic demand in the United States is clearly contracting relative to a year ago.
Consumption also is slowing down due to high inflation and its effect on household disposable income. That’s why it’s key that central banks contain inflation by reducing the amount of money in the system and adapting interest rates to inflation to contain price escalation.
The probability of a recession in the United States has risen to 50 percent according to the Bloomberg consensus, and to 45 percent in the eurozone. However, all metrics point to an evident recession in the private sector. Credit conditions remain strong and, although they’ve recently tightened, they’re far from crisis levels—but certainly equivalent to recession periods.
A severe slowdown implies that rate increases are likely to end in November, following the U.S. midterm elections, and that central bank policy will remain accommodative. That would be a double danger because the sticky elements of inflation won’t be truly addressed and the incentive for governments to repeat the failed spending plans will be enormous.
The U.S. economy has encountered almost no impact from the Russian invasion. It has extremely limited trade with Russia. Energy prices are elevated, but the United States is energy independent. In fact, it has become one of the largest exporters of liquefied natural gas to Europe, thus saving the European economy from supply cuts.
If there’s a recession in the United States, it isn’t due to the Ukraine invasion or external factors, but due to incorrect inflationist policies implemented during 2020 and 2021. The United States is suffering the hangover of another set of misguided Keynesian policies. Monster government spending and massive monetization of debt have created a mess in an economy that should be leading the world today precisely because of its energy, technology, and labor market advantage.
FAN YU is an expert in finance and economics and has contributed analyses on China’s economy since 2015. Fan Yu
This ‘Crypto Winter’ Is Different
Even if prices recover, the future of crypto markets is uncertain
This time is different” is a dangerous phrase in the world of finance.
But for the cryptocurrency market, this time may actually be different. We’re in the midst of a “crypto winter,” a term describing a period of very low prices for the nascent digital currencies market.
This crypto winter has been especially severe, with total market capitalization down by more than $2 trillion since the all-time highs reached last year. Is this the beginning of the end for what some critics have labeled as “Monopoly” money, or will this be the turning point where the industry matures from here?
How about both are right?
Crypto proponents will point to several past crypto winters as evidence that this winter, too, will pass, and crypto markets will again hit all-time highs. Depending on one’s definition of “crypto winter,” there have been at least five previous periods of severe drawdown, with 2011, 2013 to 2015, and 2017 to 2018 as particularly brutal downturns for Bitcoin, the biggest cryptocurrency. And after every winter, the crypto market recovered and reached new all-time highs.
The rebound may already be occurring, as some of the leading cryptocurrencies, such as Bitcoin and Ether, have recovered from recent lows.
But short-term price movements are irrelevant to long-term prognosis. A price recovery could just as likely be a so-called dead-cat bounce as well as a return to all-time highs. Crypto’s longer-term outlook remains unclear.
What is clear, however, is that this is a completely different industry than the one that suffered the last crypto winter and the winters before that.
Today’s crypto industry is staffed— more than ever—not by technologists or cryptography nerds, but by former Wall Street bankers and traders. These refugees fleeing a heavily regulated industry found themselves in a land with very few rules and regulations. And without the shackles of regulators, these investors built up entities by employing huge amounts of debt and invented crypto-based lending schemes collectively and loosely termed “DeFi,” or decentralized finance.
The technology behind these schemes may be novel and may employ platforms such as blockchain, but conceptually, they’re no different than high-yield lending. In some cases, the loans are completely unsecured, and in many cases, they’re secured and overcollateralized with other assets. The term “assets” is used loosely here, as the collateral can be in the form of cash (fiat money) or other crypto tokens with value and worth that are themselves dubious.
The amount of debt and leverage in the system today is unlike any other period in crypto’s history. So when prices of tokens declined, a cascade of margin calls followed, and funds, lenders, and crypto institutions became forced sellers.
This market downturn—like ones prior to this—wiped out many crypto investors. It also wiped out many crypto and DeFi businesses. But unlike prior downturns, many of these failing businesses are well-known, employed hundreds of people, ran ubiquitous ads, and attracted hefty valuations and capital investments from venture capital firms and traditional financial services firms looking for a beachhead in this newfangled industry.
All of this leads back to our original thesis. In an unregulated market such as crypto, there inevitably are many scams, entities with shoddy business models, and entities taking excessive risk.
But it’s also a turning point for the industry. Lawmakers at both the state and federal levels are no longer ignoring or turning a blind eye to the risks that the crypto market poses. There’s bipartisan support in Congress to form new laws governing this market. Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission have brought enforcement measures in recent months. SEC Chairman Gary Gensler has said that the crypto industry is “rife with fraud, scams, and abuse.”
So with a similar outlook as the American “Wild West” at the turn of the 20th century, the cryptocurrency industry will no longer be the same going forward. If there’s an industry with innovative businesses and technologies that can survive and thrive going forward, 2022 will be its legitimate inception.
