We have been harping on the question “are you prepared?” for years. We have asked if you were prepared financially, mentally, physically, and with your maker? The potential boogeyman as we suggested could come from anywhere or any angle but the end result would affect the economy and thus finance (credit) and would then spill over socially.
I have to admit, a “pandemic” was low on my list of possible sparks, but after thinking it through, a pandemic is a financial disaster. Yes it is a human disaster and many will die, but the odds of dying from the virus are and will remain quite low. The real problem is what the human response will be. I say this because we live in a world of just in time inventory AND production. We also live in a financial world with more debt and financial leverage (and thus monthly debt service) than ever before. So much so that even a small hiccup (which this does not appear to be) where business slows and contracts will be enough to quickly default some credits. The problem is not the initial defaults, rather, it is the “contagion” throughout the system because our world is so inter connected (globalism).
We saw this back in 2008 where one entity (Lehman) going down had the ability to torpedo the entire system if it were not for $10’s of trillions mobilized from the central banks. Remember, back then “liquidity” was shoved into the system so the banking system could withstand the shock of a small handful (but large) of upside down institutions. I would use the analogy that 2008 was a snapshot event which lead to the motion picture of what they called “recovery”…expansion never came. Today is different, because back then the central banks and sovereign treasuries had the ability to print/borrow in an effort to reflate…which they have continually done since then. Now, in a world with a debt to GDP ratio of 332%, who has the ability to step up and reflate?
The world is awash in debt while interest rates are extremely low and at unprecedented levels. Interest rates have been engineered lower by central banks out of necessity. This “necessity” is not so much to spur the real economies on (as they say), rather, rates have been crushed to facilitate the payment of debt service. Bluntly, there would be no financial markets left if rates were at a historical norm of say 7%. The danger of course is that rates do go higher…! What if interest rates do go up? This is a question no one even asks anymore.
This is not to say central banks will ever willingly raise rates around the world. They will not, they cannot! However, there are scenarios where market rates go up all over the world in the face of and in spite of central banks. This could occur for a myriad of reasons but I believe the prime possibilities to be a currency crisis where a major currency or currencies begin to lose purchasing power rapidly, or a major default or a domino of defaults.
Thinking this through, were a major currency to collapse versus other fiats, interest rates would need to rise in that particular region to “risk adjust”. Additionally, were ALL currencies collectively lose purchasing power (think versus gold/silver “going up”), interest rates would also need to rise to risk adjust. You might want to read the previous sentence a couple of times because THIS is exactly why gold and silver have been sat on all these years, to prevent the perceived need for rates to go higher to adjust for currency risk.
Looking at the default issue, as bonds go through the process of defaulting, their prices drop. Lower bond prices mean higher yields, simple related math. If a sector or even sovereign region threaten to or actually default, rates associated will go higher. Should a default begin and turn into a global domino series, rates everywhere will go higher unless central banks buy everything sold and hold in their portfolio defaulted credits (as they did in 2008). In reality, this is exactly what caused the problem in the first place, central banks buying up everything in sight…including stocks!