Why You Should Be Very Afraid Of A K-shaped Recovery - YouTube

So 2019 really was the ideal time to start a  youtube channel focused on economics because  

the months since this channel has taken off  have not exactly had many dry news days.

The economic impacts of the coronavirus  have been felt far and wide and we have  

covered these problems in-depth in  a handful of videos on this channel.  

But the logical question that most  people are asking is what comes next?

Disasters happen and they are never  pleasant but part of being a nation,  

a business or even an individual is being able to  deal with adversity and come out the other side.

Because of this people are expecting a  recovery of sorts, and it seems like the  

only point of contention will be what letter  of the alphabet this recovery will represent.

You have likely heard of a v-shaped recovery,  so-called because it would reflect a sharp  

decline in the financial markets and then  a sharp recovery making the shape of a V.

Other speculations include a w shaped  recovery where we will see 1 recovery  

then another decline as the effects  of government stimulus and relief  

packages wear off only to be followed  by another genuine recovery later on.

Pretty much at this point, if a  letter has some kind of topography,  

alphabet obsessed economists  have used it in a prediction.

Of course, the big issue with this is  that nobody can really predict the future  

so that means until this whole thing plays  out we really won’t know for certain.

But that doesn’t mean that these predictions  are simply the result of economists desperately  

trying to justify their existence in an  increasingly thin difficult job market either.

In fact policies and procedures should be  put in place by governments to appropriately  

deal with any one of these types of  recoveries, if and when they happen.

But amongst all of this, there is one type of  recovery that we should all be very afraid of,  

one that is not getting nearly as much  airtime and one that is actually being  

hurt by a lot of current policies  and that is a K shaped recovery.

What’s more, is that this type of recovery  is not a hypothetical or a speculation,  

it is happening right now before our eyes,  and that shouldn’t come as a surprise.

It was actually the same type of  recovery we experienced after 2008,  

so perhaps predicting anything different  is the real farfetched reality here.

But as always we need to look at a few things  

to really understand what this  K shaped recovery looks like.

So what even is a K shaped recovery?

What are the forces that are driving it?

How should governments, businesses,  and individuals plan for it?

And while we are having fun speculating

What will the K mean for  our economies in the future?

ADD INTRO

Now a v or u or w shaper recovery is pretty  easy to understand. Just put the letter over  

the top of the dow jones industrial average  price chart and hey presto predictions made.

But the eagle-eyed amongst  you might have realized that  

K doesn’t really work for this its  got too many lil squiggly bits. Sooo

What is a K shaped recovery?

A k shaped recovery starts out the save as  

any other recovery profile. With  some kind of economic decline.

The largest quarterly drop in  GDP growth in recorded history  

and swelling unemployment figures  should fill in for that pretty nicely.

Now as for the actual recovery part of  a K shaped recovery that splits into two  

just like the letter, with one portion of  the economy going back to or even exceeding  

past prosperity and another portion of  the economy continuing to fall behind.

Now in this case the divide between  these two portions of the economy  

are wealthy asset owners and  big businesses in one category,  

and then regular wage earners and small business  owners in the second category. Shocking I know.

This is already starting to happen and the results  are clear. The S&P 500 grew to its highest level  

ever in the same month that the overall  economy recorded those record losses.

American billionaires have added a staggering 637  billion dollars to their collective net worth,  

while unemployment has spiked into double digits.

Now the reason this is happening is that  financial markets that drive the wealth  

of most American billionaires  are planning for the long term.

Investors know that eventually, this health  crisis will have to come to an end and at  

that time the businesses that they own will be  there and ready to start turning a profit again.

So long as their companies survive  through a year or so of slower business  

they will come out the other end all the same.

The chances of them actually making it though  have been massively improved by generous  

government stimulus and record low-interest  rates, which means even businesses whose core  

operations may have been impacted  are feeling pretty flush with cash.

What’s more is that this  is the worst-case scenario.  

for a lot of businesses like Amazon,  and Uber, the idea of a world avoiding  

shopping centers and public transport  has been a massive short term win.

Now unfortunately the average world  citizen does not have the luxury of  

making financial plays over the years or decades  

they have to put food on the table today,  which without a job can be extremely hard.

Sure government support is there but  for most households, it will not come  

fast enough or provide enough income to  support their day to day living expenses.

This means that those families  will have to do one of two things.

One cut back on living expenses, and no  

we are not talking about giving up a morning  Starbucks, and Disney plus subscription,  

we are talking about deciding whether or not  to pay for electricity bills or groceries.

Now the second option is that they  can start to dig into their assets.  

Now given that more than 70% of  American adults have less than $1,000  

in savings these might not  be the assets you think of.

People will have to sell homes, cars, and other  personal belongings. In the off chance that  

they have retirement savings it might mean  smashing open that piggy bank prematurely.

The Australian government has allowed its  

citizen’s early access to  their retirement savings.

This policy allowed people economically  impacted to access up to 20 thousand dollar  

that would have otherwise been locked  away from them until the age of 65.

Now in the short term this was fine,  

it allowed people to make their  next mortgage or rent payment.

But a majority of people accessing  this cash were younger families  

that had decades left of potential compounding  over the course of their working lives.

20 thousand dollars today may keep food on the  table a roof over the head and the lights on,  

but it means forgoing hundreds of  thousands of dollars at retirement.

Now it’s difficult to comment on this  being a good policy or a bad policy.  

Even the cushiest retirement probably doesn’t mean  much if your young family is out on the streets.

But what this does show is that  a downturn hurts everybody,  

but the true devastation is not felt  in weeks or months of scary headlines,  

it is felt, compounded over a lifetime  by those who couldn’t weather the storm.

Now the Australian example looks  at people who were fortunate  

enough to actually have retirement savings.

For some people, the solution will be  accruing debt. Racking up credit cards,  

personal loans and maybe refinancing their  home, if they are lucky enough to own one.

For these families, they will wish  they were missing out on compound  

interest because it is going to be  hurting them in the other direction,  

with loan payments that might  go on for years after crisis.

One other thing to keep in mind amongst  all of this, is that this will not simply  

be those with means riding things out  while everybody else gets pushed under.

This chaos will actually present  a great opportunity for those  

in the top part of this K shaped recovery.

The 2008 financial crisis presented a very  similar situation to the one we are in now,  

all be it far more watered down.

In the wake of that crisis,  

people were able to capitalize by buying  up distressed properties and companies.

Blackstone is a private equity company that today  is one of the largest residential landlord in  

the united states thanks to the 30,000 homes they  purchased out of foreclosure in the wake of 2008. 

Blackstone in a recent letter to their  shareholders detailing their 2020 Q2  

performance they made note of the fact that  they had $156 billion dollars in “Dry Powder”.

Dry powder is a fancy finance term for cash or  cash equivalents that is ready to be invested.

What this means is that they are poised ready to  snap up some bargains as soon as they go on sale,  

be that in the form of cheap houses from  forced sales, loans to households trying  

to stay afloat or simply shares in a market  that seems oblivious to the wider economy.

Blackstone is just one example of this,  lots of seriously wealthy institutions  

and individuals have been hoarding  alot of cash for exactly this reason.

Now capitalizing on economic misfortune feels bad,  but realistically businesses do this all the time,  

they are entities designed to run an  efficient market. If they see a asset  

priced below value they but it, if they see  an asset priced above value they sell it.

It’s just that in the midst of an  economic downturn this mechanical  

process can seem a bit hmmm scrooge mcducky.

But for the businesses that can do it, good  on em, it’s a sign of solid asset management.

What is also solid company management are the  plans that are not so secretly being worked on  

for after the recovery.

We will actually do a video on this topic  in much more detail in the next few weeks  

but for now, there are billions of people around  the world who are now working from home full time.

This has been a big technical  challenge for a lot of businesses  

but necessity is the mother of invention  and a lot of companies have made that leap.

With the realization that almost all  professional office-based work can be  

done from home comes the realization that almost  

all professional office-based work  can be done from Manilla or Mumbai.

Ok, doom and gloom aside big picture it sounds  like there should be some steps to take to avoid  

the special k becoming a regular occurrence  that hits developed nations every 10 years.

So how do we

Avoid the K

This is something that is ultimately going  to come down to governments and individuals.

If businesses can make money off misfortune  they are going to make that money, but it  

should be the role of governments  to avoid this as much as possible,  

and to be honest, for people to take a  bit of personal responsibility as well.

On a national or even a global level  downturns see a peak in inequality.

Now regardless of your opinions on wealth  inequality, even the most hardcore fat cats  

would probably agree that this divide  should be driven by some people getting  

richer during the good times, rather than most  people becoming poorer during the bad times.

So something needs to be put  in place to account for this.

Now countercyclical fiscal stimulus  in the form of government grants,  

welfare cheques, business  loans and tax cuts are great.  

But its actually only half of the solution and  if anything it is the least important half.

Fiscal policy has two modes,  expansionary and contractionary.

Exapnsionary fiscal policy  is what we are seeing now.  

The government trying to prop up the  economy by pumping money into it,  

but they almost always fail at flipping the  switch back over to contractionary fiscal policy.

Contractionary fiscal policy involves taxing  more and giving less government money away.  

Which are not exactly wining campaign slogans,  

so governments are often times  alot slower to adopt this.

Now despite what even most economists think,  

contractionary fiscal policy isn’t used to  save up a pool of money during the good times.  

Sure it certainly can that buuuuttt  I mean a lot of developed governments  

have completely given up on the dream of  a surplus in the next million years or so…

No the real motivation of  contractionary fiscal policy  

is to get people used to living in a world  where cash doesn’t necessarily come easy.

Taxes are high and less government  spending means that on average  

people will be bringing in less money.

Of course since this is only done  during times of economic prosperity,  

the overall health of the economy will  more than makeup for this, but nobody,  

not businesses, municipalities nor individuals  will be lulled into a sense of complacency.

This might just sound like it is starving the  economy of oxygen, and it kind of is in a sense.

To really stretch the analogy, world-class  athletes will often train in high altitude  

environments to get used to exercising with  thinner oxygen. That means when game day comes  

the thick air of see level gives them a new boost  of energy beyond what they have trained with.

Contractionary fiscal policy is  training the economy for tough times.

But cmon, welcome to the modern western world,  nobody want’s to put effort in anymore. So  

if you want to prepare for this you  are going to have to do it yourself.

Now on an individual level everybody knows  the solution. Live below your means and save.

There is a great adage is that a  healthy economy is like high tide,  

everybody gets to frolic  in the ocean and have fun.

But as soon as that tide goes out you get  to see who wasn’t wearing any pants, or  

put basically who was living beyond their means.

People can get away with living paycheque to  paycheque for a long time during economic booms,  

but if they find themselves pantless at low  tide, it is already too late for them. They  

have lived beyond their means and  now they are going to pay for it.

Now one of the issues here is that the  means of the average American household  

doesn’t pay for the lifestyle that people  expect of the average American household.

If you think of middle america you will probably  think of a 4 bedroom 3 bathroom house, 2 cars,  

a holiday every year, and maybe a few toys  paid for by 1 and a half working adults.

The thing is though, even  two average full-time jobs  

don’t pay for that kind of lifestyle  in most areas of America anymore.  

But since that standard of living is the  assumption people continue to fall into it.

The Overspent American is a book by the  economist Juliet School that chronicles  

the way that the American dream  has increasingly moved upscale  

while simultaneously everyday costs of living  have risen and wages have remained stagnant.

This isn’t a uniquely american problem either,  

most developed western nations are  dealing with a very similar predicament.

So even though everybody  knows the solution deep down.  

Live below your means and have an emergency  fund, not a lot of people are willing to do it.

Compare this reality to nations that actually do  have a high savings rate, china, korea, signapore.

In these countries, you will find  things like multigenerational housing  

is commonplace, where families will have up  to 4 generations living in the same household,  

with parents working and grandparents  looking after the children.

Now this is obviously hugely financially  beneficial because not only are housing  

costs reduced but so too are things  like utilities, spending on furniture,  

land rates, and household upkeep all while  having childcare built into the package.

All of this said living with  your parents past the age of 25  

in most western nations still  carries a bit of a stigma with it.

Final Thoughts

The K is coming and it is going  to be more devastating to a lot  

of households than a response  by the same name in a text…

The shape of the recovery on average might  not matter much for a majority of people,  

if they are already sunk.

Times of crisis are times of opportunity but its  important to have the discussion about whether  

this opportunity should come in the form of  taking advantage of distressed households.

Now it is easy to shrug this distress off as  the result people living beyond their means  

but as we have seen that has  become increasingly easy to do.

Outside of everything it should go without  saying that you probably want to be  

on the right side of that K, and to be  there you need to make good investments.