Zero and infinity

THE tide turns again. The Fed has initiated a sea-change. This may have an impact similar to Bernanke’s May 22, 2013 speech that initiated the ‘taper tantrum’, only currently the direction of the change is opposite to that. Basically, and after Clarida’s vindication of Powell, the Fed managed to broker a carte blanche. The cheque is payable both in 2020 and 2021. Risk appetite in financial markets will soar quasi-automatically, but I don’t know how EM currencies could respond to that. Some EM currencies might appreciate against the USD going forward, but others will nonetheless feel the heat further. The real economy implications of monetary policy change in the U.S. are also unknown because they will be conditioned by the future course of the outbreak. Let’s state clearly that the two pillars of practical macroeconomics have been abandoned last week: the 2% inflation warning threshold has been relaxed and the natural rate of unemployment no longer binds. These two changes showcase the severity of the COVID-19 recession in the U.S., and they also underline the possibility of another U.S. recession. Given China’s and global manufacturing markets’ slow – and slowing – responses to COVID-driven fiscal and monetary measures, such a possibility would spread out. Again there is a possibility that, come 2021, attitudes toward risk in financial and real markets might diverge. Both in China, in the EU and in the U.S. there may have to be yet other large fiscal stimuli packages to check the real and household sectors’ damage. In other words, last week the Fed has admitted the possibility of a prolonged (both American and global) recession, in my opinion.


As the credit boom comes to halt, there are other issues that are allowed, or rather encouraged, to surface. The gas find in the Black Sea is one such issue. However, as time goes by, the magnitude of the reserve, its recoverability ratio – how much of the gas can be diluted and extracted at reasonable cost, the difficulty in estimating the cost-benefit at the time of the extraction – which may take at least 5 years or even more – the capital that has to be invested upfront, etc., will be put under scrutiny. Remember that the discovery of the Leviathan gas field was announced in 2010 but effectively gas only began to surface in 2019. Also, even Israel has foreign partners. Including the Russian distribution and the Houston-based American firms partnerships, Israeli firms may only have so much as 50-55% of shares. Now Leviathan-cum-Tamar adds up to around three times the Black Sea discovery, and Israel imports natural gas much less than Turkey. So, the natural gas announcement can’t bear on the near future, and it can barely have an impact on voting behavior. The prospect of a couple of billion (maximum) in annual revenues lies far ahead, once it sinks as economic meaning, may not alter current perceptions much.

The other source of distress, the Eastern Mediterranean dispute – writ large, including Libya – is more severe and historically deeply-rooted. I tend to think unequivocally that because Greece’s overtures have historically been against all relevant Treaties, they are in fact legally on very thin ground. Example, a reference to the Lausanne Treaty alone waters down all Greek claims. Yet this isn’t the main problem for the population at large. All peoples react in the same vein faced with such repeated faits accomplis. Everyday nationalism always prevails. So, this kind of unsettlement with Greece – which had historical precedents such as the 1987 and the 1996 crises – has political potential in the sense that it can alter perceptions and bend voting decisions. It has political potential for both Turkish and Greek citizens. Yet the dispute has to be enduring because, although such ‘news effects’ change political perceptions, they can only change them for a very short period. Political memory is very short. For instance, the outbreak is peaking again as we speak, and there are many doubts clouding the real trajectory of the epidemic. This will have far more weight on voters’ choices than other facts and events.


What to do with the 9.9% GDP contraction in Q2 is unclear. Let me try to make sense of the data. The V-shaped recovery I had alluded to two months ago seems to be vindicated in a sense. The first signs of the so-called V were observed in May when confidence indices began to recover. At that time, I had flirted with the rather unconventional estimate of 8-9% GDP contraction in Q2, but I raised that to 12-13% thereafter. The reason why the forecast range was as wide as 8-13% is due to the fact that the precise impact of the credit boom was hard to measure. First, electricity consumption is no longer a viable leading indicator. Industrial production almost always tells us a great deal about GDP. However, even that metric has to be conditioned on a new factor: credits. Loan growth (that is, debt) means everything in this economy. This time around, because direct income support to households leaves a lot to be desired, consumer loans came to the limelight. Public banks’ 13-week MA FX-adjusted consumer lending growth reached 130% in May, an unprecedented rate. By the same metric, private banks reached 38% by the end of June. That, too, is far too high. Loan growth receded in August but even so by the week of August 21, total loan growth stood at 48%. This is what we called a fall in the loan growth rate. Yes, the rate of expansion slides down, but even at those rates the third quarter growth will be positive and may even showcase a complete V. Q4 2020, on the other hand, will show what I can call a stationary state. At around zero, the whole year’s final score might be like 1-3% GDP contraction. Better than many other countries, but coupled with 2019, it depicts about 1% minus GDP print for a period over 24 months, including the pre-COVID period.

How to interpret this? If we go by quarters, in the last 17 quarters we get an average of 2.83, and if we use annual data we reach to 2.5 per annum. If we look at the data in a seasonally- and calendar-adjusted vein, the yearly average is as low as 0.6. Okay, this is not the right way to look at it, but whichever way we approach the growth problem, we come up with a low 5-year average. The 5-year window tells us that growth has been subpar, much lower than the potential rate. It also drives potential output down because actual and potential outputs are correlated over 17-20 quarters. The construction sector’s continual contraction that spread over 8 quarters tells us that the growth model is completely stuck currently. Actually the chain index methodology only allows us to ‘impute’ contributions to growth, which are notional, in a sense, with this method.


We can say the world economy is in deep trouble, so 1-3% GDP contraction compares well with that. This is one way to present data. Nevertheless, the immediate economic consequences of the outbreak is one thing; the accuracy of the response is another. Furthermore, the malaise is deeply rooted, and goes far back. Budget deficits soar – suffice to look at the new Treasury borrowing table -loans are over-burdened, interest rates are ultra-low, even depressed, reserves eroded. Even so, very low growth rates are achieved, unemployment is hitting the sky, and inflation is soaring again. It could have been numerically worse, but the cost is quite high. Personal incomes are falling, per capita debt is rising, and the coefficient of foreign capital to production is falling. There exists now a echanism of stop-go cycle embedded in the structure of the economy.


The 5-year window and the quarters-ahead spectrum are two different concepts. The V-shape may well prove to be correct if the Q3 picture I depicted is accurate – a steep rise in GDP growth, that is – but the mechanisms that shore up this shape may cause more problems than ever. The V-shape only means less than expected contraction, by the way, and not that the over-burdened, debt-laden economy is set to fly with high colours.

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