12 April 2020
In 2020, I learned about the macro economist Raoul Pal through a number of podcasts, and his pessimistic view of the global macro situation resonated with me prior to the COVID-19 crisis. He believed a nearly perfect-storm of characteristics existed that pointed to the coming of a deep recession. And then COVID-19 happened.
To continue having access to his views, I subscribed to his Real Vision service, which he dubs, “The Netflix of Finance”. One of his latest videos, titled “The Unfolding”, lays out the ideas behind his belief that we are headed into the worst economic crisis of our lifetimes.
Although I don’t pretend to understand all of this completely, I’m wanted to try to summarize his thesis here, as much for myself as for the reader. I would, however, encourage readers, if they can afford it, to subscribe to Real Vision, as the content for those interested in finance is outstanding. (I felt The Unfolding alone was worth the subscription price.)
COVID-19 hit the world at the worst possible time; at the tail end of a sequence of bad events:
Then we had the massive black swan, COVID-19, in which world economic out has ground to a halt. COVID-19 has created both demand and supply shocks. Demand, as in people are not consuming. Supply, as in companies aren’t producing anything.
Raoul anticipated three resulting phases:
Because of sudden panic and uncertainty, we saw the sale and liquidation of everything—stocks, bonds, gold, bitcoin, etc.—as people rushed to get into the temporary safety of cash.
Credit spreads widened, as everybody realized credit was going to get liquidated as well. This caused the financial system as a whole to freeze-up, at which point the Federal Reserve stepped in with a huge stimulus package.
However, this wasn’t really providing “stimulus”, but rather an attempt to simply getting the financial plumbing working again.
The stock market dropped by over 30%, which would be characteristic of a mild recession. Raoul feels there’s a strong possibility it will later drop by 80%, characteristic of a true depression.
Just like in 1929, we can expect and have seen an initial bounce. Over the past week, the stock market has risen more than 10%. In a six month period of 1929, the bounce of the Great Depression saw a 45% rise in the stock market.
Why? Because there is optimism in the face of the initial shock. New COVID-19 case numbers are stabilizing. Maybe we’ll find a therapeutic. Maybe we’ll get a vaccine. Maybe, maybe, maybe!
But the 1929 bounce was based on a false narrative, and this one likely is as well. Raoul believes things are far worse than the market is reflecting.
And this leads us into the final phase, the insolvency.
Raoul believes we’re going to see the largest insolvency event in recorded history.
None of this can get resolved quickly, as “flattening the curve” means power cycling the economy over and over, country after country, as localized outbreaks occur, preventing the full economic re-synchronization.
US 10-year bond yields are dropping to zero. But then, the Consumer Product Index (CPI) will go negative (because nobody’s consuming). This means that real yields (the difference between CPI and the bond yields) will go up, and when real yields go up, you destroy the economy.
And this time, the Federal Reserve can not fix this. They have no room to continue dropping rates.
The growing strength of the US dollar will break the global financial system, as there is far too much global debt denominated in dollars, and not enough dollars to go around to pay this debt. All non-US currencies will drop, and some will collapse.
Corporations in South Korea, India, Brazil and elsewhere are desperate for dollars, and the banks will issue the limited supply to the best creditors. The worst will be left scrambling, and go insolvent.
The end result in a world of negative GDP, nobody with cash, everyone in debt—is insolvency. And full debt-deflation then happens when everybody becomes insolvent.
Raoul believes this is a generational shift, the “Fourth Turning” that Neil Howe talks about in his book. A massive, massive change in which the market crashes to depression levels, everybody goes bust, and which may end with the world having to abandon the dollar standard, as the US dollar skyrockets.
How to protect yourself? Raoul believes:
Readers of my book Money for Something who followed my own allocation, the Golden Butterfly—a slight tweak on the Harry Browne Permanent Portfolio—will fortunately already have a sizable allocation to long-term bonds, gold and cash, that will have held up well in the current crisis, and hopefully going forward.