The Unfolding — Anatomy of the COVID-19 financial crisis | Dafacto

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The Unfolding — Anatomy of the COVID-19 financial crisis

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.)

How we got here

COVID-19 hit the world at the worst possible time; at the tail end of a sequence of bad events:

  • In 2016, interest rates began to rise globally, which, as one would expect, caused economies to slow as we saw GDPs around the world begin to drop.
  • This would generally lead to a "normal" recession, but a second bad event happened at the same time: a trade war, which pushed world-trade into the negative, as seen by the dropping of the PMI (purchasing managers's index), an index of the prevailing direction of economic trends in manufacturing and services sectors.
  • Less trade resulted in a stronger United States dollar, as USD were being removed from the global system. A strong dollar isn't good for the world as a whole.
  • Lastly, we had an oil conflict, as Russia and Saudi Arabia began competitive production, which led to the collapse of oil prices. This severely impacts economies like the United States, which are heavily dependent on their energy industries.

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:

  1. Liquidation
  2. The Bounce
  3. The Insolvency

Phase 1: Liquidation

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.

Phase 2: The Bounce

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.

Phase 3: The Insolvency

Raoul believes we’re going to see the largest insolvency event in recorded history.

  • Global GDP growth will be negative, quarter after quarter.
  • The world has far too much debt. United States corporate debt between 1950 and 2019 has grown as a percent of GDP from 20% to 45%.
  • The United States government debt has grown to 110% of GDP, and will take massive additional amounts to try to stimulate the economy with new money. Central banks all around the world will try to stimulate.
  • The problem, however, is that the velocity of money will be zero. People have clearly changed their habits, until a COVID-19 vaccine is available. We can see this in sales data (50%+ drops) and traffic data from TomTom (down 80% in China on the weekends). I personally see this in myself; Even after this lockdown is over, I'm not going to expose myself to infection by going to restaurants, coffee shops, gyms and other group settings before a vaccine is available.
  • Perhaps one third of the $3T of BBB-grade United States corporate debt will be downgraded to junk rating, requiring their sale by credit-rating-constrained entities. But there won't be any buyers, and so the market will freeze.
  • A pension crisis is being born, as the largest wave of people ever (the Baby Boomers) enter retirement, and they currently own (and will sell) a huge amount of stocks and bonds.

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:

  • United States bonds should be OK in the short- to medium-term.
  • United States dollars should be OK for the short- to medium-term.
  • Gold and bitcoin should do very well in the medium- to long-term.

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.

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