Left Hook By Diana Stoyanova

Did 2020 Break Economics?!

Recapping the year that challenged everything we knew about how nations work, economics and what to expect from our futures.

2020 (the ‘year-who-must-not-be-named’) launched an all out attack on economics. At every turn there was an event, a person or a theory that was throwing economic principles and nations into disarray. Did the years assault break economics, and do we need to rethink everything we thought about how the world worked?

This article talks about high impact moments, their effects, and what they might mean for our futures and for economics.

Where we live+work

As every real estate agent says it’s all about location, location, location. Most of us have been staying in place for almost a year now and our lack of location sharing is having massive ramifications on the world around us. Entire supply chains are reconfiguring to deliver more products to homes and home offices. The rise and rise of Amazon is a perfect example of the rapid scaling up of online shopping and home delivery.

That global spiderweb of parts and suppliers is hard to justify and maintain with varying international lockdowns and restrictions. When local unemployment is considered then it’s even harder to reconcile global supply chains. If governments are future looking then they will help domestic manufacturing rise from the ashes of the coronarecession.

That being said, businesses need to be geographically diversified so that if one city or country is shutdown then they can continue operations. I believe smart businesses will focus on end-to-end production at local or regional sites. The crazy network of suppliers like that of the iPhone below should be wasteful things of the past.

Apple iPhone Manufacturing Map — Sourced from Ohio State

CBD’s and office spaces around the world will need to adjust to a likely permanent change in employee preferences. People will want to work from home more frequently and workforces will naturally become more distributed. This creates a tonne of job opportunities for people in regional areas but I suspect it will coincide with the outsourcing of white collar jobs. The challenges here will be the cost of the enabling technology and creating and maintaining culture. The benefits of seeing people, bumping into them in the office, water cooler chats and positive workplace cultures will be hard to replicate from a distance.

CBD’s will naturally lose dominance and could return to a 50’s-60’s era where elite corporate jobs are in the city and the majority of people work in their home regions. Although, if we return to work soon then a high percentage of people will revert to old habits and the change won’t be as profound. Either way, office buildings may need to be redesigned to include more collaborative work spaces and digital conferencing. Commercial buildings should focus on mixed use with more retail or residential space alloted and reasons to bring people to the city. If we don’t create reasons to go to the city then that old 5pm CBD ghost town will make a comeback.

If the money and people aren’t in the CBD then they have to be somewhere. So the winners are local shops and businesses. Co-working spaces, rental office spaces, and generally local cafes and shops will continue to be winners of the work from home shift. The art will be in balancing what is done locally and what is ordered online. Just because people are working from home doesn’t mean they know their neighbour.

Massive Government Spending: Money Printing+MMT

Finance and economic journalists have been obsessed with Modern Monetary Theory (MMT). Tonnes of people believe this is new gospel and that the governments use of fiscal stimulus is evidence of MMT working in real time.

Put simply, MMT is the idea that governments can spend as much as they like as long they’re spending in their own currency because all they need to do is print more money. The basis of the logic is that western governments have been printing a tonne of money since the GFC and inflation hasn’t resurfaced so we don’t need to worry about it.

This is flat out wrong. It’s compelling and appealing and I get the logic but it’s just wrong. Yes there has been money printing by the government and yes there hasn’t been any consumer price inflation but that doesn’t mean there hasn’t been any inflation at all. The financial system has become so warped by a weird combination of self interest and excessive regulation that the money the government is printing isn’t really getting into the hands of everyday people for them to spend. Without them spending then you don’t get consumer price inflation. So really monetary policy should be about access to credit because if people can’t get loans then the money can’t get into the shops — but then, where has the money gone? The money has to go somewhere afterall.

Well, all that crazy money printing has gone into assets and created asset price inflation rather than consumer price inflation. So the owners of assets, financial securities, equities, houses, etc. have seen huge increases in wealth as asset prices shot up since the great monetary expansion. It also has to be noted that there’s no such thing as a free lunch, the money has to be accounted for eventually.

During the government induced crisis of COVID19 there has been massive fiscal stimulus and money going everywhere. We’re seeing savings rates going up and spending going up. This is pretty interesting as it’s highly unusual to see both of these aspects going up. People general save more because they spend less. What this shows us is that the government stimulus has given a lot of households more income and this is quite different to that monetary stimulus. The government stimulus is going directly to households rather than via the financial system so the outcomes are drammatically different.

People are saving because of changes in behaviour that have been forced upon them. It’s hard to go to a restaurant for dinner if you’re in lock down, but this will shift when the full force of the Keynesian stimulus tap is turned off. People will either save because they are fearful or spend because they are optimistic. Massive government spending doesn’t actually change the economy unless it’s targeted to particular sectors or businesses. If it’s general money for nothing then all that happens is that a whole heap of cash goes out for people to spend today. It’s not all sunshine though as government stimulus spent today is new taxes or reduced benefits tomorrow. The money doesn’t come from nothing and it will need to be accounted for somewhere. Whether that’s in a collapse of the currency, a sovereign debt default or in higher taxes — it has to be paid for, as RBA Governor Dr Phil Lowe says “there’s no such thing as a free lunch.”

Housing+Loans

There’s always so much to unpack and analyse in the housing market. Let’s try and keep it simple. If you have an amazing memory then you might recall that in April I talked about valuing and pricing housing. Essentially the value of a home is made up of the cost to build the home, a macro economic premium (the sentiment of the market, housing supply and demand etc.) and a utility premium which is how much you value the attributes the house has to offer. This year has dramatically changed how a lot of people see utility/value. More people are looking for backyards, space, natural lighting and extra rooms. Afterall lockdown needs a home office and a backyard to try and stay sane.

This broad shift in personal preferences means people are valuing regional and county properties more. A mini de-urbanisation event is occurring and regional property sellers are the winners here. Apartment owners are the big losers.

The other big driver in the housing market is what’s going on with mortgages, loans and credit. After anticipating a +15% drop in housing prices due to mortgage stress and default, I was surprised when banks in Australia stepped in to buttress the housing market and facilitate loan deferrals. That’s right. Australian banks gave people the option to stop paying their mortgages for a period of time during lockdowns due to increasing unemployment and income pressures. The market only declined by about 5% from the market peak and interestingly banks have reported about 10% loan deferrals.

The future of the market will continue to be driven by usual factors like housing supply which government policy is significantly impacting, demand which is changing due to shifting values and access to credit which appears to be tightening due to bank balance sheet risk.

Physcists Attack Economics

The physicists are back attacking economics. They have a tendancy to do this every now and then and really revamp the maths on a couple of equations and then leave the field. I don’t know if that’s because they lack the courage to debate with so many stubborn economists, to argue against both hands or because simply economics is just too broken. However, the latest attack has been led by Ole Peters in his Ergodicity Problem in Economics.

This is a great addition to the field but it doesn’t really prove economics to be wrong or changed, it simply refines existing equations and improves the assumptions. The complexity of the world around us and the unpredictability of human decision making has always led economists to make simplified models and assumptions. Although modern economics has embraced mathematics I see the world of economics more as a way of thinking. A logic to view, understand and analyse the world. There’s simply too many time lags, varying individual decisions, and impacting events to explicitly model and explain all the moving parts. Economic policy from 30 years ago still has profound effects on what happens today (Thatcherism and Reaganism).

Both economists and physiscts have to accept that humans aren’t simple, that models need to do their best so we can understand, analyse and manage the risks in the world around us and that a few flaws are okay. Thanks Ole for your updated version of utility theory and demonstrating that science is progressive, but no this hasn’t fundamentally changed economics.

TO 2021 AND BEYOND!

There’s a lot to be excited about and a lot to be worried about with the arrival of 2021. To make life a little easier I’ve put these in dot point and you can decide whether the glass is half full or empty.

Downside Risks

  • If history rhymes then the Spanish Flu could be a model for COVID19 and that means a virus mutation and a second wave that affects young people
  • Tonnes of government and private debt as the fiscal and monetary stimulus is turned off
  • China continues to challenge how the world is organised and global trade, poltical relationships and economic harmony struggle or suffer
  • People return to the office en-masse then go back into lockdown and businesses fail to adapt to rapidly shifting behaviour
  • 2021 is worse than 2020

Upside Opportunity

  • Vaccines successfully roll-out around the world, travel resumes, business and trade flourish
  • Businesses embrace work from home culture and redesign office spaces, the spending on embracing a working from home world creates prolonged economic stimulus, innovation and new jobs
  • Domestic manufacturing returns and economic dynamism reappears in the west as nations become producers rather than consumers
  • Green technology and sustainability booms which rapidly reduces the risks and scope of disaster from climate change
  • International co-operation on the fight against COVID unites nations and opens more markets for free trade and global economic opportunities
  • Huge optimism and confidence pushes markets, economies and households forward. Best year of the 21st Century

Anything could happen next year and if I I’ve learned anything then it’s that I sure can’t see the future. Just have to make the most of the hand we’re dealt and fingers crossed 2020 doesn’t have any hidden horcruxes.

If you have any questions then please feel free to comment, and if there is anything you’d like to see analysis on or read about in the future then let me know.

Also, please note that this article does not represent financial advice or the views of any organization; it is only the opinion and analysis of the writer.

Thank you for reading.

Yours,
Chris Leeson

Bringing finance and economics to you with a focus on in-depth analysis and everyday life.

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