The enemy of a major economic slump is debt

This is a hard commentary to write. The situation is obviously very grave but also extremely fluid and no one has any special or privileged insight as to when a degree of normality may return. All pandemics end but it would be foolish on our part to suggest that it will be over within a few months. What is clear is that the world is tumbling into a serious global recession with significant unemployment. When both supply and demand collapse the end result is obvious and unavoidable. Governments and central banks have thrown several kitchen sinks at the crisis but with a world in lock-down it does little to lift economic activity. Expenses go up but incomes go down.

As we journey through this economic and social debacle it will quickly become apparent that the enemy of a major economic slump is debt. Sadly, the world is awash with the stuff. We seem to have learned nothing from the Global Financial Crisis. Central banks have started to print with abandon but the private sector cannot and despite lavish hand-outs many businesses and individuals will go to the wall. It’s a question of solvency. In 2019 a survey in the U.S. indicated that 69% of Americans have less than U.S. $1,000 in cash on hand. One of the financial stress factors in the U.S., in particular, is the high cost of healthcare. COVID-19 is not going to make this easier.

Government and private debt relative to GDP has been steadily building throughout the world for decades (see below). Collapsing interest rates and the seeming fixation by governments and central banks on boosting asset prices has disguised the potential for economic Armageddon. The crisis of 2007-2009 almost brought it about but extraordinary injections of central bank liquidity and brazen bail-outs of “too big to fail” corporates and banks held off the day of reckoning – and, disturbingly, encouraged even more reckless behavior. The current crisis is much broader as it is, first and foremost, a global health crisis which has, in turn, smashed economic activity. We are just a few steps down a perilous road.

Debt in advanced economies (non-financial)

The enemy of a major economic slump is debt - Debt in advanced economies chart

Source: World Bank/Institute of International Finance & IMF, January 2020

In our February commentary we remarked on research by the IMF warning of the dangers inherent in the leveraged loan market. In the U.S., loans to high risk corporates (junk-rated) amount to U.S. $1.2 trillion – up from U.S. $800 billion in 2015. These loans are packaged by the banks and purchased by yield-hungry investors throughout the world. Sound familiar? Just above junk rating (at BBB) are approximately U.S. $3 trillion of loans to another swathe of heavily leveraged corporates. It is likely that a fair number of these will fall into the junk category as this economic downturn plays out. Once again, the call went out for the Federal Reserve to ride into the debt mess on its white charger – and that is precisely what it has done – QE infinity is what it is being called. The ultimate buyer-of-last-resort. And thus, the bail-out game will go on while the remaining vestiges of free markets are abandoned.


Real personal incomes, virtually everywhere, have been depressingly slow to increase for many years. In the U.S., we have the extraordinary situation where average weekly real earnings are only now moving towards the level achieved in the early 1970s! In Japan the index of real wages has been in steady decline since the 1990s (see below). In the UK real wages hit their peak in 2008 and have yet to make it back to those heights.

Japan: Index of real wages

The enemy of a major economic slump is debt - Japan wage index chart

Source: Refinitiv Datastream

In the U.S., in particular, the financial hi-jinx of the stock market (increased leverage and share buy-backs) helped enrich corporate executives and prop the living standards of millions of private investors. The stock market bubble was mistaken for economic well-being. In fact, U.S. (whole economy) pre-tax corporate profits have gone nowhere if measured over the five years to the end of 2019 (see below) while real GDP has been ambling along at an annualized 2.2% despite rhetoric from the President that would have you believe it was somewhat better. Over the same five-year period the Dow Jones Industrials Index leaped at a compound annualized rate of just over 10% (excluding dividends – source: Datastream). The bubble has now burst but we are certain that memories will be short and animal spirits will again bounce hard on the debt trampoline with the unwritten assurance that the Federal Reserve has their back.

U.S.: Pre-tax corporate profits (quarterly at annual rates – billions of dollars)

The enemy of a major economic slump is debt - US pre-tax corporate profits chart

Source: Refinitiv Datastream

The Eurozone

In the Eurozone we have a situation where country-by-country monetary and exchange rate independence was effectively wrenched away 20 years ago with the birth of the single-currency bloc. Only the European Central Bank can run the printing presses which leaves the economic also-rans in a parlous situation in a major downturn. Greece hit the serious skids in the last financial collapse and will now do so again but we mainly worry about Italy with its mountains of public debt and a COVID-19 crisis among the worst in the world.

Germany is by far the largest and most solvent of the Eurozone nations but even here real output per hour in industry (productivity) has been stagnant for the last ten years – in fact, gradually falling over the last two years. The economy was hovering on the brink of recession prior to the virus crisis and will now be most definitely mired in recession.

Germany: Labor productivity (output per hour in industry (constant prices))

The enemy of a major economic slump is debt - German labor productivity chart

Source: Refinitiv Datastream

It seems unfair to single out individual countries as “we’re all in this together” but it can’t go unsaid that those countries with fiscal space will come out of this crisis in better shape than those that were already stretched. The same can be said for corporates and individuals. Leverage can be great – until it isn’t.

The Eurozone is being tested again. Can this clumsy, illogical political arrangement make it through another crisis? Fundamental economics says “no” but the politicians will scrabble very hard to keep it patched together. Perhaps one day they may not bother.

Bonds vs. equities

It seems to be a natural law that equities will always beat bonds over the long-term. However, the last 40 years have been unusual as bond yields have collapsed providing stellar capital gains to the holders. In the UK, if measured since 1990, benchmark 10-year government bonds have beaten equities (assuming full reinvestment of income and dividends). With equity markets still dancing around the edge of an uncertain precipice the gap could turn out to be even wider in the next few months.

UK: Bonds versus equities

The enemy of a major economic slump is debt - UK bonds vs equities chart

Source: Refinitiv Datastream

The question to be asked now is – what next? The reality is that the only way for government bonds to provide a reasonable return in the future is for yields to head below zero and keep heading further into negative territory. If that happens, we will be in the midst of an economic depression with staggering levels of unemployment and significant deflation. The capitalist system will be on the edge of destruction.

Let’s try and retain a degree of perspective. This crisis will pass and stocks will be significantly less expensive than just two months ago. The good and well managed firms will continue to be good and well managed. Profits will dive, and, in many cases disappear altogether, but they will come back as economic order is gradually restored. In the meantime forget traditional investment arithmetic. The published dividend yields mean nothing as dividends will be cut or totally removed. Price-earnings ratios are irrelevant as the “e” is unknown. However, take a long-term view – not less than five years.


The history of oil is already replete with strategic manipulations but now we have one more to add to the long list. COVID-19 had started to impact global oil demand and prices when Russia, at an OPEC meeting on March 6, decided to walk away from a “friendly” 3-year pact with Saudi Arabia by not cutting production to match demand. Saudi Arabia promptly followed suit. And surprise – the oil price then fell further. At the time of the OPEC meeting Brent Crude was selling for around U.S. $50 a barrel. Today, the price is fast approaching U.S. $20 a barrel.

Why is this happening? It seems it is a blatant attempt to squeeze the unconventional oil extractors in the U.S. out of the game so that control can be restored to where Russia believes it rightfully belongs. The U.S. has been so successful with its shale revolution that it is now the biggest oil producer in the world (see over). The only flaw in the U.S. plan is that shale production is relatively high cost – requiring a price of around U.S. $45-50 to break even – and many of the producers (often tiny companies) are heavily indebted. There’s that word debt again. By March 12 U.S. $110 billion of bonds sold by U.S. energy companies had fallen into distressed territory. According to S&P Global approximately U.S. $27 billion of U.S. oil and gas bonds come due this year. Refinancing will be a tough ask.

World oil production - by country (2018)

Country/region Thousands barrels daily % of world total

United States



Saudi Arabia




































Rest of world






Source: BP Statistical Review of World Energy, 2019

It is clear that a destabilized oil industry is not helpful during the current crisis. Many of the major international (conventional) oil companies will be unprofitable at current price levels for crude. Costs will have to be slashed. More unemployment and distress.


Vladimir Putin is doing his best to emulate President Xi Jinping of China, that is, arrange things so that he can effectively remain in power for life. Mr Putin has been leader since 2000 despite a law that bars Presidents from serving more than two consecutive six-year terms. He managed to get around that by swapping to the role of Prime Minister from 2008 to 2012 and installing Dmitry Medvedev as his Presidential puppet. He resumed the Presidency in 2012 and is due to step down in 2024.

However, an amendment to the constitution was introduced on March 10 and, with undue haste, rushed through the Duma (Parliament), with no dissents. The amendment will allow Mr Putin to run for two more consecutive six-year terms (from 2024) taking him through to 2036 – by which time he will be 83. The Constitutional Court has now approved the amendment leaving the only hurdle being a national “people’s” vote at a date to be determined (delayed because of the coronavirus). However, the vote appears to have little basis in Russian law and close observers believe it will simply be a formality. To help it move in the right direction there is a ban on public protests.

There are anti-Putin movements in Russia and his popularity has been waning in recent years but we have no doubt that all of this will proceed as orchestrated meaning that we need to get used to the idea of Putin being around for quite a bit longer. Even longer than the dictator Stalin whose “reign” lasted for 29 years from 1924 to 1953.


In these difficult times it is worthwhile revisiting our favorite metal – gold. Year-to-date the price of gold in U.S. dollars is up around 8% – rather better than the stock market! In many currencies it has surpassed its highest level on record thanks to the appreciation of the U.S. dollar. What interests us, however, is gold’s historical importance as “money”, a medium of exchange and a store of value. It has been used for these purposes for thousands of years yet it is calculated that the total stock of gold ever mined amounts to (only) around 190,000 tons. A huge amount of dirt has to be shifted to find relatively tiny amounts of gold. Current annual global production amounts to around 3,400 tons. Jewelry remains the single biggest demand source although central banks have been net buyers for years (especially Russia). (Source: World Gold Council).

We have shown this chart before but we think it is worth showing again. Measured in U.S. dollars and relative to the rate of inflation in the U.S., gold has provided a real rate of return to investors since 1800. For more than 200 years – now that’s pretty impressive. Of course, the history of gold goes to the early human civilizations but price and inflation measurement becomes increasingly woolly the further back we go. We’re happy to settle for the knowledge that it has always been scarce, has always been an accepted and valued currency and has outlasted all of its “fiat” rivals by scores of centuries. Keep it in
mind – particularly at a time when fresh supplies of fiat

Gold price indices – Data for the United States: 1800-2019 (the price of gold and the purchasing power of gold based on consumer prices)

The enemy of a major economic slump is debt - Gold price indices chart

Source: ‘The Golden Constant’ by Roy W Jastram 1560-2007; Updated by Jill Leyland and Pyrford International

Electric cars

We love electric cars. They look good, are fun to drive, whisper quiet, need little maintenance and they accelerate like a Martian rocket. And, they make us feel good because they satisfy our “Green” aspirations. Or do they?

Consider the following:

  • Like any “normal” car they are made using steel, plastics, aluminium, rubber, glass, all of which require stuff being dug out of the ground.
  • They use batteries – lots of them. To make batteries you need cobalt, copper, nickel, lithium, manganese, graphite and other bits and pieces. Coping with this demand growth will be problematic at best as it will require the digging up and processing of vast quantities of raw materials. One estimate we saw quoted in the Wall Street Journal was that each electric car will require the processing of 230,000 kg (230 metric tons) of raw materials. Even if this proves to be an overestimate there’s still going to be a lot of digging required.
  • A study by the International Energy Agency (IEA) suggests that an electric car with a 400 km range and charged with electricity produced at the global average will have to be driven 60,000 km to pay off its higher CO2 emissions in production.
  • After around 8-10 years the batteries will need replacing. This may prove to be the useful life of the vehicle so it may not be a significant issue. However, disposing of all of these batteries safely will require a very significant step-up in global recycling capacity.
  • The power needed from the grid to recharge the batteries as they take over the world of automobiles is obviously massive. The demand for power will probably be concentrated in the evening hours as users will tend to plug their vehicle in after they arrive home from the day’s activities. Problem: that is precisely when the sun slides below the horizon and electricity production from all the shiny new solar panels expires. Thus, significant base-load power will be required. And where does that come from?
  • Government financial support for electric vehicles is huge. The IEA estimates that each electric car on the road has cost U.S. $24,000 in subsidies, research & development and extra infrastructure investment. Perhaps all that money could be used in defraying CO2 in more effective ways?


If you can afford their steep price don’t let us dissuade you from buying an electric vehicle. As we say, they are fun. But don’t drive it out of the showroom thinking that you are helping to save the planet. It’s not making a scintilla of difference.

The final word

How to wrap up in the current extraordinary environment?

It seems there is a battle between economics and health. “Don’t worry about the death rate, just keep the economies alive” is the view of some (or perhaps many). What happened to the view that every life is precious?

Whichever way it turns the legacy of this catastrophe will last and last. It is clear the world was ill-prepared for a global pandemic. Many mistakes were made. We hope lessons have been learned.

Governments everywhere will end up with monstrous levels of debt. Stimulus and relief packages equivalent to 10% or more of GDP are common. Central bank balance sheets will spiral out of control. Substantial slabs of government bond issuance will end up being held by central banks (along with mortgage-backed securities, corporate debt, equities The world of money and finance has been turned on its head.

We would like to think that the private sector once and for all figures out that vast amounts of debt are a recipe for financial ruin. But it probably won’t as large parts of it are being bailed out. We would like to think that share market bubbles are a thing of the past. But that’s just being naive. We would like to think that governments and central banks cease their fixation on pushing up asset prices. Again, naive.

But let’s end on a positive note. The pandemic will end. Normality will take a long time to return but return it will. Share prices, for the first time for a long time are starting to look reasonable. We believe government bonds are now pointless from an investment perspective. Let’s just hope we now don’t have a gigantic bounce in share prices fueled by the central bank injections, pushing them back to bubble levels. Or are we, once again, being naive?

Stay safe. Stay well. Be sensible.


This report is for general information purposes only and is not intended to predict or guarantee the future performance of any investment, investment manager, market sector, or the markets generally. We will not update this report or advise you if there is any change in this report. The information is based on sources believed to be reliable. We do not represent or warrant that the report is accurate or complete.

This presentation may contain targeted returns and forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “anticipate,” “outlook,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue reliance on such returns and statements, as actual returns and results could differ materially due to various risks and uncertainties. This material does not constitute investment advice. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.

Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.

Gold is subject to special risks associated with investing in precious metals, including prices being subject to wide fluctuations; a limited and unregulated market; and sources being concentrated in countries that have the potential for instability.

The J.P. Morgan Government Bond Index United Kingdom Index is composed of sterling-denominated domestic government debt securities issued by the United Kingdom.

The FTSE All-Share Index represents the performance of all eligible companies listed on the London Stock Exchange’s (LSE) main market, which pass screening for size and liquidity. The index captures 98% of the UK’s market capitalization.

Investments cannot be made in an index.

Pyrford International Ltd. (Pyrford) is a registered investment adviser and a wholly owned subsidiary of BMO Financial Corp.

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