An investor’s guide to good government stimulus

We are in a strange political environment. Globally there have been trillions of dollars of government stimulus announced, deficit hawks have turned chicken, and formerly staunch opponents of government intervention have been leading the charge. How should investors assess each government stimulus announcement?

One day the Australian government told us they had the right level of stimulus. The next they announced a miscalculation by a cool 3% of GDP but assured the public that the new level was also correct. 

Which begs the question: in today’s world, is government stimulus ever wrong? Surely moar stimulus good / less stimulus bad for investment markets is too simple. Although some days it doesn’t seem like it. 

Soaring public debt

 There are a few different frameworks investors should examine stimulus through:

Government stimulus effect on factors of production

First, I want to take you back to the OG economists, Adam Smith, Ricardo, Marx. Let’s use a restaurant as an example of how they examine the factors of production:

  • Land: the lease on the building  
  • Capital: Loans for the fit-out of the restaurant, or to the building owner to purchase the property. 
  • Workers: the waiting staff and chefs in the restaurant 
  • Entrepreneurs: the owner of the restaurant that took the economic risk to put it all together.

I’m going to extend this further. Let’s say we live in a country with only four industries: a factory, a restaurant, a bank and a grocery store. And coronavirus hits. The restaurant is deserted and running at a loss, with the owner staring at bankruptcy.

The question is, who is going to bear the brunt of the economic pain?

  • Land: The restaurant could have a considerable rent reduction. The downside is that the landowners will suffer, and might go bankrupt. But even if they do, another landowner would step in (at a reduced price), and our overall economy would still be OK with everyone employed. i.e. bad for an individual landowner, OK for the economy. 
  • Capital: The restaurant could stop paying interest to the bank and maybe write down some debt. The downside is the bank will suffer, and won’t lend to others. But again the immediate economic impact is relatively low if most remain employed.
  • Workers: We can fire a bunch of workers in the restaurant. The downside is that with no money, the workers don’t spend on goods from the factory and reduce their grocery spend. Because of this, the factory has the same problem, and need to lay off staff. Which results in even less demand for the restaurant and the grocery store and a negative economic spiral ensues.
  • Entrepreneurs: We could send the owner bankrupt. The problem here is you might end up with no restaurant, all of the workers fired and the same issues as above. The landlord is stuffed: it might be years before another entrepreneur opens a new restaurant. Plus our factory workers, grocers and bankers now have nowhere to eat out. And restaurants don’t own many assets, and so the banks might not get much back. 

Net Effect: Through this lens, the government stimulus targeted to help entrepreneurs and workers at the expense of capital and land will be less disruptive. I’m not making a moral judgement here about who “should” bear the pain. Just about which government policies and stimulus will have a more effective short term economic impact. 

Demand-side or supply-side government stimulus

Government stimulus can target additional supply or target demand.

For example, subsidising a new factory or worker salaries, cutting taxes or regulation tend to be supply-side reforms. In particular, China has launched a number of these programs.

On the other side, demand-side involves more significant government consumption and income support for citizens.  

The world is severely lacking demand. So, supply-side stimulus is not going to have the same impact, except indirectly by employing more people. 

The other problem that supply-side stimulus creates is more trade tension. Say China subsidises the manufacture of more toasters through a mix of underpriced infrastructure, tax cuts and regulation. But there is reduced demand in China, and so these toasters need to be sold overseas. When the US government sends a cheque to an unemployed US citizen who uses it to buy a new toaster from China, the US has effectively subsidised a Chinese job. The US would much prefer their stimulus to be spent on a US toaster made by a US worker. And so China’s supply-side stimulus is likely to see trade tensions escalate.

Net effect: to fight the coronavirus impact, demand-side stimulus is better than supply-side. With the caveat that supply-side will work if you can “steal” demand from other countries.  

Governments: Adapting or clinging to the past

It was eminently reasonable for governments to put into place policies to “tide things over” for a few months in case there really was a V-shaped recovery. But these policies become self-defeating quickly.

Take, for example, the analysis above suggesting that keeping entrepreneurs afloat is a good policy. Many governments have suspended insolvency laws in some form which helps in the short term. But if this gets extended for too long, then it quickly becomes a more significant issue as moral hazard takes root. Say we have an industry with nine honourable retailers and one dishonourable retailer being supplied by six honourable suppliers:

  • In a normal scenario, if the dishonourable retailer stops paying its supplier, the supplier takes it to court. The retailer either pays or is wound up.
  • But now that isn’t an option, and the dishonourable retailer can keep racking up bills, maybe even cycling through suppliers, not paying and not being able to be prosecuted.
  • Some of the suppliers (being honourable) might even declare bankruptcy because of the non-payment while the dishonourable retailer stays afloat.
  • This can then “infect” the other retailers who lose their suppliers.
  • The one dishonourable retailer might have infected half of the industry by the time it is wound up.

Net effect: policies that help people and companies adapt to the new economic reality are good. Systems that try to maintain the old economy may have been helpfully initially, they no longer are.

Government Stimulus effect on Inequality 

Economic inequality was already reaching relatively extreme levels in many countries. Coronavirus shutdowns are increasing that difference. Many lower-paying jobs cannot be performed from home, plus casual workers were the first to lose their jobs.

Central bank bond-buying leads to more inequality. It is up to governments to reverse this through stimulus.

If they don’t, the greater economic inequality will lead to the election of increasingly extreme politicians and demagogues, promising snake oil solutions to the masses.  

Investor Wrap up

It is time to move on. New policies are needed that assume the virus is with the world for an indefinite period. Investors should factor in low growth if tax cuts and supply-side stimulus dominate. And investors should also factor in increasing trade tensions. 

The initial policy dump by governments and central banks was, for the most part, quite effective but focused on short term fixes. Economists and investment markets widely lauded these policies. The most significant growth risk is if politicians simply extend the short term policies, particularly the rules around insolvencies. 

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Comments

  1. The primary issue as it stands is that a large portion of recent /past demand, looked at in aggregate, has been funded with debt, so if the policy is to target demand then you have no choice but to continue putting more money into the pockets of all citizens, not for the short term – continuously. In theory, punters will deleverage during the many years of receiving cheques in the mail but in reality the economy will morph into a large zombie and the cheques will continue until the currency fails.

    Then the reset we need today will take place. The damage to the debt-driven global economy is terminal.

    • Goldstandard1MEMBER

      “In theory, punters will deleverage during the many years of receiving cheques in the mail but in reality the economy will morph into a large zombie and the cheques will continue until the currency fails.”
      I agree, but human behaviour in the short term are keeping it going because they are taking the cheques and gambling them on sports and the sharemarket with a V shaped recovery in mind. Once that busts there will be blood (more blood).

    • “Any Ermo-style discounts for doing-it-tough MB members?”

      Hayek would take you behind the shed and give you a good flogging for using a “special emotional plea” which would then skew market price clearing …

      On the other hand and like I said to DrSmithy, not that long ago, my services are available to all and would be happy to quote, then walk thought all the various options considering your price point and level of protection and finish your comfortable with.

      Oh btw your conception of debt is inaccurate because the system your using is and has not been applicable for a long time E.g. the future does not pay back the past with stuff …

      • On the contrary, skip, ALL debts get paid. No exceptions. (Don’t matter whether there’s a Jubilee, MMT or defaults galore – they all get paid).

        If you accept the above without question the rest falls into place quite nicely…

        • Debit is a curious word that has many meanings too some, yet at the end of the day it only signifies the completion of a contract and whatever money form that is used to facilitate that legal bond is irrespective.

          E.g. is sex a form of money to satisfy a contract.

          • Protective and ascetic coatings, core business is Qld’er – post war renovations and repaints.

      • Skip what business / trade are you in? (Genuine question, I know you’ve said in the past but I’ve forgotten).

  2. Say we have an industry with nine honourable retailers and one dishonourable retailer being supplied with by six honourable suppliers:

    In a normal scenario, if the dishonourable retailer stops paying its supplier, the supplier takes it to court. The retailer is either pays or is wound up.
    But now that isn’t an option, and the dishonourable retailer can keep racking up bills, maybe even cycling through suppliers, not paying and not being able to be prosecuted.

    Great example!

    inequality was already reaching relatively extreme levels

    Hence UBI:

    5 Aug 2020

    Jay Weatherill says now is the time to make childcare free

    • Jay Weatherill is a moron, this idea picks winners and losers. The winners are parents and providers of care, the losers are those single or childless families.

      UBI is a much fairer implementation of MMT then each person can spend as they deem necessary. The latte economy will collapse rapidly.

      • A UBI has no affiliation with MMT, past or present nor future.

        The concept of the UBI is a conservative economic theory which seeks to diminish the State in making targeted policy choices which are deemed intrusive to market based social formation. Per se Milton argued that to forward an increase in market driven social out comes the government could issue a UBI and then end all the government interference. To the point that too arrive at the preferred out come that democracy would have to be diminished lest the unwashed use it to just vote themselves more free money without any productivity E.g. only capital is productive as it leads all investment aka job creators meme. The entire premise behind that philosophical world view is neoliberal where everything is the result of market based survival of the fittest optics and no collective agency can rob the deserving of their wealth and the freedoms it grants, irrespective of the social dysfunction it might create E.g. its a sociopolitical theory which both romanticizes and vindicates Victorian ideology and called it a boon to humanity and life on this world.

        MMT is just a description of what policy choices that a developed nation with its own autonomous sovereign currency can utilize for domestic reasons. Trading with other nations and how contracts and currency valuations its a matter of time and space near and far.

  3. Nice to hear some commonsense in all this craziness – thanks for that. Might be why Bezos just sold $1.42 billy of AMZN shares! It’s reality, it’s not gonna be good, just hope the Fed’s/CB’s and gov’s make the right choices.

  4. Kudos Damien … breath of fresh air as it were …

    Although it seems your post had a Pavlovian response from the usual suspects, sadly from a historical stand point it will be these sorts that will throw sand in anything which might alleviate unnecessary suffering – social or economic, dis-enable transition to more modern and future driven economic activities as a front runner rather than playing catch up, and lastly preserve National Capital.

    Yes at China being mercantilist, but that has a historical undertow and geopolitical ramifications due to the aforementioned – old wounds thingy with a side of venture capital globalism flows, labour – reg arb to buff equities in the near term.

    Its a real issue to inform the investor class of the foibles of those that were born into the neoliberal period and due to it the psychological path dependency – can’t see any alternatives.

    Right back to the GT of we need to destroy the village to save it thingy … sigh …