The Inequality of COVID-19.

Every major disruption or crisis results in the redistribution of wealth. There are always winners and losers.

Before we discuss the winners and losers, we need to understand the economic and financial players in the game.

The Elements In Play.

The Economy.

We need to review what we said about the economy in #28.

Assets are the engine room of the economy. The whole system relies on assets being put to work such that they create wealth. No monetary theory can get around the fact that if you put money under your bed it will slowly lose value over time. The same applies to capital. If you put your wealth into capital that is not earning you a return you will slowly move to a point where you have nothing.

Because of transactional costs and inflation capital needs to be put into assets that are going to return over 10% per annum. This point may be contentious for some and I am not going to go through the argument here but suffice to say if on average your superannuation returns 7 – 8.5% you will end up on a part pension. At 10% you will have a comfortable retirement and the life you dreamed of.

Warren Buffett said the job of a CEO is to invest the company’s capital. It is the return on the capital invested that makes the economy go around.

Wealth.

Wealth measures the value of all assets of worth owned by a person, entity or country.

Wealth is determined by taking the total market value of all physical and intangible assets owned, then subtracting all debts.

To understand this, we need to define an asset, and in this there is some conjecture.

The generally regarded definition of asset is an item of property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies. But the financial definition is more specific in being a resource with economic value that is held with the expectation that it will provide a future benefit.

It could be argued that the benefit should come in the form of a future income, and therefore capital is only an asset if it provides an income. But that is a discussion for another day.

Money.

Money is something that is generally accepted as a medium of exchange. Because it can be used in a transaction it is also something that can be used as a storehold.

Examples of money are: Commodity money, fiat money, fiduciary money and commercial bank money. Commodity money would include gold and cryptocurrencies.

Where is the money going?

When there is a major disruption people or entities that own wealth often transfer that wealth for one asset to another. As money is required for the transactions to take place it is common for the wealth to be stored in money waiting for changes in the market to occur. 

Before we get into the looking at who is going to come out well and who is going to struggle we need to look at where the money is flowing at the moment, because there have been some substantial movement of cash in the past 10 weeks.

1. The Government is paying out in Job Seeker and Job Keeper some $260B.
2. April saw $60Bn increase in deposits from individuals and Companies.
3. $29B to be withdrawn from Super funds in the next few months. $6.3Bn to date.
4. Banks have $160Bn in loans falling behind.
5. NBN has raised $6.1B in debt facilities, at an undisclosed amount but said to be substantially less than the 3.96% they have been paying the Government.
6. $38Bn bid for government bonds within hours.
7. Globally $3.9Trill has been created through QE.

This means there are several things going on.

1. Governments are creating new money.
2. Money is being sucked out of the stock market and redeposited in banks, waiting for a home.
3. Some people with money are buying up the government debt.
4. Some people are liquidating their assets into money.
5. Some are just liquidating assets and spending it.

This means there are three groups of players in the game.

1. Those with assets.
2. Those with money.
3. Those with no assets and no money.

Looking at the future of money.

There are three potential scenarios.

1. The world returns to normal and governments start to earn a lot more than they spend so they can pay back to debt.
2. Some Countries default on their debt and as a result their currency is devalued, leaving the holders of cash and bonds with a loss.
3. A lot of the money finds its way into the financial economy resulting in high inflation rates which in turn devalues the value of money.

Looking at Categories of Money.

Cash and Bonds have been divided into three categories.

1. European style negative interest bonds and cash deposits. These are held by the ultimate conservatives hoping to maintain a semblance of the status quo. The problem is that if there is inflation your bonds become worthless.
2. Australian style bonds. A problem if there is any kind of inflation.
3. Junk Bonds. Will get a reasonable interest rate but at what risk. If the holder goes into bankruptcy, you lose.

Gold. 

The Gold market has always been good in a crisis of this type. The only problem is that it is a zero sum game. The gold creates wealth when it is dug up and presented to the market, but after that it is just a medium of exchange, it creates no wealth. According to Ray Dalio the average return on holding gold in the last 170 years has been 1.3%. that is why it is a zero sum game. If you hold onto it for long enough you will be even make inflation rates. Therefore trading in gold is the only way to go. 50 years ago I decided not to trade in gold because you were playing against some really smart guys who did if for a living. Now you are trading against some really smart guys who program huge computers. If you think you can win, good luck.

Cryptocurrencies.

The same applies as for gold. 75% of the value is in the power used to create it. The next 25% is in other costs and a profit for the miner. But once it is sold it never creates any more wealth. As for trading bitcoin, refer to trading gold.

Summary.

If you hold money you can buy cash in which there is no upside, or you can trade gold or cryptocurrencies. The upside doesn’t look great. However the downside could be dramatic if we go into a period of inflation.

Property.

Commercial Property.

It doesn’t matter if you are a multi billion dollar landlord running a few shopping centres or a small investor with one property the problems are pretty much the same. Cash Flow.

COVID-19 has produced a slow down in cash flow, so if you cannot meet normal payments you have a problem.

Multi-billion dollar companies are initiating capital raisings, which dilute the ordinary shareholder in the long run and produce great profits for those who have the cash the buy in. 

Small investors are putting off loan repayments or refinancing. Both come at a cost.

The moral of the story is that those with cash or the ability to get it are going to come out stronger, those that do not have the cash are going to lose as the market comes back to normal.

Residential property.

The scenario is pretty much the same as for commercial property. Those that are highly geared are in trouble.

If you are very highly geared than it is double trouble because if you put off your repayments and get past your LVR the pressure increases.

Those that were having trouble pre COVID with their repayments will have even more trouble post COVID. Some will fall over.

As we have discussed elsewhere over time the property market cannot decline because the replacement cost continues to build. Any price decrease will be a function or either people that have to sell or people that have to move, or people that are cashed up and want to use this period to upgrade while paying less stamp duty.

The answer is the same. Those with capital will thrive, those short of cash will find themselves in a worse position.

Equities.

As discussed elsewhere there are two distinct ways of using equities: Long time investment and short term trading.

Investment.

If you are a long term investor you will have a strategy to account for market volatility. In the case of retirement, you are more worried about your income than your market value, which is where stock picking has a downfall.

Volatility leads to market movement which leads to lots of change. 

COVID-19 led to capital raisings, loss of dividends, all these tend to have a negative impact if you remain neutral. Capital raisings dilute stock value if you do not partake. 

Trading

In the case of trading you hope to have sold out at the top and then bought back in at the right price. For traders’ problems lie in transactional costs and tax.

Winners and Losers.

The winners will be those that come out of the crisis with capital in hand and then put that capital to work.

Winners.

Those with Capital.

They will have got that capital through savings. These are the people that changed their life in lockdown, stopped spending but still retained their income. They banked the difference. When they came out of lockdown they had a goal, made use of the Home Builder scheme, continue to save and borrowed. They then took a risk and bought a new home and renovated, built a new home, or invested in equities. These invested assets rode the climb out of the crisis and set them up for life.

Losers.

Those with no Capital.

These are the ones that pulled capital out of super and spent it, put paying their mortgage off, spent up big on non-value adding things around the house, increased spending to alleviate boredom.

Those with Lazy Capital.

These are the people that have saved and then buried the money in a hole in the backyard, or in government bonds at 1%. Life is full of risks. You can fall over if you take to many risks but even worse you can fail by not being prepared to act.

Those walking the line.

Before the COVID-19 it had been reported that more than half of residential mortgage holders were classified as distressed loans. At the end of the lockdowns Alan Kohler reported that a total of $224billion in loans from 744,904 mortgages and businesses were deferred, according to the Australian Bankers Association. $165billion in mortgages and $101billion in business loans.

Summary.

On a personal level.

Pareto is real, that is the Pareto Distribution is a part of human nature. That means that coming out of yet another crisis 20% of the population will march ahead, the rest will fall further behind. The ones that move ahead are the ones that will take their capital and make it work for them. Those that stay behind are those that haven’t been able to save and those that were in front but will fall behind are those that take their capital and hide it waiting for a safe time to bring it out.

To explain this more fully I suggest you watch. https://www.youtube.com/watch?v=i0iL0ixoZYo

On a National Level.

For the nation to go ahead it must inject capital into the economy that is then used to produce a return of 10% plus. 

Money that is injected and doesn’t return an income is a further debt that needs to be paid back at a later date.