IceCap Asset Management: The Effectiveness Of Keynesian Economic Theory Has Reached Its End

Submitted by Keith Dicker of IceCap Asset Management, as excerpted from his latest monthly note, "The Law Of Holes"

Since the COVID Crisis accelerated in March, we estimate aggregate global losses and capital formation destruction to be $30 Trillion. We also estimate aggregate global stimulus to be up to $8 Trillion.

For $8 Trillion to offset $30 Trillion, we need to see a rapid recovery dominated by an increase in the economic multiplier. A quick and rapid recovery will allow many losses to recover. A slow and sluggish recovery will cause many losses to become permanent. This leads us to ask what is reasonable to expect for a recovery period and the economic multiplier?

The answer lies with the chart (next page) which details exactly how fast economic activity has been swishing around. M2 Velocity of Money chart produces 2 quite important messages.

Everything has limits

For starters, the maximum speed achieved was during the period 1995 to 2000, when it recorded the top speed ever  recorded of 2.20. In other words, the current $8 Trillion in stimulus would swish around to the equivalent of $17.6 Trillion of stimulus for the global economy.

Considering we have $30 Trillion in estimated losses; it may take a bit more stimulus to truly recover. And even more importantly, to prevent many of these temporary losses from becoming permanent capital impairments.

Of course, the estimate of the multiplier is never perfect, and the estimate of stimulus and losses are indeed estimates. In other words, there are a number of moving parts which means IceCap’s perspective might be off.

However, consider what happened to the Velocity of Money from its peak in 2000 to current reading. It has collapsed from an all-time high of 2.2 to an all-time low of 1.4.

What we find interesting and what helps us determine our market perspective is appreciating the response by the World's major central banks to the 2000 Technology Bubble.

The coordinated monetary response was achieved by reducing interest rates to the lowest levels ever recorded.

In effect, it was the first time in modern day monetary history, that central banks effectively reached the limits of  Keynesian Economic Policy.

When this fact is overlaid with the fact that the Velocity of Money subsequently began a 20-year period of deterioration, it catches our attention.

Put another way, once the major central banks collectively cut interest rates to the lower bound, the effectiveness of Keynesian Economic Theory had also reached its end.

Fast forward to current day, this makes us wonder how the $8 Trillion in stimulus will be enough to prevent permanent capital losses from the COVID Crisis. Our conclusion: it won’t.

And because the $8 Trillion will be ineffective, and because the World’s policy makers continue to embrace Keynesian Economic Theory, we should expect to see even more deficit spending and bailouts, and even lower negative rates, and even more money printing to support credit markets.

The effectiveness of Keynesian Economic Theory has reached its end. Yet, the continuance of policy makers ignoring The Law of Holes, creates visibility and opportunity for the investment world.

* * *

And this is where The Law of Holes should be applied.

At every single event in this diagram, central banks and governments responded with increasingly more aggressive stimulus in the form of interest rate cuts combined with deficit spending.

And since each crisis was larger than the previous crisis, it meant each policy response was even larger than the previous policy response.

Continue reading in the full slideshow below.