Investment Commentary | Third Quarter 2020
7 min read
‘The Lipstick Effect’ was a term attributed to Ronald Lauder, then head of the cosmetics company founded by his mother Estée.
He observed that sales of luxury cosmetics rose strongly in the weeks after 9/11, and same held true during the last economic crisis in 2008-09. Whilst sales of Cartier watches and Ferraris collapsed, small, affordable luxuries held up well as consumers awarded themselves a treat – something nice to make them feel better about life.
As with so much else, the current crisis is different and Estée Lauder reported falls across their make-up, fragrance and hair care products. There’s little point wearing lipstick under a face mask and those who are working from home have been focusing purchases on hygiene over appearance. Call it ‘The Dettol Effect’ as consumers treated themselves to a stockpile of bleach and a steady supply of antiseptic hand wipes.
One thing which hasn’t changed during this recession is that short-term inflation has collapsed and interest rates have too. The US central bank, ‘The Fed’, has suddenly decided that it wants to get inflation up. They’ve been floundering around trying to get it to their 2% target for years but keep missing it on the downside as structural forces like technology and globalisation pull it down. Further complicating matters is the fact that inflation will be extremely volatile due to unprecedented changes in what we are buying – you couldn’t get bread-making yeast for all the gold in Fort Knox in March, yet couldn’t give away oil or airline tickets.
Why the focus on getting inflation up after forty years of trying to keep it down? One answer is the high levels of debt accumulated by governments who have simultaneously seen tax revenues collapse and their spending soar on support measures. The UK government spending deficit this year will go from 2% of GDP to 20%, and the ratio of total outstanding government debt to GDP will exceed 100% across many economies. As some point in the future, markets might start to worry about all this debt and demand higher rates to compensate them for the extra risk.
There are several ways to deal with these debts, assuming we rule out reneging on it of course. Option one is to grow the economy quickly to increase the GDP part of the equation – difficult to engineer in a mature economy. Secondly, they could raise taxes to pay the debt down – but the numbers here don’t look good as the deficit this year is expected to be £375bn in the UK meaning our annual income tax take of £200bn would have to almost double to balance the books.

Finally, they could inflate the debt away. The amount of debt is fixed, but if inflation rises, it becomes easier to service as your income and GDP rises relative to the debt, though around 30% of UK government bonds are linked to inflation.
Central banks such as the Bank of England could also throw markets a clever feint to reduce the debt. They have been buying huge amounts of debt to bring down long term rates in a process called Quantitative Easing. Might one arm of the state find a clever way to cancel the debt issued by another arm? Perhaps the government could package up all the debt incurred during the crisis, take advantage of current low rates, and issue a single massive ‘Covid’ bond with a maturity of 100 years? When the time comes to repay the principal sum borrowed, inflation and growth will have massively reduced it in real terms. Demand for long dated bonds has grown with ageing populations, and Austria and Mexico have joined the 100-year bond club in recent years.
Whatever they choose, the past is a very different place and we need new, creative ideas from politicians and central bankers to ease the financial pain, before scientists come up with the solutions to rid us of this virus.
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