Six weeks into lockdown mode, the U.S. economy is a mess. States are just now starting to open back up, but the damage has been done — some of it permanently. The current unemployment rate in the United States is 14.7% and by some calculations (likely the bureau of labor statistic’s U6 measurement), as high as 23.6%, not far from the peak of the Great Depression.
Bankruptcies are beginning to pile up too. In the month of May alone, Neiman Marcus, Gold’s Gym, and J. Crew have filed for bankruptcy and J.C. Penny is considering it (AMC Theaters possibly too). Wall Street believes the vast majority of the 20 plus million Americans jobs lost will only be temporary — but maybe not so with bankruptcies piling on. Even companies that avoided bankruptcy are slashing jobs at a historic rate: Boeing cut 16,000 jobs in April and, according to a coronavirus layoffs calculator site, 375 startup companies have laid off more than 42,000 employees.
Ok, the point is made. Unemployment is breaking out as a bad as the virus. People are losing their sources of income. Jobs are vanishing — temporary or not.
But there’s something else going on that’s headed straight for the unemployment quagmire.
In the six weeks of shutdown due to COVID-19, the Federal Government has spent over $6 trillion. Trillion with a ‘T’. That’s $6,000,000,000,000 — or one trillion dollars per week. $2.4 trillion of that amount comprises four coronavirus relief bills; this includes the CARES Act, SBA Payroll Protection Programs. The remaining money has come directly from the Federal Reserve, who has acted aggressively to stave off economic collapse through numerous programs, including purchasing securities directly. On top of all this, the Fed also reduced bank reserve requirements to zero. This means if you deposit $100 in a bank, they can lend out all $100 of it, keeping none in reserve. This has massive implications — too much to explain here, but watch this to see the impact of reserve requirements in bank lending.
Furthermore, the Fed has also lowered the federal funds rate (the rate banks use to borrow from one another) down near 0%. This rate is used as a benchmark for various other loan rates, reducing the cost of borrowing for mortgages, auto loans, etc. This is the equivalent of turning on the spigot and the handle coming off.
Sure, what’s another $3 trillion on top of the 6 just minted?
In short, there’s more money coming but not necessarily jobs. So what’s the word no one is talking about?
An odd little portmanteau of “stagnation” and “inflation.” It is a period of high inflation coupled with economic depression. It’s odd too that no one in the media or government is mentioning it, because it looks exactly where we’re heading: $6 trillion and counting in six weeks coupled with job losses and bankruptcies.
Stagnation is a nasty beast because it’s difficult to resolve. In an inflationary environment, rates can be raised to cut off the spigot of currency expansion and reel in spending — a by product is reductions in borrowing and ‘tightening of the belt’ so to speak. Value returns to the currency. In a stagnation — or deflation — prices are falling and money is hard to come by. Loosening the belt allows money to flow a little easier, lending to be encouraged, which leads to businesses expanding via credit (and hiring).
So what do you do when you have falling employment and rising inflation?
If you ‘tighten the belt’ to choke inflation, it worsens the unemployment and makes it even more difficult for businesses to access credit. The currency may level off, but higher interest rates deepen the deflationary hole. If you ‘loosen the belt’ to make credit easier to obtain (e.g., federal funds rate) to save jobs, inflation gets worse prices go up and you risk a total collapse of the currency a la hyperinflation.
The choice is no win, but the effect felt by the average American is even worse. Job loss or cutbacks result in less income. People are left rubbing nickels together and deciding to pay bills or put food on the table. But in a stagflation, prices are rising due to inflation of the currency and suddenly you can’t afford bills OR to put food on the table. You can’t afford anything and there’s no way to bring in more money with the drag on employment.
The last time stagflation hit the United States was in the 1970s. Core inflation (CPI) was over 5% annually during the back half of the 70s, with unemployment high and an official recession running from November 1973 to March 1975. (As a point of reference, the Fed’s federal funds rate during the 70s was mostly between 5% and 10% — it currently is 0.25% to 0%) To choke off the inflation, Federal Reserve Chairman Paul Volcker raised federal funds rate to near 20%, throwing the U.S. into another recession but alleviating the increasing inflation.
I believe Volcker was a rare breed and no one today would pull the trigger on such a hefty interest rate increase. But there was no COVID-19 lockdown in 1979. With unemployment so high, companies going bankrupt or drawing heavily on available credit, jacking interest rates up would shatter all remaining functional pieces of the economy. To wit, another word has surfaced that people are talking about — NIRP.
NIRP stands for Negative Interest Rate Policy. NIRP is the theoretical physics of economics. A negative interest rate works in theory, but suddenly everything goes to plaid. It goes something like this: If an interest rate is 10%, that is the amount it ‘costs’ to borrow money. A loan of $10,000 would cost you a total of $11,000: the original $10,000 principal plus $1,000 (10%) interest. An interest rate of -10% would (in theory) pay you to borrow money. You would borrow $10,000 and get $1,000 for doing so. An $11,000 loan costs you $10,000.
Up is down. Black is white.
This would greatly increase the velocity of money, as banks essentially got paid to take out loans. The problem is, this cuts both ways. Cash deposited at a bank that previously paid interest now costs money. Your $20,000 life savings earning 1% annually now costs you 1% to leave in the bank. Last year your $20,000 became $20,200. This year under negative interest rates it goes from $20,000 to $19,800. You lost $200 by having it in savings.
The concept behind NIRP becomes searingly obvious — borrow and spend. Who in their right mind would save money with negative interest rates? Who wouldn’t borrow when you get paid to do so. In theory, since mortgage rates are tied to the 10-year Treasury yield, but in theory you would pay back less than you borrowed to take out the mortgage.
NIRP would cause everyone to borrow and spend away savings (why keep it in cash losing money when you can invest it or buy something with it?) But how would this impact things like bank profitability when you’re paying people to take out loans? In a NIRP world, home-owners would refinance to try and take advantage of negative rates which would disrupt interest and mortgage-backed bonds. The whole thing is bizarre.
So if the Fed doesn’t crank up interest rates in positive territory, then the only end game here is inflation and prices going up while people struggle to hold or regain jobs. The government can hand out cash in relief packages all it wants to offset jobless and loss of income, but this just further fuels the fire. If this keeps going, a $1,200 stimulus check from the government won’t buy much or things just won’t be affordable at all.
But cutting stimulus checks gives the pretense of ‘doing something’ for the people on the street. Granted, they’re walking a fine line with the COVID lockdown, but spending into infinity is going to be a losing proposition for all. Giving someone a check is simpler than explaining how velocity of money or banking interest rates work.
These germs of disease have taken toll of humanity since the beginning of things–taken toll of our prehuman ancestors since life began here. But by virtue of this natural selection of our kind we have developed resisting power; to no germs do we succumb without a struggle…
H.G. Wells “War of the Worlds”
Updated Edit: I started this post when COVID-19 was first hitting U.S. shores. So much has changed in four weeks and there’s been so much news it’s been a struggle to keep up. However, with each passing day I was increasingly sure the below is true. I intended this to be a much larger article as well, but the deluge of information is going to cause me to break some of the segments out into their own blog posts.
Our world has changed. Not from terrorism. Not from the results of this election year. But from one of the smallest creatures in nature. At less than 50 nanometers in size, COVID-19 proves that even the smallest thing can make the greatest impact. In a few weeks, its presence was felt already on a global scale; here in the U.S., it’s only been the matter of a week and much has changed.
This blog post is important because I feel like we’re at a watershed moment. Just a few weeks ago, the stock market was at its all-time high. Everything felt business-as-normal. We were deep into an election cycle, with non-stop new and critique about the Democratic candidate for President of the United States. There were also still sports.
Now, we’re looking at entirely different country (or even world). It’s starting to feel like a science fiction movie: closed borders and travel bans, closed tourist locations, churches, restaurants, and schools. People have to stay away from each other. The way we work has been forced to change (more on this below). There are also plenty of unintended consequences, mainly economic ones. The U.S. stock market has been decimated; fear runs amok with heavy selling, with days of heavy buying dispersed in between. It’s an economic whipsaw, panic expressed in red and green numbers day in and day out — no one knows whether to buy or sell. Officially, the U.S. stock market has entered a bear market, suffering the fastest 25% drop in history. To many, this feels like the end of the world.
But there’s something interesting here.
This feels like a watershed moment. Things are going to change, regardless of how this plays out. We are living through history at this very moment. Much will be reevaluated in the coming weeks and months and below is just a sample.
The economic ramifications cannot be downplayed. The U.S. market has suffered heavy selling as people bail out of stocks. Initially, it began as a result of downgrading the outlooks of large companies due to the shutdown of Chinese manufacturing. Factories in China and South Korea have been shuttered for over a month, and are struggling to restart. The length of closing is or will lead to shortages are less product are being manufactured — and many, many global companies rely on them. The disruption of supply chains has led to lower sales, which began pushing stock prices down. Selling begat selling, and then it turned into a rout.
Worse than a battered 401k or fund balance sheet is how the Federal Reserve has reacted. A few weeks ago, the Fed tried to get in front of the selling by cutting the benchmark federal funds lending rate by 50 basis points (bpts). Simply put, lowering the funds rate makes it “cheaper” for banks to borrow money from the Fed (the lending rate is the interest rate banks pay back to the Fed for borrowing; so if the funds rate is 1%, a bank could borrow money from the Fed at 1% and lend it out at 3% and make 2% profit). Last night, on March 15, the Fed lowered the lending rate to the 0% range. This means banks can borrow from the Fed essentially for free. If that weren’t enough, the Fed also fired up a $700 billion quantitative easing program — which it will use to buy up U.S. Treasuries and mortgage-backed securities (remember those?)
In a nutshell, the Federal Reserve is flooding the economy with fresh money to try and stave off recession. Its primary weapon is the federal funds lending rate — which dictates how “expensive” it is to borrow money. This new rate and QE program have effectively made the dollar “cheap,” and could have severe impacts on the value of our currency. In a black hole of selling, deflation sets in — prices drop, cash is in high demand, and businesses penny-pinch. What would could ultimately have is inflation — or hyperinflation — and severely damage our currency’s purchasing power. The U.S. Dollar is the de facto global reserve, with all other currencies pegged to it (there’s not enough time to go into all this now) and ramifications would be global if it suffers in value.
Pittsburgh Mayor Bill Peduto said the city will adhere to advice from the Centers of Disease Control and will lower the maximum occupancy levels of all events from 250 to 50 individuals. Today, Allegheny County Executive Rich Fitzgerald also urged non-essential businesses, like bars, gyms, theaters, child-care centers, golf clubs, and hair salons, should close or implement alternative work strategies for the next two weeks starting March 16, to help stop the spread of coronavirus.
Even if these places stay open, they may see very little or no patronage. Sales will go down. The service industry is going to suffer. In Portland, my brother-in-law drives for Uber. The amount of rides request for him has fallen off a cliff — no one wants to ride share for fear of contamination. The lack of Uber rides has him looking for Amazon Flex deliveries, but there are way too many Amazon drivers now because they also drive for Uber and have no rides.
Even Hollywood has felt the pain. Tentpole films have been delayed, new films have had their productions frozen or shelved, and no one’s going to the movies right now. Early estimates by The Hollywood Reporter indicate losses by the movie biz to be as high as $20 billion. Travel bans and Tom Hanks’ getting sick have completely upended tinseltown and there’s a scramble to maintain business; in TV broadcast schedules are disrupted by delayed productions and production halts on new pilots. Shows may not be ready or finished in time. And then there’s the question of insurance for the industry (from the same HR article):
Meanwhile, it is unclear any of the losses will be covered by insurance. “If we are talking in terms of protecting lost revenue due to enforced shutdown or scale-down of operations, some property policies may offer limited amounts of coverage, although many have specific communicable diseases exclusions,” said attorney John Tomlinson, who specializes in insurance and risk management law.
Temporary theater closures could lead to permanent change in the industry. Wedbush securities analyst Daniel Ives, who covers the technology sector, said coronavirus could usher in a new era of consumer behavior that puts some theaters out of business for good. “For the first time since we launched coverage of the exhibition industry, we think the industry is genuinely at risk. There is valid concern that COVID-19 will limit theatrical attendance globally, whether driven by theater closures, capacity limitations, or fear of contamination,” he said in a research note.
With schools and numerous businesses closed, parents and children are all relying on streaming services for entertainment. If it goes on long enough and Hollywood is willing to put new releases online to rent, there could be a large shakeout of theater chains. Will theaters reopen only to have some eventually close permanently if audiences don’t return? A discussion I saw among filmmakers on Twitter were theorizing the return of the drive-in theater, as it would allow moviegoers the ability to maintain ‘social distancing’ between cars. As a filmmaker myself, I plan to dive further into the future of the entertainment industry in a future post.
The most brutal consequences come from the stock market, where the Dow Jones has lost 30% of its value in only 3 weeks, out-doing the carnage from the 2008 crash. Retirement plans and pension funds have been decimated as the market has turned into “sell everything as quick as possible.” The market can’t determine valuations with manufacturing in China shut down, supply lines strained or cut, and businesses reducing hours or shutting their doors.
What this amounts to is the great tree of the economy is being shaken much like it did in 2008. Healthy or resourceful businesses will survive. Those at risk financially or have been teetering will be wiped out.
The decades-long grand experiment of Globalization may end with the COVID-19 pandemic. The active concept of free-trade, open borders, and centralized manufacturing has been put to the ultimate test. There has always been great risk in China owning much of the world’s manufacturing, given their geopolitical and cultural standing. And I’m not even talking about Communism.
In 2018, China owned more than a quarter of all manufacturing in the world, far ahead of the U.S. in second place. If something were to happen there, the world would be severely disrupted. There have been ‘head fakes’ in the past 20 years — SARS, avian flu, swine flu (H1N1) — diseases originating in China, where pollution is heavy, sanitation can be lacking, and population is dense. I can speak for this first hand — I’ve been to Southern China provinces on business trips to factories. On several trips, coworkers came down with illnesses and/or food poisoning (I don’t eat seafood, and wonder if that’s why I didn’t get sick). These past illnesses should have been cause for concern that the world’s manufacturing hub was at constant risk.
Now, with coronavirus, much (if not all) of these factories are shuttered in the fight with the virus. There are shortages and other countries economies are impacted. Tech companies like Apple (or Samsung, with factories in South Korea) have had their supply lines severely disrupted. Apple is the poster child for Globalization: materials are sourced from around Asia; iPhone components (like the display) are built in Japan before being shipped to China for iPhone assembly. With manufacturing spread across borders, coronavirus is the ultimate perfect storm to cause chaos. In an article titled “Coronavirus: Globalists May Soon Become an Extinct Species,” author A. Gary Shilling writes:
The coronavirus’s disruption of supply chains not only unhinges U.S. imports but also raises national security concerns. China is the world’s biggest supplier of active pharmaceutical ingredients and the Indian generic drug industry, which the Food and Drug Administration says supplies 40% of U.S. generic drugs, relies on China for most of its active ingredients. Even after the virus scare subsides, look for more pressure from Washington for more reliable sources of goods, among other protectionist measures. Domestic producers will benefit but so too will those in Mexico. The results will be lower global efficiency and slower economic growth.
That has renewed talk of Japanese firms reducing their reliance on China as a manufacturing base. The government’s panel on future investment last month discussed the need for manufacturing of high-added value products to be shifted back to Japan, and for production of other goods to be diversified across Southeast Asia.
What happens to the flood of refugees and immigrants headed to the EU and find the borders closed? At the beginning of the month, Turkey said it was opening the flood gates for migrants into the European continent, with Greece countering that it was suspending asylum and stationing troops. According to the New York Times, both moves are illegal under EU law and “International protocols on the protection of refugees, of which Greece is a signatory, also prohibit such policies.”
The EU could possibly collapse as well, as the virus puts serious strains on inter-member trade relations regarding protective medical gear. France and Germany essentially hoarded their protective gear, denying other member states. France, in particular, “requisitioned all current and future stocks of protective masks.”
It’s not just Europe, either. The U.S. has announced an international travel ban — no one comes in or out. Borders with Canada have been closed. “Non-essential travel” between U.S. and Mexico has also been shut down.
So how does Globalization survive with restricted borders, international blame for the virus spreading, and crippled cross-border supply chains? At the very least, Globalization will be rethought when this is over. Some countries may use it as an excuse to break free of the EU or bring more manufacturing home to their countries. Reliance on unfettered, open trade may change. It’s impossible for there to not be geopolitical ramifications — China may suffer the most from this as corporations look to take their manufacturing base elsewhere to a country with less risk. Without widespread manufacturing and employment to grow their middle class, Communist China could slip back into the economic Third World. Will that happen? Who knows.
Regardless, world politics will never be the same.
The New Great Depression
There’s no doubt four weeks in to lockdown the people on the street are hurting the most. In the past 4 weeks, 22 million Americans have filed unemployment claims — by far a record. Now, this comes with an asterisk. For the first time, states are allowing self-employed (aka contractors) to apply for unemployment, and you can file for unemployment benefits if your hours have been reduced due to COVID-19.
While that may bump the numbers a bit, it certainly does not offset the amount of people who haven’t been able to file yet due to state unemployment offices being overwhelmed. States are forcing people to go online to file, but the state sites are crashing from the traffic. Because people have been unable to file yet, the official government U3 unemployment numbers are likely inaccurate at best, heavily underreporting at worst.
I think it’s naive to think that all these people will suddenly return to their old jobs when the lockdown is lifted. Many of these jobs won’t be there — and what about independent contractors and freelancers? These will be the hardest to return to work. Many employees of recognizable brands won’t have locations to return to either as companies close up shop and/or file bankruptcy — namely restaurants and discount stores.
Other industries that may be shrinking include shale, cruise lines, and airlines.
Does Anyone Really Know Anything?
I’ll end it with this bit: does anyone really know what’s going on? It sounds scary to even pose a question on such a scale, but after four weeks I cant help but openly wonder. The symptoms to COVID-19 keep changing or expanding — it was originally a respiratory illness with signs that included fever and cough. Then it expanded to bodily pain. More recently, loss of sense of smell (or taste) and foot sores as byproducts of the disease.
Without answers how can we have a plan? How long with the economic malaise go on? How long CAN it go on? Countries and states are devising plans to reopen for business, perhaps hoping warmer weather will deal with the disease.
There’s always the fear of a second wave coming in the fall.
Regardless of how this turns out, we are undoubtably living through history. Our personal lives and the course of humanity may be steered by this. It sounds overdramatic but how could it be any other way? Over half the population of this planet are in lockdown, forming new habits and getting used to the ‘new normal.’