“When the facts change, I change my mind. What do you do?…”
— John Maynard Keynes
As time plods on, my thoughts on the economy grow increasingly dire. The reason is not the drip of horrible data releases – that was to be expected – but the mere fact that time itself makes our predicament more inextricable. It is becoming increasingly clear that the Covid-19 coronavirus exogenous shock is not a one-quarter phenomenon.
Governments are increasingly ‘socializing’ the idea that quarantines could last not weeks, but months. We’ve heard rumblings of this from officials in the UK, Canada and the US. Even as China appears past the peak on paper, it too continues to suffer from moderate forms of quarantine (e.g. movie theaters are still shut) and prolonged weakness as both domestic and export markets collapse. China’s experience shows that a v-shaped recovery is highly unlikely.
Except for the occasional grocery-store mission, I have not left the house in weeks. Other than food and utilities, I have not spent a penny. My ‘win’ however, is someone else’s loss and is a microcosm of the type of world we are approaching.
The epic collapse
March payrolls declined by over 700,000. This is just getting started:
Source: BLS, CNBC
Weekly initial claims are up 6.6 million. An unprecedented number. (I’ve highlighted the increase because it just looks like part of the chart’s vertical frame otherwise.)
Source: St Louis Fed
The world economy has come to a standstill.
On April 4, 2020 the IMF Managing Director, Kristalina Georgieva, said this is worse than the global financial crisis:
“Never in the history of the IMF have we witnessed the world economy come to a standstill. This is in my lifetime humanity’s darkest hour, a big threat to the whole world and it requires for us to stand us, be united. It is way worse than the global financial crisis. This is a crisis like no other.”
This is clearly not priced into the market. Currently, the S&P 500 is 27% off it’s all time high. During the 2008-2009 financial crisis, the market fell 57% from it’s highs. It would seem to me that there is considerable room for downside, if this is worse than the global financial crisis.
Notably, during the global financial crisis S&P 500 earnings per share bottomed roughly the same time as the market. Given the current Covid-19 lockdowns could continue for at least several more weeks, it is entirely plausible that S&P 500 earnings – and the S&P 500 Index – won’t bottom at least until early summer 2020.
There is clearly more room for downside. Perhaps 30% more downside, if the global financial crisis is our yardstick.
Great Depression 2.0
Even more troubling, however, is that this isn’t a normal cyclical downturn that can simply reverse after inventories are liquidated, companies create new efficiencies and new investment opportunities arise. Like during the Great Depression, the entire world economy is unraveling due to a sudden and widespread shock. This will only worsen with time.
Think of it like a cat playing with a ball of string. If some of the string comes unraveled from the ball one can easily re-wrap it around the remaining ball. However, the more the string comes unraveled, the harder it is to re-wrap. Eventually, the ball ceases to exist and you’re just left with a pile of string.
The longer the Covid-19 shutdowns continue, the more difficult it will be to put the economy back together. The economy will experience a permanent destruction of aggregate demand.
If I could snap my fingers today and return everything to normal, enough animal spirit still exists to spring the economy back to life. Restaurants could quickly re-hire staff with confidence customers would return. There are plenty of fully employed people to fire up aggregate demand once again.
However, as time goes on more restaurateurs will throw in the towel. More businesses will disappear. More people will become unemployed – many permanently so. The knock-on effects on commercial mortgages, loan losses, homelessness and wealth erosion will increasingly get out of control.
After a prolonged drought, people become very conservative about water usage. The same will happen with money. Those who do have discretionary income will stuff it in their mattress in fear that their time will come. Businesses won’t invest or hire. Even if banks are willing to lend, who’s going to borrow and invest?
This is our WWII moment. Even after the virus is defeated, if the battle is long and difficult the fear will remain. Everyone will be waiting for the other to make the first move to spend, invest or hire. In doing so, nobody will make the first move.
The world will enter a liquidity trap not seen since the 1930s.
Luckily, today’s world might by-pass some of the policy mistakes made during the 1930s. We have faster access to information and broader understanding of monetary and fiscal policy. There might not be bread lines, but the scale of economic devastation could certainly surpass that seen after the 2008/2009 crisis, looking more like a Great Depression 2.0.
Even after we won WWII, many feared a return to the depression economy. At that moment, however, the United States became the most powerful nation on the planet. It retained massive production capacity and became the cornerstone of a new global monetary system. Moreover, huge global fiscal spending to rebuild Europe and Japan began, which helped prevent the world economy from slipping back into depression.
Today, if the world economy remains shut for much longer our only salvation will be massive government fiscal stimulus not seen since the WWII era.