Tuesday, March 10, 2020

Fighting the Next Recession Using a Squirt Gun with a Spray Nozzle

As I write this, it is unclear how large the coronavirus effect will be on worldwide economies. It will be negative; we don’t know how bad. Nor do we know how long the direct effects will continue. Parts of China have already returned to work, but many places have not reopened. According to Bloomberg news, pollution levels are still 20% lower there than at the same time as last year.[i]

Italy has essentially self-quarantined, the country forbidding public gatherings including postponing all sporting events. Israel now requires all incoming travelers to self-quarantine for fourteen days.[ii] In Iran, some of the top leadership is infected.

The U.S. has recorded over 700 cases of coronavirus through March 9. But here’s something to consider: it takes about five days for the symptoms to show up. If people are stupid (and who would bet against that?) and don’t take self-quarantining seriously when they feel ill or are exposed, then the U.S. is only at the early stages of contagion.

Stock market volatility is caused by uncertainty. (With certainty, markets reflect the news—up or down—and then go on with life.) How many people in the U.S. are ultimately infected by coronavirus and how many die are not the questions the stock market really worries about. As President Trump has pointed out, many more people are likely to die of the flu (or gunshots or traffic accidents, which the president did not use as a comparison, although he could have) this year. No, the real concerns are the economic effects of government policies to contain the virus.

I predict those effects will be sufficient to cause a worldwide recession. What I don’t know is how long and how serious it will be. Economic expansions do not die of old age. Expansions cause imbalances in the economy and eventually some external shock demonstrates those imbalances are no longer viable. The resulting recession corrects those imbalances and sets a new base upon which to build a new expansion.

The U.S. economy has been expanding for eleven years, fed in part by enormous Federal Government deficits. During those eleven years the national debt has increased by $10.7 trillion. The projected budget deficit for the current fiscal year is projected to be over $1 trillion.[iii]

This massive injection of borrowed funds to prop up the economy has worked. February’s job’s report indicated unemployment was at a 50-year low of 3.5% with 273,000 newly employed workers for the month[iv]. Damage from coronavirus will show up slowly in government statistics, but prior to this shock, the total economy was constrained not by capital to borrow or by unemployment, but by the lack of qualified workers.

Into this debt-fueled economic expansion arrives the coronavirus and government responses to it. China shutting down travel in infected providences seems to have worked. The number of new cases recently reported is much smaller than in the rest of the world. But their economy has not yet restarted in full. The worldwide effects are being felt, and they will continue for a long time.

A Marketplace interview airing last Thursday (3/5/20) indicated that LA Port traffic was down 25% from the same time last year. Containers are piling up at the port because of the lack of ships to return them to Asia. United Airlines and others have announced significant reductions to their March and April schedules. Events bringing large numbers of people together are being cancelled around the world. The London Book Fair expected 25,000 people to attend. Now no one will. Tech conferences and marketing conventions are being canceled in droves. These affect not only the immediate loss of travel, hotel rooms, meals out, etc. Longer-term, they affect orders for goods and services that will never be made because of lost exposure, innovations delayed, startups squashed.

Reduced travel and transport of goods requires less oil. An oversupply leads to a decrease in price. That’s short-term good for consumers (as President Trump extolled), but terrible for the U.S. oil fields in Texas and the Dakotas where high-leveraged exploration outfits will first shut off drilling and then close their doors through bankruptcy.

These are data points in a large picture of uncertainty—enough uncertainty that the U.S. Federal Reserve in a unanimous decision cut its benchmark target interest rate by 50 basis points from a range of 1.50% to 1.75% to a new range of 1.00% to 1.25%. (A basis point is 1/100th of 1%.) They are obviously worried and made this move “in support of achieving its maximum employment and price stability goals.”

Fed rate cuts have a few short-term effects (banks immediately cut the rates they pay savers, new borrowers have lower finance charges, often stock markets increase). However, the reason the Fed makes cuts is not for the short-term effect. It’s because they worry about the longer-term. Lower interest rates will (eventually) stimulate the economy through the process of businesses deciding to invest more because more projects are profitable given the lower borrowing costs.

Can cutting interest rates mitigate damages from the coronavirus shock? Not likely. They won’t repair supply chain issues. Interest rate cuts can’t get quarantined people back into factories or offices or out buying from restaurants. Interest rate cuts may delay bankruptcies in over-leveraged firms, but they won’t prevent them. Nor do they put money on the table for people who have lost their jobs.

Trump has discussed a payroll tax cut to stimulate the economy: a broad brush that will increase the deficit without targeting people in ways that will stimulate consumer confidence and buying. Those who still have jobs don’t need more money to buy more stuff—especially if there are shortages caused by supply chain difficulties. And Trump’s mentioned supporting the oil industry to offset their losses, reminiscent of his approach of tapping the American taxpayer to pay farmers for losses caused by his tariff wars.

I am not averse to spending money to address the current issues. But let’s do it in a manner that does build confidence. Instead of spreading money using a squirt gun with a spray nozzle, sprinkling a little everywhere in hopes some of it will work, we should fire-hose our spending to promote confidence and address human losses.

The bipartisan $8+ billion-dollar legislation to address coronavirus is a good start. Why not make sure everyone can be tested for coronavirus without an economic cost to them? If they don’t have insurance, make it free. If they have insurance, pay for the deductible or reimburse the insurance company for their costs.

How about reimbursing those who suffer work loss because they have to self-quarantine? Or compensating those who don’t have sick leave and become infected? How about a plan to reimburse those who must stay home with their kids because their schools are closed and who can’t work from home? These measures directly put money in the pockets of those who most need it—and will spend it and directly help the economy.
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James M. Jackson authors the Seamus McCree series. Full of mystery and suspense, these thrillers explore financial crimes, family relationships, and what happens when they mix. False Bottom, the sixth and most recent novel in the series is set in the Boston area. You can sign up for his newsletter and find more information about Jim and his books at https://jamesmjackson.com.

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