“It looks like the unemployment rate is headed to 15 percent,” said Chris Rupkey, chief financial economist at MUFG Bank, in a note to clients. “This isn’t a recession, it’s the Great Depression II.”And yet you may have noticed a sustained rally in the stock market over the past two weeks. If you had bought at the bottom on March 23 you would have made a 30% return by now.
All this might lead you to experience some cognitive dissonance. If we're headed for another Great Depression, why is the stock market rallying? Wasn't the great crash of October 1929 and subsequent bear market one of the hallmarks of the original Great Depression? Might it be that this time the market knows something that Chris Rupkey and the Washington Post don't? Well, it's possible, but I doubt it.
There is one enormous difference between what is happening today and what happened in 1929, namely, that in 1929 the Fed didn't intervene to try to fix the problem and today it is staging the biggest intervention by a central bank ever in human history. In a nutshell, it is offering essentially free money in the hopes that people will take it and use it to keep the economy from collapsing during the pandemic. As the same time, Congress is also pumping vast amounts of cash into the economy through what appears likely to become a series of stimulus programs. At the moment all this appears to be working. Supermarket shelves are still reasonably well stocked (except for toilet paper). There is no widespread civil unrest. The churches and the gun stores are still open, at least they are if you lucky enough to live in a red state (and yes, that was intended to be ironic).
So maybe it's working this time. It is certainly working as a temporary stop-gap. Things would certainly be much worse right now if not for these measures. But there is a very, very big danger for the medium-to-long term.
The problem is that the stock market is being propped up by cheap credit which is exactly what led to the crash of 1929. Banks are borrowing money from the Fed and using that money to buy stocks, which are cheap by historical standards. If the economy were functioning normally they would be a bargain, having dropped 37% from their peak. (And note that percentage drops don't combine intuitively with percentage gains. A 37% drop followed by a 30% gain is not the same as a 7% drop, it's a net 18% drop.) But the economy is not functioning normally. Vast sectors of it -- travel, entertainment, restaurants, pretty much the entire hospitality industry -- have been completely shut down overnight, with ripple effects into other sectors that supply the hospitality sector. So the actual value of the U.S. economy is dropping like a stone at the same time that cheap credit is pumping up the price of stocks.
This is not the same as October of 1929. This is much, much worse. In 1929 the U.S. economy was basically sound. There was just as much productive capacity after the October crash as before. What amplified the crash into the Great Depression was the Fed's failure to relax credit which in turn led to a cascade of bank failures. A similar thing happened in 2008, except that lessons were apparently learned and we kinda sorta dodged a bullet.
Today there is not as much productive capacity as there was a month ago. There is a lot less. So there are only three ways that this can play itself out:
1. We find a way to end the lockdowns and return to work before too much time goes by. The only way this could be done safely is through the discovery of an effective treatment for covid-19, or more widespread testing so we can be more selective about who we isolate. The other possibility is to just throw in the towel and let a million people die.
2. The Fed continues to prop up the market for as long as the crisis continues.
3. The banks who borrowed the money realize that they now hold overpriced stocks and begin to sell in order to lock in their profits. Once prices start to drop, panic selling sets in.
At the moment the Fed has indicated a willingness to do #2 but whether they are really willing to stick with this in the long run is unclear. Artificially propping up prices by pumping money into the economy is no panacea. Germany tried that during the Great Depression and it did not end well.
We dodged Great Depression 2 in 2008 by the skin of our teeth. We did that in an era when the crisis was driven entirely by policy and not by any underlying physical factors, and when the people in charge were mostly competent and honest. Today none of those things are the case. We have an actual significant drag on the economy, and the country's leadership is both corrupt (really really corrupt) and incompetent (really really incompetent).
We Americans are a resilient and resourceful people and maybe we'll figure out a way to make this all work out somehow despite the headwinds. But I wouldn't bet my life savings on it.
[UPDATE] If you were pinning your hopes on the prospect that the Trump administration is not rampantly incompetent but rather perhaps just a little slow on the uptake, and that now that reality has set in they will finally do the Right Thing and deal effectively with the crisis, well, I wouldn't count on that either.
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ReplyDelete@Ron
>Banks are borrowing money from the Fed and using that money to buy stocks, which are cheap by historical standards.
Where are you getting this from?
We find a way to end the lockdowns and return to work before too much time goes by. The only way this could be done safely is through the discovery of an effective treatment for covid-19, or more widespread testing so we can be more selective about who we isolate.
Are you sure the only ways are "effective treatment for covid-19" or "more widespread testing ..."?
Isn't it possible that there are more ways, but you just haven't thought of them?
The other possibility is to just throw in the towel and let a million people die.
This is why it's hard to have an adult conversation on restarting the economy -- sophomoric moralizing about "a million people will die!" if people go back to work.
People need to go back to work, and soon, regardless of the state of virus transmission in the country. The harm of the economic shutdown to people is large and cannot continue.
If you recall, the initial concerns about covid-19 leading to the shutdown were:
1) A very high death rate.
- Update: not so high
2) Hospital capacity was insufficient to treat the sick needing hospitalization.
- Update:
A. Hospital capacity has been increased and hospitals are not being overwhelmed
B. We will soon have more than enough ventilators and PPE (high volume manufacturing)
C. Hydroxychloroquine and azithromycin is looking to be an effective treatment
Given that the initial conditions that led to the shutdown are no longer valid, the shutdown needs to end.
Post-shutdown, the spread of the virus can be addressed by:
1) social distancing to the extend practical
2) use of PPE
3) high-risk individuals need to act to protect themselves. That is, instead of protecting everyone, concentrate on high-risk individuals protecting themselves.
4) Use of testing for contact tracing and isolation
5) Adequate hospital capacity and equipment to treat those who become very ill
6) Eventually, a vaccine
> and the country's leadership is both corrupt (really really corrupt) and incompetent (really really incompetent).
It's becoming clearer now. You're wrong about everything because you read and believe the Narrative and lies published by the #FakeNews.
Take down "Preaching the gospel of evidence, experiment and reason since 2003." Replace it with, "A politico repeating crap I read on the internet with no serious attempt at finding the truth."
Perhaps it's telling that your 5th post was to an HIV/AIDS denial site.
> Where are you getting this from?
ReplyDeleteIt's pure speculation on my part.
> Isn't it possible that there are more ways, but you just haven't thought of them?
Yes, of course. The problem is, no one else seems to have thought of them either. If they had, you'd think they'd have gotten more press.
> The harm of the economic shutdown to people is large
That's true.
> and cannot continue.
Of course it can. Maybe it *should* not continue, but it certainly *can* (and most likely *will*) continue.
> Given that the initial conditions that led to the shutdown are no longer valid, the shutdown needs to end.
The initial condition was that somewhere in the country there was one contagious infected person who didn't know they were infected. That person created two such people, each of whom created two more such people, which led us to our current circumstances. That initial condition has not changed at all. In fact, if we stop now, all of the sacrifices we have mode so far will have been for nothing. We are no more prepared for infection on a massive scale now than we were three months ago (thanks in no small measure to Trump's continued dithering).
> 2) use of PPE
Of which there is still a massive shortage (thanks in no small measure to Trump's continued dithering).
> 4) Use of testing
Of which there is still a massive shortage (thanks in no small measure to Trump's continued dithering).
> 5) Adequate hospital capacity and equipment to treat those who become very ill
Of which there is still...
Ah, fuck it. And fuck you too, Publius. You are such an idiot you're not even worth the bother of trying to educate any more.
I think you're mistaken about macroeconomics.
ReplyDeleteOne thing about the current economy, is that capital and labor have not been destroyed, e.g. in a war or tsunami or earthquake. Instead, the economy has been on "pause". There is certainly a loss of real wealth in this missing quarter of production. But, similarly, there is no real barrier to returning to the previous economy (once the pandemic can be dealt with). If you buy a stock, and are looking to project forward cash flows a year from now, the best guess is something closer to the economy a few months ago, not to the current state. Stock prices are about forward expectations, not about current performance.
The Fed caused the 1930's Great Depression. The Fed also caused the 2008 Great Recession. Both of those could have been (easily!) avoided, with appropriate monetary policy. "Cheap credit" is not "what led to the crash of 1929". The crash (and especially the subsequent Depression) was caused by tight money, at the moment of the crash. The story that a long period of "easy" money earlier, "inevitably" leads to a later "correction" or crash, is false.
Banks are not borrowing money from the Fed, and using it to buy stocks. Most of what the Fed is doing is QE, which is buying financial assets (Treasury bonds), thus expanding the money supply -- not loaning money to banks.
You say that, in 1929, "there was as much productive capacity after the October crash as before." But that's exactly the same today. In both cases (but for different reasons), that productive capacity was mostly idle. But it was there, ready to be used.
In 2008, we didn't "dodge a bullet". Instead, the Fed repeated many of the mistakes of the 1930's, and caused the decade-long Great Recession after 2008. Yes, it wasn't as bad as the Great Depression. That's hardly a ringing endorsement. It was only the second-worst economic performance in the last century.
Finally, your concern about German hyperinflation: clearly, there is a problem with too little monetary stimulus, and you get a recession or depression. And clearly, there is a problem with too much monetary stimulus, and you get hyperinflation. But why are you rejecting the obvious middle ground, of merely offering the "right amount" of monetary stimulus, to navigate between the two extremes? Don't allow deflation, and don't allow hyperinflation. Simply target the usual 2% inflation (and provide sufficient stimulus to achieve that). You haven't really offered a theory of what goes wrong there, just that you find it "unclear".
@Don:
ReplyDeleteYes, the economy is on pause. And if it only stays on pause for a few weeks or even a few months we can probably just reboot it to the state it was in before.
The problem (as I see it) is that there is very little reason to be optimistic that it will only be a few months. SARS-CoV-2 is a really nasty little bug because it has a long asymptomatic incubation period. Unless we get the number of infected people back down to zero on the entire planet (and that is pretty clearly not going to happen) then as soon as the lockdown is removed we will be right back where we started, and 3-4 months after that we will be right back where we are now. We are like Wile E. Coyote who has fallen of the cliff and caught a branch. As long as we hang on to the branch we are OK. As soon as we let go we'll start to fall again.
The only way out of this is to let go very, very carefully, and that means, at a minimum, lots and lots of testing. But I don't see testing capacity ramping up to anywhere near the required levels any time soon. I certainly don't see the administration advocating for it, or advancing anything even resembling a coherent plan. That is what makes me pessimistic.
> Banks are not borrowing money from the Fed, and using it to buy stocks. Most of what the Fed is doing is QE, which is buying financial assets (Treasury bonds), thus expanding the money supply -- not loaning money to banks.
Well, yeah, OK. But when you expand the money supply all that money has to go somewhere and in the absence of consumer demand it ends up inflating the cost of capital assets. So the route that the dollars are taking from the Fed to Wall Street is a little more convoluted than just banks going to the discount window and turning around and buying stocks. But one way or another, more money in the absence of economic growth is going to lead to higher prices in the short term that are NOT reflective of an actual increase in value, so caveat emptor.
> why are you rejecting the obvious middle ground, of merely offering the "right amount" of monetary stimulus, to navigate between the two extremes
Because of the time scale. Like I said, if we really could restart the economy in a few months I would be on board. But I don't see how that can realistically happen.
Think about it: Imagine that June 1 rolls around and we've successfully flattened the curve. Covid case numbers are going down. Now what?
Frankly, I would be really surprised if even this scenario comes about. Because we have no national lockdown, I think that some states who were late to the party could still be on the rising edge of the curve well into the summer. This is a big part of the problem. For the lockdown to be effective it has to be coordinated, and it's not. Pandemics are one circumstance where federalism turns out to be a really bad idea. Viruses don't respect state borders.
OK, it looks like we're on the same page about a couple week/month economic "pause".
ReplyDeleteI'll admit, I don't yet understand the path for undoing the lockdown. It's only been about three weeks, and apparently has been successful so far at giving us more time. We've also learned a lot in that time: it's apparently less deadly than originally thought. Risk is clearly highly correlated with age, and some pre-existing conditions. Transmission seems almost exclusively person-to-person, so many other activities are safer than first believed. Avoiding touching your face, and washing your hands, seems highly effective.
And there are a number of national models out there to compare to. South Korea has a lot of testing and relaxed its lockdown. Iceland has tested a huge fraction of its population. Italy is a disaster. Sweden is apparently only doing "voluntary" social distancing. Is that going to work? Or will that turn into a disaster in the near future? A few weeks from now, we get to see.
The bay area will be in lockdown until early May. I don't know what happens then (new technology? antibody tests?), but I'm hopeful that we'll have learned enough by then to have a new path forward.
"higher prices in the short term that are NOT reflective of an actual increase in value"
Just a minor comment here: it's very important, in macroeconomics, to distinguish the "real" economy from the "nominal" economy. Lots can happen with prices (nominal), and that may or may not have an effect on the real economy (physical goods, actual services). There is always only a loose connection between "price" and "value". In particular, it is critically important to distinguish between changes in the overall price level (aka inflation), vs. changes in relative prices (one real good rising in real value over another real good). Just looking at the absolute dollar value of some good doesn't tell you very much, by itself.
"Imagine that June 1 rolls around and we've successfully flattened the curve. Covid case numbers are going down. Now what?"
I don't know! That's a really fascinating question. I will say, if the US stays on lockdown through the fall, that's a whole different world. But again, it's only been three weeks. I don't have very good visibility into a forecast of what the world might look like even three more weeks from now.
@Don:
ReplyDeleteI think we're on the same page about just about everything in this case.
> I'm hopeful that we'll have learned enough by then to have a new path forward.
I hopeful too, but I'm not optimistic. Whatever the path forward ends up being, it will have to be a world-wide effort, and we have a man in the White House who is actively hostile towards international cooperation, science, competence, even reality itself. That is one hell of a strong headwind.
Did you see Trump's response when asked about what metrics he would use to make the decision about whether to re-open the economy (not that this is really his decision to make, but whatever). He pointed to his own head and said, "The metric's right here. That's my metrics. That's all I can do." Which is to say, he has no metrics. He's just going to shoot from the hip like he always does. After all, what more can we ask from a stable genius like Trump?