April 21, 2020
As governments around the world have thrown trillions of dollars/euros/yen/etc. at their economies to stave off the effects of the COVID-19 shut down, there is great discussion about the shape of the recovery. (Hint: It will be an L shaped recovery for the foreseeable future.)
While there is no modern equivalent for the re-opening, there are many excellent models of what a small part of the world looks like after a massive shut down. Any economy suffering massive loss of production due to war would work well as proxies. With just two ‘world wars’, some reasonable guesstimates can be made about economic activity after massive shutdowns.
In February 1937 the US and the DJIA were recovering from the great depression. The DJIA was at 3,428. Over the next 5 years the war in Europe partially shut down major economies in Europe, debt levels rose and people started dying, although not in great numbers yet. In May 1942 the DJIA was at 1597, just 46% of its 1937 value, but keep in mind the US had not yet entered the war in Europe, but had been attacked at Pearl Harbor. As the tide turned in the war (and debt levels continued to rise), the DJIA climbed again to 2961 in May 1946 just 86% of its pre-war high. It then turned down sharply, hitting 1825 in May 1949 as debt and joblessness ravaged the post war economy.
There are indeed some major differences in the economies. Looking at the gamut of differing conditions, the largest difference is likely that governments around the world are unleashing liquidity (lending) to prevent the collapse of asset prices. This is probably a mistake, and it ultimately won’t work. It will sustain asset prices for a short time, but it won’t sustain people for more than a few months.
This insight, yet unproven, highlights another key difference. The money being spent by governments to save the economy is not building value. It is being used to defend asset prices that appeared to be unsustainable in many areas before the outbreak. Every industry is different but $1 billion delivered to an airline might support a grounded airline for a month (Air Canada has about $1.4 billion a month in revenue and net of jet fuel, about $1 billion a month in expenses. Their operating margin in Q4 2019 was about 8%). Of course their supply chain may suffer a bit but will stay mostly intact as long as their suppliers are supported as well. That same $1 billion would provide $110 to every family in Canada to be used on what is important to them (food, shelter or a trip on an airline).
Another key area is the composition of debt. The addition of sovereign debt will return debts to post war highs as % of GDP, but in the USA, GDP grew rapidly during the war and produced hundreds or thousands of innovations in areas such as electronics, flight, medicine, manufacturing. Post war, GDP growth collapsed for 5 years as the war machines were idled leaving the nation’s economy to stagnate. Many people around the world had no money left to buy anything but the basics of shelter and food.
The excesses of the 1929 stock market only became apparent after the decline, but it took 25 years for the DJIA to return to it’s 1929 peak, finally reaching it in 1954. The interim period was marked by the great depression and two world wars. It is reasonable to suggest that the world unfolded as it should during this 25 year period. The stock market was simply a proxy for the human events, hopes and fears during the period. In the end a chart of stock markets is a lousy way to estimate the human cost of these events.
The US GDP during and immediately after World War II is likely an excellent proxy for the recovery from COVID-19 however as there was limited damage to infrastructure, a dramatic loss of non military demand and excessive debt loads. There was a clear medical impact (wounded soldiers) and the poverty, homelessness and other social issues brought about are excellent proxies for the fear and social distancing the world is facing today.
Another intriguing examination of the timeline is that this ‘war’ to protect assets didn’t begin with COVID-19, but rather during the 2008-2009 financial collapse. Over $12 trillion has been added to the US national debt between 2008 and 2019. The COVID-19 pandemic will add a further $6 trillion in 2020 alone. That spending has not yet shown significant increases in innovation such as those developed during the 1936-1945 period. (This can be seen very clearly in productivity measures. )
While the current trend of the stock market is up, the economy before the pandemic was not improving rapidly (despite rising asset prices) and it is likely that the economy following the pandemic will be even more moribund given the drag of debt, overcapacity in production and reduced demand.
A final aspect contributing to the probable stagnation of the economy is that governments have manufactured low interest rates in an effort to spur the economy. This was acceptable when economic risks could be (and were) managed, but now there is an exogenous event that has highlighted risks that are NOT monetary. That risk and the inevitable bankruptcies, loss of income and other threats will likely increase the cost of borrowing in the medium term.
These issues are likely to last for a prolonged period due to economics, not COVID-19 and the recovery will almost certainly be ‘L shaped’.
For readers who would like to review the various US Government support programs in more detail, the following links will help to start the process.
Here is CNBC’s review of what what the US government has done to support the economy since March 6th. Excluding the ‘unlimited’ support announced on March 23rd, the total from this article is up to $2.3 trillion USD excluding student loan interest.
The US Federal reserve has added $2.2 trillion to their balance sheet through the purchase of various assets (including junk bonds!) since January 1st (through April 15th).
The Federal Government signed into law a $2 trillion stimulus package on March 27th. Visual Capitalist has an excellent visual representation of where the money is targeted.
The US $M2 money supply has increased by $1.4 trillion between January 2nd and April 6th. Some of that will be a direct result of other actions mentioned above.
The total of these announcements is over $6 trillion to support the economy.