The current viral depression is unprecedented in world history. We have seen occasional epidemics, and we have seen periodic depressions, but this crisis combines the two because of the unique nature of the virus and the response to it. It is the first time ever that large parts of the world’s healthy population are being quarantined. These preventative measures are being taken because people who are asymptomatic may spread the disease and because fast, free, and reliable testing are not as easily available in most of the world as they have been in parts of East Asia. East Asians also routinely used masks and disinfectants when the disease became known. Western people and poor people around the world generally did not. Instead, if they could, they self-quarantined.
The result has been an immense cessation of production. Large parts of the U.S. economy are shut down, including in-person services such as shopping and dining, but also the huge automobile industry, much of aerospace, and other large sections of manufacturing. Much of the government is not functioning, including the courts – right up to the Supreme Court. There is talk of stopping mail service in June. Movie and TV production has largely stopped. Nearly all schools have transitioned to much less efficient online education. Nearly all exams, even the SAT, are being replaced by simple and insecure online essay versions. Never in history has production slumped so broadly and so quickly.
Unemployment has skyrocketed to depression levels over the past two weeks. Normally, no more than a couple hundred thousand people file new claims for unemployment insurance in the U.S. every month. A really bad month is 300,000 new claims. During the past two weeks, ten million Americans filed new unemployment claims. This is beyond any previous spike in all of U.S. history. Economists’ models are coming up with nonsensical predictions because they are based on market assumptions that have no bearing during this time. For example, one report read that unemployment might reach 30% and GDP could fall 2%. How could output drop so little with almost a third of people off work? This is the kind of senseless talk echoing among our pundits. They are clueless in the face of such enormous changes, as is President Trump.
This crisis reverses the sequence of every previous one. Typical capitalist crises occur when credit tightens and demand thus falls. Unemployment usually follows, rather than leads, such a financial crash, as in 2008 and 1929. Although we did witness an enormous stock market crash (followed by a partial rebound), asset prices are holding up rather well and government bond yields are the lowest in history. Yet private efforts to raise capital, such as IPOs, are faltering. Many debtors will cease payments and the credit system may rupture soon, although lagging the real economic shutdown this time rather than leading it.
The U.S. Congress last week passed an unprecedented $2 trillion CARES spending bill that immediately rallied the stock market, but it will not save the U.S. economy from a depression this year. Many commentators are euphemistically calling this an economic stimulus, but it cannot counteract the massive shutdowns caused by the COVID-19 pandemic; it will only redistribute the losses. In order to have a real stimulus effect, the proposed additional-$2 trillion infrastructure bill is necessary, at the very least, to jumpstart the economy after the current quarantine period ends.
Normally, a fiscal stimulus as massive as CARES could be expected to boost economic growth, but this is true only if idle capital and labor can be roused to production. With so much of the economy shut down by quarantine measures, much less is being produced, so regardless of the additional money people might have in their accounts, there will be less to buy, not more. Adding spending power while real production is curtailed will merely guarantee price increases. More money chasing fewer goods creates inflation. Which prices increase the most depends on where this new spending power flows.
It might be more accurate to call this CARES appropriation a creditor bailout. Without such massive government intervention, many businesses and individuals would go bankrupt or at least default on their loans. This would jeopardize many banks and other creditors. The bill will allow creditors to be repaid and their wealth preserved, but at the cost of higher prices for ordinary consumers. About half of the total spending will flow directly to businesses, allowing them to pay creditors while their workforce is idled. Profits thus maintained from the public purse is what caused stock values to recover from their low point before the bill was passed.
What the CARES bill cannot do is replace the vast amount of production lost during the many months of quarantine. Virtually the entire summer season may be lost worldwide for the travel and tourism industries. Greatly reduced travel has also caused a collapse of crude oil prices from around $60 a barrel during the months prior to the virus to as low as $20 a barrel recently. Such a low price will devastate the massive oil shale and fracking business, which floated on a sea of debt now unpayable without massive bailouts. Not only are brick-and-mortar retail companies devastated by people turning to online shopping, but also commercial real estate. Another massive mountain of debt is thus jeopardized. What the bill might accomplish at most is merely staving off a huge wave of bankruptcies.
Additionally, stabilizing the credit system will not restore growth quickly after the months-long quarantine period finally ends. Some industries will remain depressed, including leisure travel, since people may be loath to take trips while danger from the virus lingers. This is particularly true for the cruise ship industry, which concentrates a population of people made largely of elderly passengers in a confined space. It might take a year or more for leisure travel to return to pre-crisis levels.
The existing creditor rescue bill will not necessarily restore production and hence jobs. That requires providing new demand for labor that will be displaced by long-term changes in consumer habits. That is why the proposed infrastructure bill is important. It promises not only to transfer income to those at risk, but to actually stimulate production directly with new construction activity to replace jobs inevitably lost in industries that will be depressed for long-term.
Quarantine procedures, while necessary for public health, are knocking out months of production around the globe. Even India is now on lockdown. This cannot help but contract the global economy. A global depression is inevitable. The only way to prevent it becoming more prolonged is to add fresh stimulus to economies around the world during the recovery phase, such as the aforementioned proposed infrastructure bill.
Yet all this deficit spending means an enormous and sustained increase in government debt globally. Debt levels were already high because of the costs of recovery from the 2008 crisis and massive tax breaks to the rich and corporations, such as the U.S. tax bill of 2017. Despite all these tax breaks and subsidies gorging corporate coffers, many used the boom period to buy back their own stock rather than making productive investments that might have actually grown the capacity to produce more. The quarantines further slash real production.
Thus we have artificially boosted asset prices and debt without the requisite production of real goods to back them up. The result must be that either asset owners – mostly the rich and corporations – claim a larger share of sluggish production, or the real incomes of most folks are cut by wage stagnation coupled with consumer price inflation. There is no way to expand asset ownership so fast, maintain income for those asset owners, and keep ordinary consumers prospering. Real losses will occur because production dropped. Now comes a titanic struggle to determine who gets axed. It is a game of musical chairs but corporate players call the tune.
Trump expects to make this all viable by keeping the interest rate on government debt near zero. With such a massive increase in debt, this is only possible if the Federal Reserve becomes the principle buyer of government securities. No self-respecting private investor wanted to own government debt even prior to this crash, when yields on 10-year Treasury bonds were only around 2 percent, which is historically very low. Now, 10-year yields are at new record lows of about 0.6%. Repo market rates for short-term secured private borrowing are now so heavily subsidized by Fed liquidity injections that they have fallen to 0.03%. This is the extraordinarily low rate the speculators pay to borrow money to finance heavily-leveraged derivative positions gambling on this heightened volatility.
Unleashing the speculators like this is like throwing gasoline on a fire. It is sure to put many leveraged positions on the losing side of bets. Mortgage lenders are already demanding government bailouts for their heavy losses on derivatives meant to hedge against interest rate risk. This is just the tip of the iceberg that is yet to rip open our titanic quadrillion-dollar (face value) price gambling business. As in 2008, derivative gambling on toxic securitized debt is again rampant, with the heavy default levels in the $1.6 trillion student loan market joining mortgage and other irredeemable debt. There has been so much attention on the stock market and the viral quarantines that these ragged financial foundations are escaping broad notice for now, awkwardly and unevenly papered over, as in 2008, by trillions added to new government borrowing.
All this extra spending power without additional production will inevitably cause inflation, so real interest rates will be negative, as they already are in much of the eurozone and Japan. Banks and other financial companies have been using government securities as a convenient reserve asset, but because of low yields, they have already been minimizing their holdings using accounting tricks involving the same bond showing up on multiple bank balance sheets. They will be even more averse to government debt as a reserve asset in the future. If the Fed and other central banks around the world must become the principle buyers of greatly expanded government debt and its yield is negative, they will inevitably expand their holdings of higher yielding private securities, as they have already been doing, in the hopes of at least breaking even on their own massively-bloating portfolios. This is a new and bizarre era in public finance.
If global central banks do not or cannot massively expand, interest rates on government debt will inevitably shoot up to levels that will soon claim a burdensome share of public revenue, crowding out other forms of public spending. Only much higher yields could potentially attract private investors into the government securities market in sufficient numbers.
Trump has now proclaimed himself a wartime president. The level of expansion of government debt will indeed be on the scale of a world war. Yet there is no commensurate expansion of private savings or goods rationing that would allow for financing this massive debt expansion; consequently, the painful fight over the distribution of real losses is being postponed to the near future.