- The coronavirus is here, there is no cure and there is no plan to deal with it.
- The Fed seems to have decided that it will fight the virus and try to sustain growth using rate cuts - a dubious strategy.
- China’s economy slowed sharply as the country used draconian measures to reduce contact among people to quarantine, isolate and defeat the virus.
- Many investors in the US seem to think China’s results are a model for the US, but there is no evidence for that.
- We should have no confidence that the way to sustain growth is by using traditional macroeconomic policies. COVID-19 and the way it must be attacked to contain it is a game changer, as it changes how the US economy works.
The expression “There is no crying over spilled milk even if it isn’t spilled quite yet" begins to capture the dilemma of what to do in the wake of the coronavirus.
The coronavirus wave may still be on its way, we are not yet fully in its "wake." It may not have fully washed over us yet. Whatever the consequences, they are more or less in train, and we are in whatever state of preparedness that we are in. It is too late to get "more prepared."
Learn from China
Economists have reacted to this with their usual knee-jerk response and have used their favorite tool, one of their precious rate cuts (my precious...) - in this case, a cut of 50bp. But there is no patented response for policy to a coronavirus type of event. And it is important to look at China and to learn from it and from what it has done that is both good and bad, effective and ineffective, applicable and inapplicable. It is important think through what China has done step by step and not to generalize to grasp what will translate to the US and what won’t.
Why the virus goes viral
The virus is not an EMP shock that knocks out capital equipment, rendering it useless and requiring instant investment. It is a disease with a high death rate for a flu. It is particularly lethal for older people and especially for people in ill health (see death rate/also here/for age profile and other here). No young people also have died - as of this writing, no one under the age of 30 has died. The disease is highly communicable and apparently can be transmitted asymptomatically, which makes it hard to stop (see Virus Transmission). And for some unknown reason, the disease seems to be prone to generate "super spreaders" - people who, without symptoms, can and do spread the disease to many others before it is discovered. By now, enough of the virus has been "spread about" that "community infections" are being reported. "Community infections" are infections of people with no known contact to other persons known to have gone to China or come in contact with others who have had the virus. That explains what the country faces and why it is hard to stop it. It is like an invisible, attribute-less foe.
Going down the wrong path…
I think a rate cut is the wrong response. It is a "business as usual" economic response to a shock that will inhibit growth, and the COVID-19 is that and it will do that. But it will do so in a very particular way. A macro-policy response like cutting interest rates is wrong because the way that China (seems to have) stopped this disease was to take actions to slow or eliminate contact between people. Such a tactic slowed and may have even contracted economic growth very rapidly. And while "slowing growth" is not really the objective," it is the result of this approach, and it strikes me that taking action to try to ramp growth up is counterproductive to slowing the spread of the virus. So, policymakers, take your pick: do one or the other, but don’t pretend to do both.
Survivability vs. Growth
My thoughts on this may have been stimulated by young Greta Thunberg who is trying to point out the perils of growth. While most adults think she is mad (or at least should go back to school), her forward-looking point that sustainability and survivability should trump growth is obvious.
Should policy remain focused on growth?
What we have with the coronavirus is another example where policymakers wish to not succumb to the virus and instead want to generate growth that will power though it - as if that is possible. For far too long, we have worshiped growth. The time has come to refine our goals for policy. Who is to say that profit-maximizing behavior is superior to sustainability-enhancing behavior? If you are dead, you can’t enjoy any increase in output. Maybe a period of flat growth is one of the best ways to fight the virus if it’s done the right way?
Slow it; grow it; and don’t blow it
COVID-19 is going to slow the economy. There is no cure for it (see Prevention). And it may even generate negative growth. We would be far better off if policymakers accepted this "fate" and endeavored to mitigate the impact, as well as to educate the population that the world is not coming to an end if US GDP declines for a quarter or even two.
Even the Fed has changed behavior
A few short months ago, the Fed was hoarding rate cuts and looking ahead to a policy of interest rate stability. But suddenly, the Fed put a 50bp cut not just on the table but into practice. And it has hinted that there could be more to come.
COVID-19 is an agent of change
The problem here is the COVID-19 is going to change the way the economy works, and that will blunt the effectiveness of the usual policy responses like rate cuts. The NBA has already told teams to make plans for what it will would be like to have basketball games with no people in the arena except the players coaches and officials.
China’s successful response
China was not an isolated case (no pun intended) - it was the example that shows the way ahead. The way ahead is to reduce greatly person-to-person contact. That is easier to do in a communist country than in a capitalist democracy (if, indeed, we still have that) (see what China did... that may not work elsewhere).
Some on Wall Street want to "pretend" that this will be all over in a quarter, pointing to China’s greatly lowered rate of infections. But remember that China has achieved that result (if you believe the numbers) with radical isolation and quarantine policy. We will not achieve such a rapid and thorough stoppage of the transmission unless we do that too. Would we dare do what China did?
Slowing the economy means not using fiscal or monetary policy responses to speed it up at the same time. There may be some channels where activity can be diverted and boosted safely, but they are not likely to make up for the actions that it will take to slow the spread of the virus that will also slow growth. Even with a macro policy response, it is clear that the economy will slow.
Why bother to cut rates?
Some Fed members argue that there will be some sectors safely stimulated. Others argue that low rates may cause some investment that otherwise would not take place.
What if there is regime change?
But I prefer to look at this notion that the virus causes a "regime change;" it changes how macroeconomy works. It causes economic agents to interact differently; in that, case policy will not work the same way as it used to... if at all.
The mini-max fallback…
In fact, during certain crisis periods, economists have found that businesses will shift strategies from profit maximizing to survival strategies. An example of this is the well-known mini-max strategy in game theory. When times get very uncertain, businesses may shift from being profit maximizers to doing the thing that is likely to produce the smallest loss in the event that the firm makes the wrong decision (minimizing the maximum potential pain, i.e., mini-max). If that happens, lowering interest rates will not be effective.
What sorts of actions make sense?
In the last recession, the Fed took steps that we would be advised to look at again - not to replicate them, but to apply the lessons (more). Some of the things the Fed did in the Great Recession are things that the Fed no longer has the power to do since Congress restricted the Fed in the wake of that recession. But other regulators could use a policy of forbearance, encouraging banks not to foreclose on loans that go delinquent during the coronavirus period. Taken together, these were specific policies meant to bridge particular problems in the economy that cropped up in the Great Recession and prevented the delivery of credit to end-users. In this turn, small businesses are going to be particularly at risk. The Treasury could target programs to help small businesses. The object should be to underpin businesses during the period when growth will slow so they can survive and to keep the slowdown from cumulating and worsening. Targeting those who are affected would be a better plan than an open-ended macroeconomic spending program or a tax cut that would send spending power to people who don’t need it or are now loath to use it.
Smart, targeted policy
It is time to do something smart with policy and to target the problems instead of flooding the whole garden just to water a few plants. Econometric models are likely not to be any good for policy simulation at a time like this.
Plan and think for the future to invest smarter
I urge a carefully thought-out unique policy responses to try to support those most likely to be injured - not an off-the-shelf response. This would include sweeping medical care provisions, since the poorest people with the worst medical coverage working some of the lowest-skill jobs in the service sector will have maximum contact with other people. This idea could be termed "enlightened self-interest," especially for those that eschew "welfare." Policy should be geared to make sure that people in those circumstances can get medical help and do not go to work sick and spread the disease. If you see that these steps are not being taken, you should prepare for the spread of the virus to continue and for economic harm to worsen and for markets to remain impacted longer.
Information! No more "fake news" or "fun facts"
We also need our government to be straight with us and not whitewash problems or mislead us to think things are fine if that is not true. Americans need to know the truth in order to know how to best conduct their affairs. Already, lots of travel is being cancelled. Conferences are being washed out. This weekend, I went to my usual local diner in Manhattan to find it not crowded as usual on a Saturday, but quite empty. The owner told me the local hotels were having lots of bookings cancelled. I can say with some confidence that the slowdown is coming. If the milk is not yet spilled, the container is nonetheless past the tipping point.
Markets as harbingers of fear, not discounting mechanisms
Markets are not prescient on this. Markets have no "inside information." They are reacting out of fear. But they do act as a timestamp to show when the fear levels went up. Clearly, consumer confidence stayed up even for the late revision of the U of M Consumer Confidence reading into late February. The February job report was strong, but we knew that, since it has a specific survey date (second Tuesday of the month), and that came well ahead of the stock market sell-off. So, we knew that report would not be affected by the virus panic. Stocks will eventually price to the economy. There will be a period of weakness. Stocks are pricing to a swoon in earnings that they are now beginning to anticipate. But if US authorities pursue the right policy, they can limit economic damage in a downturn and set the stage for a full recovery. Then, stocks can price for the rebound once the risks of weakened earnings fades.
The focus of policymakers
This is why policymakers should not focus on the market reaction, and rather, should focus on the market’s underpinning: the economy. And as policy does that, it needs to tell us what to expect and what it will do to make sure that any weakness we have will be limited, contained and as brief as possible. We need communication. Results will not be achieved using traditional macroeconomic policy. Right now, we have no idea what the plan is... but there is no sense of the ingredients I speak of above being put in place. In short, policy is doing the wrong thing to make this a brief economic interruption… so get prepared.
What to do: Sell or wait?
There is certainly more market decline coming. This virus hit with stocks very fully valued. Of course, lower interest rates allow P/E multiples to sustain themselves at higher levels (than otherwise...), but the future is certainly bleaker across the board. Interest rate-sensitive sectors should be helped by the market reaction and impact on interest rates even more than by the Fed rate cut per se. However, auto sales already are floundering as auto loan delinquencies are rising sharply on sub-prime credits. Housing should be helped as refi activity will go sky-high, but the spike in affordability will have to fight the pessimism of weaker growth and possibly of job uncertainty. I have already explained why lower interest rates probably won’t spur corporate investment. If you were an early seller of weakness, good for you. If not, be careful; there is always a danger to sell a stock once it has fallen 10%, partly because it is hard to know when it’s safe to get back in. And the underlying notion here is that the economy will undergo temporary weakness. Yes, the market has more downside. Buying at lower levels makes sense. We will surely see that. However, if you are a long-term investor, sitting with paper losses is still not a bad strategy, even though it might be painful. The point is to bet on the economy. If you doubt that, get out.
The risk… or not
The risk of sitting with paper losses is that sometimes those losses turn out to be real. These kinds of unrelated calamities can segue into other things that cause economic value to fall. Sometimes, the road back after a sell-off turns out to be a dead end. For example, upcoming national elections could bring new economic policies and make some old investment themes moot. So, make your choices with a degree of deliberation. It’s not going to be as simple as saying buy some high dividend equities and wait it out.
We have not faced this virus before, so policymakers do not know what to do. Do not act like there is any certainty about any aspect of the degree of the sell-off or the timing of a rebound that we can "know." Do not "trust policymakers" to do the right thing. This not a Spike Lee movie. Do not expect policy moves to have the impact they have had in the past. Do not expect the US economic recovery to ape that of China, especially if we do not take similar draconian steps to contain the outbreak. This crisis will impact business asymmetrically. But some might be harbingers, such as travel-related businesses, airlines, cruise lines, and businesses linked to conferencing. On the other hand, this could speed up online businesses, especially for grocery delivery. Find your canary in the coal mine.
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