by futurist Richard Worzel, C.F.A.
“There is no room for wishful thinking when dealing with pandemics. The right mindset is to prepare for the worst-case scenario.”[1]
– Dr. Joanne Liu, former international president
of Médecins Sans Frontières
In 1970, Penn Central Transportation Company was not just the largest railroad company in the United States, it was also the sixth largest company in the country, and had the nation’s most valuable real estate portfolio. It was an impressive, muscular organization.
It was also out of cash.
And because of that lack of liquidity, it couldn’t pay its bills. So, on Sunday afternoon, June 21st, 1970, Penn Central filed for bankruptcy, becoming the biggest bankruptcy in American history.
This was a bolt out of the blue, and caught the capital markets completely by surprise. And that inspired the most dangerous question in financial markets: Who’s next?
If massive, muscular Penn Central could go bankrupt without warning, terrified investors thought, then who else might be about to collapse without warning? How about Chrysler, or even Ford or GM? Are all of the banks safe? If not, which ones are least secure?
It started a financial panic that almost bankrupted Goldman Sachs, and started a massive stock market sell-off. Had it not been for last second, and massive, intervention by the U.S. Federal Reserve to restore liquidity, and calm jangled investor nerves by essentially declaring, “We’ll stop this, no matter what it takes”, it’s highly likely that there would have been a run on the American banking system that could well have spread, and might even have collapsed the world’s banking system.
As I said in my first blog in this series, both the financial markets and the economy run on confidence. And the Penn Central bankruptcy shattered the complacent confidence of that period, just as the pandemic has shattered the complacent confidence of ours.
To understand where we’re headed more clearly, it’s helpful to explore an arcane and abstract concept in economics called the Velocity of Money.
What Is the Velocity of Money, and Why Should You Care About It?
Let me use a drastically simplified illustration of the economy to focus on the importance of velocity. This example suggests all sorts of other economic concepts, like barter, inflation, hoarding, inventory, spoilage, and so on. I’m going to ignore all of those and focus specifically on velocity.
Imagine that there are only three people in the economy: a farmer who grows grain, a miller who turns grain into flour, and a baker who turns flour into bread. Let’s also imagine that there’s only one piece of currency, a single, silver dollar, and that it’s held by the farmer.
The farmer keeps the silver dollar in a shoebox under his bed, and uses it only once a year, to buy a loaf of bread from the baker in order to celebrate the Christmas holidays. When he gives the dollar to the baker, the baker then has enough money to buy flour, which he does immediately, giving the dollar to the miller. The miller uses the dollar to buy grain, which he does immediately, handing the dollar back to the farmer. The farmer gets the dollar back shortly after spending it, but hoards it for the next Christmas. Each person has an annual income of $1/year.
Now suppose the farmer’s wife convinces him to buy a second loaf of bread, this time to celebrate the arrival of Summer. The same transactions occur. And the farmer is so pleased with the result that he buys a third loaf of bread to celebrate the harvest in the Autumn.
Pretty soon he’s buying a loaf of bread every week instead of once a year, with all the other transactions flowing on from that. Now his income is $52/year – and so is everyone else’s.
But now suppose something scares the farmer to the point where he decides he needs to hoard the dollar again, and spend it only once a year. Everyone’s income drops back to $1/year.
That’s the kind of behavior we’re seeing in the economy now.
The Velocity of Money Has Collapsed
People are staying home, either because of lock-downs, or because they’re scared of contracting a potentially life-threatening disease. That means they don’t go shopping, which means the shops close and lay off their people. That means those employees stay home, and have no income to spend, which means the merchants who would normally sell to them have no income, which means they have to lay off their staff – and so on.
Last week, I saw an interview with a financial planner, who was telling people that in a crisis like this, they needed to hold onto their cash, and spend it only on necessities. Cut out the lattes, the newspapers & magazines, the restaurant meals, stop buying new clothes, don’t get a haircut, don’t buy a new car, and so on. Hold onto your money, because you’re going to need it to survive.
In isolation, this might be an idea worth considering for an individual family. Collectively, for the economy as a whole, it’s a death threat. If everyone did that, it would throw the economy into a tailspin much worse than the effects of the coronavirus alone would have produced. And it comes back to the issue of confidence. Confident people spend money. Scared people hoard it.
The consequences of people being scared are like a set of dominos. And that is why we will see a string of bankruptcies.
Nasty Shocks Ahead; Central Banks to the Rescue!
We are certainly going to experience a rash of bankruptcies resulting from the Covid-19 pandemic, but there are two crucial questions to which we do not have answers: Who will go bankrupt? and How many companies and people will go bankrupt? And the future course of the economy will depend greatly on those answers.
I would be surprised if a Penn Central-style bankruptcy did not occur in this environment. This might be a big company, one that seemed solid, and whose bankruptcy will catch everyone by surprise. Or it could be something more exotic, such as collateralized corporate loan obligations, the investment derivatives market, or even Chinese banks.
In fact, almost all steep recessions have at least one of these kinds of nasty, surprise collapses that shake investor – and consumer – confidence.
Following in the wake of the recent market collapse, such an event could well be shattering, causing a market panic, and inspiring people to stay home, not just because of the virus, but because they wanted to hoard their savings for necessities.
Fortunately, central bankers around the world have routinely studied (or experienced) such panics before. As a result, central banks are already taking extraordinary steps to flood the financial system with liquidity in order to forestall just that kind of nasty shock from a major company that could panic the markets. In this way, they are hoping to keep money flowing, and the velocity of money high, to keep markets moving.
They might well succeed in forestalling panic; I doubt they will be able to prevent at least some major bankruptcies. So, be prepared, and don’t be surprised if nasty shocks like this happen. This is the period when we should expect them.
But central banks won’t be able to forestall the enormous numbers of bankruptcies that will still happen to businesses, from the largest multi-national all the way down to mom-and-pop shops.
That’s where fiscal stimulus comes in, and (some) national and regional (state, provincial, etc.) governments have stepped up to provide bailouts, loans, and other kinds of financial supports to employees and employers alike, to keep the number of bankruptcies as low as possible.
All of this is helpful and good. It will come at a cost later on, but it’s needed right now, so governments, with greater and lesser degrees of reluctance, have started pumping unprecedented amounts of money into the economy in a validation of pure Keynesian economics.
But all that’s been done so far is to buy some time. All the extraordinary interventions that have been made so far are merely a down payment on what will be needed in future.
First We Have to Beat the Virus
Some commentators, including the president of the United States and the Lt. Governor of Texas, have said that the top priority is to get the economy working again, that we can’t afford to stay at home in order to stop the spread of the infection.
This is foolish, delusional thinking. I’ve compared it to deciding that if you’re in a boat that gets a devastating hole punched in it, you should ignore the hole, and just row harder. That’s crazy talk. First you need to fix the hole.
In economic terms, first you need to fix the reason people are staying home: the virus.
In Part 2 of this series, I quoted a study by Imperial College London that estimated that the U.S. could experience more than 2.2 million deaths from the coronavirus.[2] This seems to have become the study that most people are now using as the base case, the best analysis available.
Now, a new study by the University of Chicago school of economics builds on the Imperial College study in order to try to put a number on the cost of lives lost, and what the economic effect of social distancing would be.[3] They found that if America can halve the number of who die from the Covid-19 virus from 2.2 million to 1.1 million through taking steps like social distancing and quarantining known or suspected cases, it can save an estimated $8 trillionover the next six months.
Since US annual GDP is about $22 trillion, this amounts to a saving of more than one-third of total GDP.
Or, turn these findings around: if we ignore medical advice, and go back to work, to school, to church, or whatever, about 1.76 million Americans more would die[4]than otherwise, and America would, collectively, lose a sum equal to more than one-third of its annual income.
And this does not quantify the effects on consumer and business confidence from that many deaths. Virtually everyone would be related to, or know someone, who died as a result of the pandemic. The horror, despair, anger, and so on, piled on top of the economic and financial consequences would be crushing.
So, perhaps I’m wrong, but I am not uncertain: First, we have to deal with the virus while simultaneously doing what we can to keep the economy from collapsing while we do so.
How Long Before We Return to Normal?
Anytime you see a news program with an epidemiologist answering questions, this is almost always one of the first questions asked. And the answer, unfortunately, is always the same: We don’t know.
Let’s go back to the Imperial College study. First of all, it’s important to note that it’s a mathematical model and theoretical exercise, not a prediction, but it is based on the best available information, and produced by people who are competent to do such things. That’s far better than most of the TV commentators most of us have listened to.
The Imperial model suggests that in the fastest likely scenario, deaths caused by the epidemic in the U.S. might peak around the end of June, then taper off towards the end of August.[5]
Unfortunately, that might not be the end of the crisis. There are a lot of things we don’t know about the virus. Among them, we don’t know whether you can get it more than once, in which case we might see social distancing restrictions eased, only to have the epidemic start all over again, including re-infecting those who have already had it.
We also don’t know if the virus will become a seasonal epidemic, like influenza, that will attack us again in the Autumn. And we don’t yet know how long it will take to develop a vaccine, or if the virus will mutate so as to render a vaccine ineffective.
So, while the Imperial College best guesstimate suggests this crisis will pass no sooner than the end of August, the real answer remains: We don’t know.
Will the Economy Come Roaring Back?
This is another popular question, typically asked in a variety of ways. People talk about a bounce-back, or a V-shaped recovery. Or they talk about “getting back to normal.” So, assuming that the virus does pass fairly quickly, how will the economy respond?
This kind of question betrays a lack of understanding about what’s happened. It reveals that people still think that we are in the heady, affluent economic expansion of the past several years, and that this is merely a speed bump, fleeting and ultimately unimportant.
That’s wrong. The world around us has changed, and will not go back to the way it was. Other things may happen, but we will not “bounce back”.
Imagine, for the moment, that we can start to emerge from the lock-downs and stay-at-home restrictions as early as late May, which would roughly parallel what’s happening in China now, and that the economy could start up again without restrictions.[6] I don’t believe that’s possible, but let’s pretend it is.
If that happened, how would people feel, having lost up to 2 months’ income, having witnessed crashing stock markets that wiped out trillions in value, and (probably) triggered waves of bankruptcies? Would they be eager to resume their happy-go-lucky ways, spending money freely as they did before the virus hit?
I doubt it. With about 17% of your annual income vaporized while your bills kept coming, and with the shock that came with everything that happened, I suspect that people would spend gradually and cautiously. Yes, some people would go out to eat, but not as frequently as they did; some would replace things that had worn out, or restock their pantries (possibly laying in emergency supplies against a future recurrence).
But I doubt that people would splash out on new fashions, expensive vacations, new cars, or home renovations. Likewise, I suspect businesses will spend cautiously, slowly calling workers back, and ramping up operations only after demand re-emerges, but avoiding expensive capital investments or expansions.
In other words, people’s mental states will lead them to behave like the farmer at the end of my earlier example, hoarding his money, rather than the way people behaved when it felt like the good times would roll forever, before the virus hit.
The velocity of money will not bounce back. It will seep slowly upwards as people watch other people to see whether they are spending before they start to spend.
And Yet, There Are Unique Opportunities Ahead
Humans are incredibly adaptive and inventive. That’s how humanity survived. Think about it: humans are the Earth’s top predator, despite being relatively small, weak, and without natural weapons.
We are already seeing incredible feats of adaptation and invention. Car factories are being converted to making ventilators. Companies that make hockey equipment are 3D printing face masks for health care workers. Pharmaceutical companies are adapting tests devised for different kinds of viruses into tests for Covid-19 that take minutes to process instead of days.
Human ingenuity is going to produce minor and major miracles over the next days and weeks. And with these miracles, new fortunes will be made.
Some are already in evidence. Online order and delivery of food, both from restaurants and supermarkets, are getting the kinks ironed out through usage that will vastly accelerate the development of these ways of serving consumers. Amazon, Walmart, and Costco are hiring people in a world where so many other businesses are laying them off.
Online meeting software is being stress-tested with a vengeance, both in the volume of data carried, and as different kinds of software are being triaged for quality. Those companies, like Zoom or Discord, that emerge as being most useful will have made business breakthroughs that would never have been possible without this crisis.
Good companies are holding onto people, taking the financial hit, and working hard to earn trust, serve consumers, and be seen as good guys. This isn’t just an honorable thing to do, it’s a smart thing to do.
When times are good, and all your competitors are doing well, everyone spends money to try to win market share – and the result is largely a stand-off. Everyone’s marketing efforts more or less cancel each other out. But when times are tough, dumber companies cut back, often because they didn’t build up enough reserves. That’s the time when significant market share can be pried away from weaker competitors. Or, as I tell my clients, turbulent times are times when market share is up for grabs for those smart and able enough to grab it.
And beneath the visible surface of the economy, new empires are being created as people are forced to find new solutions, new ways to survive, and as they spot opportunities that the crisis has created.
Indeed, many successful companies started up in bad times, including General Electric (1890), IBM (1896), General Motors (1908), Walt Disney Productions (1929), Fedex (as Federal Express – 1971), Microsoft (1975), Apple (1975), and CNN (1980), among many others.
While it may seem counter-intuitive that bad times foster good companies, it actually makes sense. There’s less competition, suppliers are eager to take on new business and are willing to extend themselves to be helpful, and talented employees are easier to find and hire. True, it takes guts and do-or-die perseverance, but if you can stick it out, bad times are often the best times to start an innovative enterprise.
And crises bring one other, utterly invaluable thing: They force people to look at the world in new ways. One of the problems of good times is that they are too comfortable, and people become complacent, set in their ways. Such an atmosphere makes it harder to come up with new ideas.
By comparison, times of crisis are times when everything you thought you knew, believed, and felt are challenged. They inspire people to have new thoughts, sometimes just by changing our perceptions, and sometimes as necessity forces us to come up with innovative answers, or lose everything.
But no matter how or why it happens, and even though it does not look like it from today’s headlines, I guarantee you that when we look back on this period, we will identify people who came up with great ideas, or even mediocre ideas with great execution, and turned this disaster into individual triumphs and new fortunes.
There’s a saying in the futurist community: Someone always benefits from change.
Let it be you.
Copyright, IF Research, March 2020
Blogs in this Series:
Part 1: What Are Stocks Worth?
Part 2: What Will Happen to Businesses?
Part 3: Bankruptcies, Panics, and Opportunities
Part 4: What Will Happen to Governments?
Part 5: Reset of Reboot? The Virus & Society
[1]https://www.theglobeandmail.com/opinion/article-ive-fought-epidemics-around-the-world-now-its-canada-that-must/
[2]https://www.imperial.ac.uk/media/imperial-college/medicine/sph/ide/gida-fellowships/Imperial-College-COVID19-NPI-modelling-16-03-2020.pdf
[3]https://bfi.uchicago.edu/wp-content/uploads/BFI_WP_202026.pdf
[4]The discrepancy between 1.1 million who die from the Covid-19 virus, and the 1.76 million lives that would be saved is due to the collateral damage caused by the health system being overburdened by the virus, with the result that lots of people would die because they would not receive timely treatment for heart attacks, strokes, car crashes, and so on.
[5]This is also the worst case, assuming the virus ravages through the population without mitigation, overwhelming the health care system, and killing millions of people, until it burns itself out.
[6]The first case in China was reported on December 1st, 2019, while the first case in the U.S. was reported on January 15th, 2020. China imposed travel and movement restrictions of greater severity and more quickly than the U.S. has, but I’m ignoring that for this example.
