Coronavirus and the Economy

Dylan Scott COVID-19 Apr 01, 2020

In the midst of the current COVID-19 pandemic, there is a lot going on in the economy. Millions of people are losing their jobs, businesses are shutting down, and trillions of dollars of wealth in the stock market are disappearing. Though the global economy, especially during times of crisis, is incredibly difficult to understand, it is important to understand because of what is at stake. So, I will try to explain the issue of how COVID-19 is affecting the economy in the most simple and interesting way possible.

Supply

The most basic economic concept most of us have heard of is supply and demand. First, we will focus on the impact of COVID-19 on supply. More specifically, supply chains. Almost all products sold today are manufactured using a long chain of thousands of suppliers in hundreds of countries. While supply chains are incredibly efficient, they can act like a house of cards when minor disruptions happen.

Even a disaster in one country can ripple through these supply chains and bring entire sectors of the economy to a halt. For example, in 2011, flooding in Thailand destroyed multiple computer memory chip factories, which in turn led to massive consumer electronic shortages. As you can imagine, in the case of a global pandemic, these supply chain disruptions can get really, really bad.

As COVID-19 has spread throughout East Asia, the manufacturing hub of the world, the supply chains we rely on have somewhat imploded. Countries like China, Japan, Taiwan, India, and South Korea have had to shut down their factories to contain the spread of the virus. As a result, hundreds of companies, such as Microsoft and Walmart, are struggling to manufacture their products and stock their shelves.

COVID-19 hotspot in East Asia

To understand why this is, here’s an example. Let’s say one factory in South Korea that makes a display panel for Boeing’s airplanes shuts down due to a COVID-19 infected employee. Now, unless Boeing has that display in stock, they can no longer manufacture airplanes. Then, the airline, let’s say Delta, that ordered a hundred airplanes isn't getting any airplanes. And then, the pilots Delta hired to fly those airplanes aren’t getting paid. Just one factory shutting down can ripple through these supply chains and have serious consequences.

Considering that companies like Boeing, Apple, and Tesla have thousands of suppliers within their supply chains, those consequences are potentially multiplied by thousands. When we look across the entire economy, the end result is thousands if not millions of manufacturing and retail workers losing their jobs, companies like Boeing and Ford going bankrupt, and consumers facing massive shortages of everything from smartphones to airplanes.

Demand

The next half of the economic impact of COVID-19 is its effect on demand. COVID-19 has caused a near complete stop in consumer spending, the main driver of economic demand: Why is this?

First, you have the psychological problem.

Even before government restrictions were put in place, nobody wanted to leave their houses due fear stemming from COVID-19. With no one wanting to leave their houses, the demand for travel dropped to practically zero. If you want to see this for yourself, take plane tickets for an example. I mean, right now you can buy a ticket for a round trip flight from New York City to Los Angeles for $42. It’s cheap because no one in their right mind would travel across the country right now, so airlines have had drastically to lower their prices.

Map of round-trip airline ticket prices departing from New York City

Because of this sudden drop in the demand for travel, the stock prices of travel companies and the price of oil tanked. Combined with the effects of an ongoing price war between Russia and Saudi Arabia, the price of oil has reached its lowest in over two decades.

Rapid decline of the prices of oil and travel stocks

Fortunately, this drop in consumer activity was isolated to the travel and oil industries. Well, that was until world governments began to pull the plug on all non-essential consumer spending.

Now, restaurants are closed, cinemas are closed, barber shops are closed — and even Disney World is closed. People are being asked to not travel, to not patronize local small businesses, and, for the most part, to not leave their houses.

Indeed, about a hundred million Americans are currently under “stay-at-home” orders, and even more people are under these orders globally. While these orders are a necessary step to contain the spread of the virus, they are threatening businesses from small Main Street restaurants to massive Wall Street banks.

On one hand, it is hard to feel bad for many of these large corporations. These large companies had the resources to save some cash for any major disruptions, but they chose not to. On the other hand, there is plenty of reason to feel bad for these small businesses. Most small businesses do not have the resources to save for any major disruptions, so there is little they could have done. As a result of COVID-19 related disruptions, small businesses across the world and even right here in Port Jefferson are being forced to shut down indefinitely or lay off employees.

Yeah, there are a few notable exceptions like Netflix and Zoom Video that are benefiting from this “stay-at-home” economy. But, for the most part, the economy is hurting.

Results

When we combine a large decrease in supply with a large decrease in demand, we could go into a recession. Numbers have been floated around by officials of up to 32% unemployment in the United States, which would put its economic impact on par with the Great Depression.

That’s just speculation though, so let us look at the empirical data we have so far.

First, the stock market. We have all heard that the stock market has been in a period of chaos right now. So chaotic that just a few weeks ago, the Dow Jones Industrial Average had its largest point drop in its history on Thursday. Then, it had its largest point increase in its history on Friday.

You may be wondering: what even is the Dow Jones Industrial Average? It's the sum of the stock prices of forty of the biggest companies in America. This is considered a rough “benchmark” for the overall economic strength of the United States.  As confidence in the future of the American economy declines, the Dow Jones is taking a sharp downturn.

Historical Dow Jones Industrial Average data. Note the sharp downturn towards the end of the graph.

The present volatility in the stock market is on par if not worse Dow Jones than Great Recession (2008-2009), the Black Monday crash (1987), and even the Great Depression (1929-1933). The best way to visualize this volatility is a statistic called the VIX (Volatility IndeX), which roughly tracks the volatility of the stock market. Currently, the VIX is around 60, which hasn't happened since the Great Recession.

Comparison of the present stock market crash, the Great Recession, and Black Monday.
Stock market volatility over time. Note the sharp peaks during the Great Recession and present-day.

That being said, trends in the stock market can seem detached from reality, so let me try to put this into perspective:

This drop in the stock market from it's all-time high in February to its recent low marks an over $14 trillion dollar decrease in the wealth of America. The majority of that money did not disappear from Jeff Bezos wallet. It disappeared from middle-class retirement accounts and pension plans. All in all, almost all the stock market returns during Trump’s presidency have vanished in a matter of weeks.

Beyond the stock market, there have also been major swings in the prices of bonds, gold, silver, Bitcoin, mortgage rates, and, as previously mentioned, oil. This means that COVID-19 related volatility is affecting almost every single part of the economy.

The next point we have about the economic effect of COVID-19, at least on the United States, is unemployment filings. Last week, 3.3 million people filed for unemployment, which amounts to an over 2% increase in unemployment in a week. This sort of sudden increase is unprecedented, beating the Great Recession by a long shot.

Note the astronomical spike on at the end of the graph. Yikes.

So clearly, it's bad. And it’s going to get a lot worse. Yet — there is still some hope.

Relief

In a time of crisis like this pandemic, our governments are our only hopes. And right now, governments across the entire world are trying to perform CPR on their economies. But, how exactly are they doing this?

Central banks, such as the Federal Reserve in the U.S, are responsible for keeping the economy stable.They are the first line of defense that governments have against economic crises. For example, during the Great Recession, the Federal Reserve used drastic measures to try to save the economy. However, these same measures might not be able to save the economy from COVID-19. Let me explain:

The Great Recession was caused by a financial crisis. Essentially, massive Wall Street banks like Goldman Sachs, Morgan Stanley, and J.P Morgan Chase started heavily investing in mortgage lending. As these banks ran out of people to give mortgages to, they lowered their standards. Banks started tricking people with low credit scores and almost no income into taking out mortgages on homes they couldn’t afford. Part of this trick was promising people a “teaser rate” on the interest of their mortgage that they could afford, and then jacking up the rates a few years later. Then, the banks bundled hundreds of thousands of these “subprime” mortgages together into “CDOs” and sold them to investors for trillions of dollars. The banks promised to investors that these “CDOs” were a safe investment, since they contained thousands of mortgages that would never all default, or fail to be paid, at the same time. Guess what? They all defaulted at the same time. Once those “teaser rates” went away, hundreds of thousands of mortgages went into default. Fortunately, the banks on Wall Street bought insurance so in case this did happen, they would be protected. Unfortunately, the insurance companies also thought there was no way these mortgages could all default at the same time, so they didn’t keep any cash on hand to pay for the incoming barrage of insurance claims. The end result: Wall Street, the housing market, and the entire U.S. economy was on the brink of collapse.

Clearly, the government had to step in. The Federal Reserve attempted to save the economy quickly before it collapsed. While the steps the Federal Reserve took were highly controversial, especially the infamous “too big to fail” Wall Street bailout, at least we didn’t go into a depression.

The moral of the story: the Great Recession was caused by a financial crisis resulting from years of underregulation, deceit, and unnecessary risk taking. Or, if you would rather listen to the banks on Wall Street, the financial crisis was caused by poor people and teacher’s unions.

Regardless, a recession resulting from a financial crisis is quite different from a recession resulting from a public health crisis. Central banks obviously can't do much about a public health crisis. But, just because there is no financial crisis now, doesn’t mean there won’t be one in the future. As COVID-19 continues to take its toll on our economy, trillions of dollars in loans could default, central banks like the Federal Reserve are playing defense to prevent a financial crisis.

The way these central banks are keeping the financial system afloat is complicated, so I am just going to briefly summarize it. Let’s say Bank A gave a multi-billion dollar loan to an airline. Then, that airline runs out of money and can’t pay the loan. Bank A now has a multi-billion dollar hole in their wallet, which now they need to fill. They go to Bank B for help, which just lost billions of dollars on defaulting mortgages. They go to Bank C for help, which just lost billions of dollars on defaulting car loans. Since Bank B and Bank C are having their own problems, Bank A’s last resort is to go to the Fed and ask for money. Due to the ongoing COVID-19 pandemic, the Federal Reserve is able to give Bank A a 0% interest rate loan to temporarily cover their losses.

If that made no sense, don’t worry about it. The bottom line is, central banks are trying to make sure we still have an economy by the time this is all over. But, how are world governments helping their people and business make it through this?

While this is a global economic crisis, for simplicity’s sake we will just look at the United States response. A few days ago, President Donald Trump signed the CARES (Coronavirus Aid, Relief, and Economic Security) Act. This act expands unemployment insurance by $600 a week, provides direct payments to most American families ($1200 per adult and $500 per child), halts the collection of student loan payments, and gives grants to small-businesses to maintain their payroll and cover operational expenses. All of this costs around $2.2 trillion dollars. Yeah, it's a lot of money, but a necessary step to help families and businesses.

Yet this stimulus isn’t without controversy. While direct relief to Americans and small businesses is great, many are unhappy about the portion of the bill that provides trillions of dollars in loans to large corporations including airlines and hotels, which is essentially a government bailout. Some argue that this bailout is necessary because these companies are too important to let fail. Others argue that taxpayers should not be footing the bill for unnecessary risks taken by some of these companies. In order to strike a compromise, the Trump administration has floated the idea of the Federal government taking equity stakes in these companies, which would award the taxpayer when these companies recover.

There have also been some other notable measures taken to help Americans: New York, California, and a few other states have worked with banks to allow families in need to delay mortgage payments and rent; companies have taken steps to provide free services to families in need; and charities have raised money to provide for struggling families and small businesses.

One last thing worth mentioning is the idea that the “cure can’t be worse than the disease.” This idea is in some ways true: if we save lives from the virus by shutting down the economy, but more deaths are caused by suicides, drug overdoses, and starvation resulting from an economic recession, is it really worth it? But it doesn’t have to be one or the other. If our governments act quickly and effectively, we can fight the virus while also providing relief for the economic damage caused by fighting the virus. Then, when we eventually defeat COVID-19, the economy will come back stronger than ever.

Featured image by Emmett Maier and Dylan Scott

Sources

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