COVID-19 Update No.6
Last week we joined a Webinar with Edward Lazear, who is a Professor of Economics at Stanford Graduate School of Business and served as chief economic adviser to President George W. Bush from 2006 to 2009, which included the global financial crisis.
During the conversation Ed sized up the current crisis and its impact on the economy. Like anyone’s opinion about the future his views may not materialise, however his previous experience in policy setting makes his insights carry more weight than most in the financial press. We’ve summarised some of the key points from his commentary below:
Current Economy – not surprisingly we’re going to experience a deep contraction in the June quarter. The best predictor of the economy is employment. In the U.S, initial unemployment claims were around 10 million over the past two weeks, which is likely to push unemployment to near 10%. It is likely to go higher, but may be short-lived (perhaps only one quarter). Disruption is not uniform across the economy. The US (and other parts of the world) are probably already in a recession, but we won’t know until later in the year.
If he had to guess, Ed’s best estimate is that within six quarters the economy will be back to where it was at the beginning of 2020. This recession is unusual in that it’s driven by supply rather than demand, and thus should bounce back much quicker. Demand may even be higher in the near future due to pent up demand – people willing but unable to spend money in restaurants and on holidays – and we should have capacity in the economy to accommodate this demand. The closest example Ed could compare to was World War 2.
Government Policy – Ed thinks that government policy should strive to keep people and businesses liquid while we are fighting the virus and stimulate supply once we re-open our economies. He does not think these stimulus packages will drive inflation because high inflation only tends to exist in periods when there is limited economic capacity (we have plenty) and wages rise (which is normally towards the end of an economic recovery). The longest lasting effects of the virus are likely to be reduced human capital available to the economy from schools closing down and loss of work experience.
Impact of Virus – As an increasing proportion of our population has been exposed to and overcome the virus, it is less risky to return to “normal”. Two key numbers we must understand are:
1. Infection rate – Iceland has the best data on this so far. They found 4.5x more of the population were infected than those identified as having it.
2. Transmission rate – both for infected individuals showing symptoms and those who are asymptomatic.
In the U.S, they reached ~100k tests/day with a new test coming which should dramatically increase their ability to test more people. Things are in reasonable shape, but not good enough to confidently return to normal (yet).
Expected Recovery – the stock market (S&P 500) has historically been the best predictor of future economic growth. It’s still noisy, but we can learn from it. Since WW2, there have been 12 economic peaks (a recession is peak to trough). They are not uncommon and last ~11 months on average. Stocks tend to do very well (3.2% / month) around the trough. Markets recover before the economy does.
Edward Lazear’s comments remind us there is genuine bad news about, with the pandemic endangering access to health care, shutting down industries, pushing people out of jobs and making it hard to spend.
Overall, we’d suggest Ed’s comments make for positive reading. Fortunately there’s further good news for the economy:
Coles, Woolworths, Telstra, and some other employers are expanding. Even “panic buying”, whether justifiable or not, can generate employment. My local Bakers Delight is producing twice as much bread as per normal to meet demand from people working from home.
As in the global financial crisis, government stimulus payments can help cushion unemployment, even though not every initiative will operate perfectly.
The movement online of what used to be face-to-face activity will make some businesses more productive when the crisis is over, giving them room to grow and provide products and services more cheaply.
Some workers are taking fictional leave, which amounts to a gift to their employer, or sharing around reduced working hours, which amounts to a gift to the employee most likely to miss out otherwise.
Best of all, our country’s exposure to commodity price downturns is limited by our floating exchange rate. More than half our exports are resource-based or rural commodities, meaning falls in world demand could be hit commodity prices and Australian employment. But our floating exchange rate cushions these shocks, as it did during the 1990s Asian financial Crisis, the 2000s global financial crisis and at the end of the mining boom. This is shown in the graph below:
Trade-weighted Australian dollar exchange rate since float
In summary, as Ed has stated, the supply based disruption to the global economy is quite different to the demand driven recessions we normally experience. It does appear that many government responses to the pandemic around the world are focusing on the right things and will help position economies for strong demand once the movement of people returns to normal.
Author: Rick Walker
It should be noted the views expressed are those of professor Edward Lazear and not Stewart Partners