March 11, 2020 marked the official end of the longest bull market in history. The Dow Jones went down 20.3% from the record high of 29,568 points it had reached exactly a month ago. Panic and uncertainty engulfed the markets as the coronavirus pandemic continued to wreak havoc in Europe and begin its rapid approach to America’s coasts. Governments across most continents moved at varying paces to intervene in terms of public health and the economy.
The US Economic Situation
One month ago there was an unemployment rate of only 3.5% in the United States and comparatively good economic growth of 2.3% according to the US Bureau of Economic Analysis. The stock market was at record highs. Currently, full employment has ended, with predictions of the unemployment rate more than doubling in the coming weeks and reaching up to 30% in the coming months. Just last week, there was a record number of 3 million new jobless claims. As the Federal Reserve and the US government tried to calm things down with their announcements of economic measures, the stock market appeared to somewhat settle and managed to stop its declining streak, thus ending the shortest bear market in history.
The Federal Reserve moved aggressively and — perhaps in its haste to do good — proceeded incautiously with its announcement of a 50-basis point rate cut on March 3. One week later it dropped it effectively to zero. The message to the markets was that the worst is yet to come.
Congress’ Massive Stimulus Package
Nevertheless, after the stimulus package from Congress began to take shape, markets slowed down their downwards trend. The bill that made its way from Congress to the US President’s desk was worth $2 trillion, the largest ever in the world. And if the word of the Senate minority leader Chuck Schumer is any indication, another, even larger package is to follow. The President himself recently announced his intention to put forward a $2-trillion infrastructure bill.
According to the stimulus bill, individuals earning less than $75,000 per year are expected to receive $1,200 in cash payments, for a total of $300 billion. Families will also receive $500 per child. For those filing for unemployment, the government will provide $600 per week on top of whatever these individuals receive from the states. This is expected to last for four months. Moreover, 13 weeks of unemployment insurance are foreseen under the bill, with the possibility to request extensions. Freelancers, who normally cannot apply for unemployment, now can, thanks to a new government program.
Covid-19 Expenses Will Now All Be Covered
The legislation also makes all Covid-19 related medical expenses covered under private insurance. Furthermore, $10 million is the total sum of grants for small businesses, which can request up to $10,000. The small business administration can provide up to $10 million in forgivable loans per business, for a total of $350 billion. There are loans for big corporations as well, valued at $500 billion. $58 billion are reserved for airlines, whereas $100 billion for hospitals, $98 billion for drugs and vaccines and $1.32 billion for community centers. Worth 10% of GDP, there is no doubt that it is a comprehensive package. As the Senate Majority Leader Mitch McConnell pointed out though, it is actually a relief package, not a stimulus package. This is a very important difference.
In addition to the fiscal, demand-side policies, the Fed has restarted its quantitative easing (QE) program and promised unlimited monetary stimulus. As the Spanish economist Daniel Lacalle explains, it is obvious that this stimulus is not unlimited. It is, in fact, limited by the $13 trillion dollar shortage that exists currently in the world. It has increased due to other countries, especially emerging ones, having dollar-denominated debt, and soon these countries will need dollars to pay those debts. This has been a long advantage of the US dollar’s status as the world currency reserve and a safe haven.
The Economic Situation in Europe
On March 18, the European Central Bank announced an $820 billion (EUR 750 billion) asset purchase program, named the Pandemic Emergency Purchase Program, that will last until the end of the year. This came after the new ECB Chief Christine Lagarde caused the biggest fall in the Italian stock market history with her declarations that it was not the ECB’s job to close the spread between bonds’ rates. Having realized her gaffe’s devastating consequences — not only on the stock market and bond yields but also on the ECB’s credibility — she apologized. Market participants reacted positively to the new program announced, maybe because it was the only concrete package from the EU. The member states of the Union still today, as April begins, have not reached an agreement as to how best proceed. The debates on establishing the so-called corona-bonds or finding other ways to help European individuals and companies still continue without any success. Chaos is the message that comes from Brussels. The threat of incompetence from the ECB‘s current leader is what makes market participants anxious.
Europe’s Lose-Lose Economic Dilemma
To make matters worse, in addition to a lack of a proper response, the economic situation in Europe is far worse than in the US. Whereas, the American labor market was strong and the economy growing steadily when the pandemic hit, the Eurozone has been plagued with high unemployment, weak economic growth and high debt levels. This has to do not only with the lack of a common response, but also with the actual implementation of the wrong type of measures to the crisis of 2012. And that is an important lesson to learn for the current situation. If we do not identify the problem correctly, it will be impossible to implement the right solution. This is precisely what is happening around the world.
While it is true that the United States has been much quicker than Europe in preparing for a coming recession, their measures are also not enough. The US is stronger than the Eurozone, there is no doubt about it. The economic measures implemented by Donald Trump, like cutting taxes and deregulation, have helped strengthen the economy further. Consumer confidence and business sentiment have been in their highest points. Nevertheless, this does not mean the US will not be hit by a recession. The way it behaves now will be crucial to how it weathers the storm. Even in its weak state, the EU has the possibility to reverse the course it is currently in by adopting measures that work. There is no doubt that it will be hit much harder than the United States.
If the US can afford to provide helicopter money and trillion-dollar relief bills, Europe does not have the same luxury. It is highly indebted, badly managed with inefficient markets. Its labor market is highly inflexible compared to the American one. Government interventionism is high and frequent. This has done more harm than good to the economies of the Eurozone. Decades of Keynesian economics have failed in bringing more prosperity, leaving Europe with deep economic scars. In 2019, many of the major economies in Europe were already close to a recession. What the US and especially Europe need is to produce. This cannot be achieved through demand-side policies, especially when the blow is not from the demand side.
The Coming Storm Isn’t About Demand-Side Shock
Currently, the crisis that is about to hit most countries has been misidentified as being caused by demand side shock. In reality, however, it is a supply-side shock that is hitting economies everywhere. Companies are being forced to close due to government mandates. It isn’t generally because they are in bad financial health, nor is it primarily due to consumers fearing to spend. This is the starting point of the crisis. Obviously, shutting whole sectors of the economy down will inevitably lead to a recession. Supply chains will also probably shift, because both emerging and developed countries are shutting down. Fiscal packages passed by governments are not effective and cannot serve as a stimulus. Why a company that is being forced to shut down, but is in good financial health, should take loans and inflate its debt?
On the other hand, can companies with high leverage ratios afford to increase their debt? How will they repay this debt when they do not know when they will resume normal activity? These companies do not suffer because they lack access to credit, which has been accessible at very low cost for some time now. They suffer due to forcibly closing their activity. So, the problem in its origin is not on the demand side. Nevertheless, due to consumers being forced to stay at home, and because of bars, restaurants, hotels, some shops etc. being closed, this may turn also into a demand side problem.
Printing More Money Isn’t Going to Fix This
Only once the problem is appropriately assessed, can the right solutions be implemented. Printing money and giving it to people will not stimulate the economy, while the relief will be only temporary. Nor will it ensure that the private sector is ready to start the engines of the economy once the pandemic is over. In the current situation, finding ways to increase consumer spending is not going to be enough to push the GDP up. Sure enough, government spending can. However, with the condition that Europe is currently in, it cannot afford to increase its debt by incredibly high values, because the consequences after the pandemic will be catastrophic. Many companies and banks in Europe are in the same boat as the governments when it comes to debt. In Europe there are banks with high NPLs that cannot afford to risk increasing it any further.
Governments have overspent during expansionary times, and central banks have dropped rates to negative levels, limiting the effectiveness of these tools immensely. So, what should be done? First, the governments should eliminate all unnecessary spending. They should revise their budgets and drop all expenses for the year that are not essential. Secondly, they should immediately open companies that produce in the industry sector. In many countries, most firms in the services sector can do smart working. A suggestion that economists like Lacalle have made is that governments can provide lines of credit to companies that need to finance their working capital. If the governments are going to spend money at low costs, they can do so in a way that produces results. It must be paramount that economic activity be steadily reawakened.
Thirdly, governments should decrease taxes at least by half for all companies. For those companies that are not working, corporate taxes should be zero for the whole FY 2020. Moreover, payroll taxes should also be eliminated, as well as local taxes. It is paramount that the cost of hiring is reduced so that the recovery can start.
Follow the South Korean Model
Many people may argue that health is more important and being locked in our houses is necessary even at the risk of burning down our economies. The reply to that is the South Korean model should be followed not the Italian one. They performed massive tests to most of the population and it worked. If the government wants to spend money, let them spend it on tests for the virus. Then they can isolate the infected without risking the whole world economy. People need to go back to work, because they cannot live otherwise. Death by recession is as awful as death by corona. We are still in time to stop a health crisis from turning into a recession of Biblical proportions.
As the US President said, we cannot risk the cure being worse than the virus itself.