More Green Shoots

June 2, 2020

A full recovery from the COVID-19/Shutdown Crisis is going to take a long time.  We don’t anticipate reaching a new peak for real GDP until the end of 2021; we don’t anticipate a 4% unemployment rate until 2024.

However, there is a growing amount of evidence that the economy may have hit bottom in May.  It’s important to be cautious; the evidence for having hit bottom already is not definitive or bulletproof.  And, given the steepness of the economy’s decline versus how fast it will recover, production in June may still be lower than in May even if we’ve already hit the inflection point.

But the most important piece of economic news last week was that regular continuing unemployment claims declined 3.86 million to 21.05 million, the first drop since the end of February.  That’s still an astronomically high number compared to historical norms: the peak in the aftermath of the 2008-09 Financial Crisis was 6.64 million.

But, as we pointed out last week, recession typically end sometime between the peak of initial claims (late March) and the peak in continuing claims (possibly mid-May), so the deepest recession since the Great Depression looks increasingly likely to be the shortest, as well.

The news often reports the total number of people who have filed new claims for unemployment benefits, and the total is more than 40 million people in the past ten weeks.  But it’s not true that we have that many unemployed.  Some claims are fraudulent, and some people have been called backed to work.  It’s also true that the CARES Act widened the eligibility for benefits, making them available to some business owners, self-employed workers, independent contractors, and others.  Including all these categories of unemployment benefits, the total number receiving benefits is closer to 30 million from the start of the crisis, not the oft reported 40.

One problem that will impede the pace of the recovery is the unusual generosity of unemployment benefits.  A recent paper from the University of Chicago shows that 68% of workers who are eligible for unemployment checks are getting benefits that exceed their lost earnings, and that half of those getting benefits are receiving at least 34% more than their lost earnings.

Despite these hurdles, green shoots continue.  TSA says 268,867 passengers went through security on Saturday, up 39% from two weeks ago and up 187% from the worst Saturday, which was April 11.  Motor vehicle gas supplied is up 24% from a month ago.  Yes, these numbers are still down substantially from a year ago, but a recovery has to start somewhere.

And whatever your thoughts on the recent social upheaval – ranging from legitimate and peaceful protests by law-abiding citizens, to looting by criminals and riots instigated by junior wannabe-Bolsheviks – it’s going to be hard in the weeks ahead for governments to enforce stricter lockdowns than people are willing to voluntarily observe.  In turn, that could foster the further growth of the green shoots we’ve seen already.   

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist          

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Signs of Economic Life

May 27, 2020

This year’s experiment with government-imposed lockdowns has been a fiasco.  We should have been focused on sealing-off nursing homes and limiting mass indoor events, while the vast majority of businesses that were shutdown could have kept operating, with natural social distancing.

Now, as most people (those that are not elderly or immuno-compromised) realize their health risk is lower than earlier hysterics suggested, and as states loosen up on government-imposed restrictions, green shoots of economic life are appearing.  Rail car traffic, hotel occupancy, motor vehicle gas purchases, and air travel are all still down substantially from a year ago, but all have also moved off their lows. 

For example, US rail freight carloads are up 3.2% from a month ago, while hotel occupancy is up 9.0%.  Gas purchases are up 27.8% from a month ago, confirming what everyone already knew just from driving around.  The number of passengers passing through TSA checkpoints rose to 267,451 this past Sunday, versus a Sunday low of 90,510 on April 12, a near tripling of passenger activity.  Yes, this past Sunday was a holiday weekend, but last Sunday (May 17) was already up 180% from the low.

In order to tell whether the overall economy is starting to recover, we’re looking for confirmation from unemployment claims and federal tax receipts.  The bad news is that new claims for unemployment insurance remain at extremely elevated levels.  However, new claims are down substantially from the 6.9 million filed in the last full week of March, we suspect some portion of new claims are fraudulent, and that some recent new claims reflect a backlog from people who lost their jobs in prior weeks.  Typically, the average level of initial claims for a month peaks two months before the economy hits bottom.  April looks like it was the highest month for initial claims, which signals an economic bottom should come in June.   

What is also exceedingly clear is that this recession is not like previous ones.  So, we’re also watching continuing unemployment claims, which keep rising.  Typically, these peak around one month after the economy hits bottom.  So, if they peak soon, that’s a very good sign the economy is already growing again.  Unfortunately, continuing claims haven’t peaked yet, and probably won’t do so until at least June.        

Another way to assess the overall health of the economy is by monitoring the daily flow of income and payroll tax receipts the federal government is getting through withholdings from paychecks.  Using tax receipts to figure out economic trends can be tough, as withheld amounts are volatile from day to day, with big effects based on the day of the week as well as the day of the month.  And the pattern of the days in a month changes from year to year (for example, how many Mondays each month has), making comparisons that much tougher.

However, the calendar from 2015 closely resembles the calendar for 2020.  Ten of the twelve months have the same number day on the same day of the week (leap year in 2020 means January and February are different), making comparisons much easier.

And what does it show?  In the first three months of 2020 (January through March), withheld income and payroll tax receipts were up 19.7%.  That’s roughly what we’d expect given economic growth and inflation from 2015 to 2020.  But receipts in April 2020 were up only 2.6% versus April 2015, showing how economic activity fell off a cliff.  The good news is that, so far in May (through the 21st), these receipts are up 2.9% versus May 2015.  That’s less bad than the April comparison, and “less bad” signals more economic activity.

The recession started in March and is the deepest since the Great Depression.  However, it may also be the shortest.  A full recovery is a long way off.  We won’t see the level of real GDP we had in late 2019 again until late 2021.  We might not see an unemployment rate below 4.0% until 2024.  With every passing day, the lockdowns take an increasing toll; the sooner they end, the better.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist   

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How Are We Going To Pay For All This?

May 18, 2020

The largest federal budget deficit since World War II came back in 2009, as slower growth and increased government spending during the subprime-mortgage financial panic pushed the deficit to 9.8% of GDP.  This year’s the budget deficit will, quite simply, blow that record out of the water.

The Congressional Budget Office recently totaled up all the legislative measures taken so far – as well as the effects of a weaker economy (payments for unemployment benefits would be going up even with the recent law) – and they estimated this year’s budget deficit at $3.7 trillion, which they forecast would represent about 18% of GDP.

As if that weren’t enough, the House of Representatives just passed a bill that would add another $3 trillion to the debt.  Although a detailed year-by-year cost estimate isn’t yet available on the spending provisions, and the bill is dead-on-arrival in the Senate, which isn’t going to rubber stamp that proposal, it’s likely Congress and President Trump will end up compromising on some sort of additional measures that drive the deficit even higher.  As a result, we’re guessing the budget gap for the current fiscal year ends up closer to $4 trillion, or about 20% of GDP, the highest since 1943-45.

Given the economic crater generated by the Coronavirus and related shutdowns, as well as the heavy-handed legislative response, budget deficits will be enormous in the years ahead, too.

In spite of these sky-high numbers, it’s important to recognize that the US government is not about to go bankrupt.  The debt, while large (and growing), remains manageable.  Before the present crisis, the average interest rate on all outstanding Treasury debt, including the securities issued multiple decades ago, was 2.4%.  Now, our calculations suggest newly issued debt is going for about 0.25%, on average, which applies to both the recent increase in debt as well as portions of pre-existing debt coming due and getting rolled over at lower interest rates.

When debt that costs 2.4% gets rolled over at around 0.25%, that’s a great deal for future US taxpayers.  The problem is, the Treasury Department has been decidedly stubborn about not issuing longer-dated securities – think 50 and 100-year bonds – that would allow taxpayers to lock-in these low interest rates for longer, making it easier to spread out the cost of the extra debt incurred throughout the crisis.

As a result, if (or more like when) interest rates go back up, the interest burden generated by the national debt could go up substantially.

The best move the Treasury Department could make would be to use the recent surge in debt to overhaul the kinds of securities it issues.  One idea that deserves exploring is replacing all securities with a maturity of over, say, 2 years, with “perpetual” or “interest-only debt.”  No principal would ever have to be paid on these instruments; they’d just pay the same nominal amount of interest twice per year.  If we want to mix it up a bit, some debt could pay interest with gradual adjustments for inflation, just like TIPS.

This is not a new idea.  The British issued perpetual bonds starting in the 1750s, and the last ones were retired in 2015.  And although they’re called “perpetual” bonds, and they’re not callable, the Treasury Department could always buy them back at market prices to retire them.

Liquidity should not be an issue.  Every time the government needs to issue longer-dated securities, it could simply re-open that very same security.  Then the private sector could slice and dice them, on demand.  If someone needs a 10-year zero-coupon Treasury note, just take the interest payment due in ten years and package that into a stand-alone security.  Want something like a traditional 30-year?  An investment firm can package a stream of interest payments over the next 30 years and tie it to a big package of payments due in exactly thirty years.

But it’s not only the debt generated by recent fiscal measures that will burden future generations.  Overly generous unemployment benefits are disincentivizing many unemployed workers from re-joining the labor force, which slows the process of accumulating skills.  Widespread government-mandated closures also hinder skill-formation, as well as risk destroying some (or all) of the know-how embedded in business’s operations.

Yes, the debt is a burden on future taxpayers.  In this way, the fiscal response magnifies the effects of other responses to the Coronavirus.  So far, the age of the typical person who has died with the virus has been about 80 years old.  Right or wrong, our government – and society in general – has taken enormous measures to contain the virus to save the lives of our elderly population, and these moves have imposed enormous costs disproportionately borne by the younger generations who are out of jobs, school, and business opportunities. The very same group who will be paying the costs well into the future.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist      

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S&P 3100, Dow 25750

May 12, 2020

In December 2018 with the S&P 500 at 2,500, we forecast it would hit 3,100 by the end of 2019 and then pushed our forecast to 3,250 as stocks soared.  The S&P 500 rose 28.9% in 2019 and hit that revised target on the first day of trading in 2020.

We then raised the target to 3,650 for the end 2020, and the way stocks were moving higher in January and February made that forecast look reasonable.  But then the world took a detour into the Coronavirus Contraction.  As a result, we are adjusting our year-end 2020 target down to 3,100, with the Dow Jones Industrials average finishing at 25,750.  That would be a moderate gain of 5.8% from the Friday close.

The range of plausible outcomes for the rest of 2020 is very wide right now.  Key variables include factors that are normally irrelevant to forecasting markets such as the spread of the Coronavirus, how quickly the economy opens, the development of therapies or a vaccine to fight the disease, and how quickly people are willing to go back to normal.

With the economy getting crushed, some analysts are wondering how equities could have bounced so hard from the March lows.  We understand their confusion.  With unemployment likely above 15% and real GDP falling roughly 30% in Q2, how can equities be doing so well?

One key to understanding this is that investors don’t buy shares of GDP, they buy ownership stakes in a distinct set of companies, many of which are doing quite well despite the general economic carnage.

Imagine a company that has a major competitor nearby.  One day, completely out of the blue, the competitor’s facilities are all destroyed by a meteor.  Obviously, no one would celebrate this catastrophe.  However, when competitors go away the enterprise value of the surviving company rises, and you don’t have to be an astrophysicist to figure that out.

In many ways, the spread of the Coronavirus has given larger well-capitalized companies, particularly technology companies and big box stores that were allowed to stay open, an advantage over Main Street competitors.  And unlike Main Street businesses, a larger share of these companies are publicly traded.

Meanwhile, our capitalized profits model for equities, based on profits and interest rates, suggests a 3,100 level for the S&P 500 would not be overvalued.  To put this in context, a 3,100 level assumes that profits fall by 60% AND the yield on the 10-year Treasury Note climbs to 1.25%.  We forecast profits will fall about 25% this year and the 10-year Treasury will rise to just 0.9% by year-end.  In other words, even at 3,100 we believe the S&P 500 will still be undervalued.  And with profits rising in 2021, we think the S&P 500 can then rise to 3,650, a year later than we originally forecast.     

One reason to be bullish on equities is that these days Quantitative Easing by the Federal Reserve is going straight into the M2 money supply and not into excess reserves.  In the past three months, M2 has climbed at a 66% annualized rate, the fastest rate we know of in history.

Meanwhile, the federal government has ramped up deficit spending (with unemployment insurance and loans/grants to small businesses) to try to offset private-sector losses in income.  Regardless of what we think of these policies, the effect will be to support equity prices in the year ahead.         

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist   

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Light at the End of the Tunnel

May 4, 2020

When the employment report for April is released this Friday, the economic damage from the deepest of the Coronavirus shutdowns will become clear.  We estimate that nonfarm payrolls will be down roughly 22 million versus March, and the unemployment rate will skyrocket to around 17.0%, the highest reading since at least 1948.

To put that in perspective, during the subprime-mortgage panic of 2008, payrolls declined 8.7 million over a 25-month period.  Now, it looks like we lost almost three times as many jobs in just one month.  The highest unemployment rate since the wind-down from World War II was 10.8% at the end of the 1981-82 recession.  The jobless rate peaked at 10.0% after the Great Recession.

Unfortunately, we expect the unemployment rate to be even higher in May, and it is very difficult to believe that $2.5 trillion in government spending offset more than 50% of the damage.  We hope we are wrong about that, but promising money to companies for payroll expenditures – but then not allowing them to open or letting them open at only 25% capacity – will not save many restaurants or bars.

While the economic damage is horrific, there are some positive signs.  While 30 million workers filed for unemployment benefits in the past six weeks, those currently receiving benefits (what are called “continuing claims”) are up a smaller 16 million in the first five weeks of that period and will be up around 20 million for the full six-week period.  Yes, that’s still awful, but it tells us that the Payroll Protection Plan and areas of actual job creation, such as online retailing and delivery services, are offsetting some of the damage.

This kind of job destruction will be accompanied by a very large decline in GDP.  We’re estimating a contraction at a 30% annual rate in the second quarter.  But everyone already knows that.

We won’t get that data until late July, and by then we expect the economy to be expanding, albeit from a low base.  In fact, we already see some light at the end of the tunnel.  During the week ending Saturday May 2, 939,790 passengers went through TSA checkpoints at airports.  That’s up 26% from the prior week and up 40% from two weeks ago.  The amount of motor gasoline supplied has grown three weeks in a row, and is up a total of 16%.  Hotel occupancy and railcar traffic are both up from a month ago.  These high-frequency data will give a clearer read on the pulse of the economy as we gradually reopen.

Yes, activity is still down substantially from year-ago levels, or even those in January, but we are beginning to see signs of life.  It’s a sign that the animal spirits are not dead.

Anyone who ventures outside will notice more cars on the road and more activity, including in businesses that are still required to be closed to the public but are preparing for clearance to re-open.  Many researchers are using cell-phone location data to track the movement of people.  For example, Apple looks at “routing requests” on map applications.  In mid-April, both walking and driving requests were down roughly 60% from January 13th.  As of Saturday, walking and driving requests were only down 29% and 16%, respectively.

As we noted last week, we will continue following “high frequency data” like those above.  This recession will be brutal, the worst of our lifetimes.  But it is not a normal recession, and it will also be short.  Investors should keep in mind that, although the weeks ahead will be tough, there are better days beyond them.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist             

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GDP: Bad, And Getting Worse

April 29, 2020

Before the Coronavirus, the US economy was cruising for what looked like 3% annualized growth in real GDP in the first quarter.  But the effects of both natural social distancing and government-mandated lockdowns crushed economic growth in March.

As a result, we now think real GDP contracted at a 3.7% annual rate in Q1, led by a massive drop in inventories as well as declines in consumer spending, business investment in equipment, and commercial construction.  That 3.7% is not set in stone, however.  We’ll get some reports on inventories and international trade on Tuesday morning, and may refine our forecast then.  Either way, it’s going to be bad.

But the second quarter, which we’re already in, is going to be worse.  How much worse?  Put it this way: Since 1947, the worst quarter in our history was a 10% annualized drop in the first quarter of 1958, on the heels of the Asian Flu.  In the current quarter, real GDP is likely to drop at about a 30% annual rate, rivaling declines last seen during the late-1945 wind-down from World War II as well as the Great Depression.

We also expect an unemployment rate that flirts with 20%, compared to highs of 10.0% in the aftermath of the Great Recession in 2009 and 10.8% at the end of the brutal 1981-82 recession. 

The key for investors to remember is that none of this is going to shock anyone; the markets already know it’s going to be awful.  Instead, investors need to focus on how quickly we are going to recover, which will depend on finding ways to carefully ease lockdowns, the virulence of the Coronavirus in the months ahead, the timeline for developing therapies, and, ultimately, the timeline for developing a vaccine.     

In the meantime, the loss in output is going to be huge.  Real GDP for all of 2020 will be about 5.0% lower than 2019, versus the roughly 2.5% higher it would have been in the absence of the Coronavirus.  In turn, federal revenue will be down, and would have been lower even in the absence of recent policy changes, like the IRS sending out checks for $1,200 per adult and $500 per child, as well as delays in employers paying their share of payroll taxes.

The Congressional Budget Office recently updated its forecast for the budget deficit for the current fiscal year (ending September 30) and expects it to be about $3.7 trillion, or roughly 18% of what we estimate to be fiscal year GDP.  To put that in perspective, the budget deficit hit 9.8% of the GDP in 2009 and the deficit peaked at 29.6% of GDP in 1943.

In the months ahead, investors should focus on two key pieces of macro-data.  First unemployment claims.  It looks like initial claims peaked at 6.9 million the week ending March 28 and have since declined three weeks in a row, to a still humongous 4.4 million the week ending April 18.  However, continuing unemployment claims are still rising every week and will likely keep doing so for at least another month.  Watch continuing claims carefully: we expect a peak in continuing claims, whenever it happens, to signal the bottom for the recession.            

Second, we’re following the federal government’s receipts for withheld income and payroll taxes, which are reported daily.  Those are down around 10% from a year ago, but are very volatile from day to day.  We’re waiting for that year-ago comparison to hit bottom and then start getting less bad, which would suggest an economic bottom, as well. 

In addition, we’ll be following reports on auto sales, hotel occupancy, passengers going through TSA checkpoints, gas purchases, railcar traffic, and steel production (we update this every Thursday on our blog here).    

What investors need to keep in mind is that when they invest in stocks, they’re not buying shares of GDP; they’re buying shares of specific companies that offer an always changing flow of goods and services.  We think the worst news is already factored in.  Investors who can grit their teeth through the economic pain should be rewarded in the years ahead.    

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist         

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The Economy, Inflation, and Interest Rates

April 21, 2020

With each passing week, the economic damage wrought by the Coronavirus and the resulting shutdowns grows larger.  It’s not just businesses, both small to large, feeling the pain. Educational institutions, hospitals, churches, not-for-profits, and state and local governments are all finding it hard to remain financially viable.

The US has essentially turned off broad swaths of the private sector – the ultimate and only source of income and wealth creation.  Without the private sector, there is no money to pay for government, schools, healthcare, or charitable organizations.  To make up for it, the US has resorted to an open-ended expansion of the Federal Reserve’s balance sheet (and expanded their power) and huge increases in government borrowing and spending, the likes of which the US has never seen outside of wartime.

As in 2008, many are worried that huge increases in Quantitative Easing and money growth, along with the purchasing of debt directly from the market, will lead to much higher inflation.  However, for today, that doesn’t appear to be a problem.  The consumer price index (CPI) fell 0.4% in March and is up only 1.5% from a year ago.  This morning, West Texas Intermediate (WTI) oil was trading at $11 per barrel, the lowest level since the late 1990s, and 64% lower than its March average of $30.45.  This suggests another negative number for the CPI in April.          

But the drop in measured consumer prices in March was not just driven by lower energy prices.  Other factors included lower prices for hotels, airline fares, and clothing.  What do all these categories have in common? A massive drop in customers due to the shutdown. 

Sure, hotels are cheap today, but almost no one is using them; hotel occupancy rates are down about 70% from a year ago.  Yes, anyone who flies can get cheap seats, but the number of people going through TSA checkpoints is down 96% from a year ago.  Clothing prices fell 2% in March as sales at clothing & accessory stores fell 50%.  Who had time to buy clothes when you had to stock up on groceries and toilet paper?!?

In other words, prices for the actual items people bought in March probably did not fall as much as the CPI report suggested, and the same argument will probably apply to April, as well.  Bottom line: in the near term, while it may look like deflation, that’s not true for the average consumer.

As we look further out, official measures of prices will eventually turn back up.  We see multiple broad forces at work on consumer price inflation, which should prevent us from lurching into either high inflation or Great-Depression-style persistent deflation.

Obviously the Fed’s actions will boost various measures of the money supply. And the unusually generous unemployment benefits for many workers who have recently lost their jobs means those businesses that are trying to ramp up production will have to offer higher wages than usual to attract workers, which could feed through to higher end-prices.       

However, in spite of these reasons to fear higher inflation, there is one big reason to avoid fearing hyperinflation: the demand for holding money balances, by both individuals and companies, is going sky high.  The precedent of shutting down the economy will make cash King.  That’s the only way to survive.  So, yes, the money supply will be much higher, but velocity will be much lower; people will hold cash dear.   

While we think inflation measures will head back towards 2% – 2.5% in 2021, not much different than where they were immediately prior to the Coronavirus, hyperinflation is unlikely. 

Interest rates will go up eventually, too, but don’t expect a sharp rebound.  After the Great Recession, the Fed didn’t raise short-term rates again until late 2015, when the unemployment rate hit 5.0%.  After the expected spike in joblessness in the next couple of months, it’ll be a long time before we get back to 5.0% unemployment.  Meanwhile, having witnessed two massive recessions in a row, investors will place an even larger premium on safety and risk-aversion than they have for the past decade, which will hold the 10-year yield down relative to the economic fundamentals we’ll see in the eventual recovery.

We’ve never seen an economic shutdown like this before.  The ability of people and government to panic like this changes nearly every economic calculation.  For inflation, there are forces going both ways.  Only time will ultimately tell.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist      

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Job Destruction

April 14, 2020

Normally, we’re not big fans of enhanced unemployment benefits.  But the current severe economic contraction brought about by the Coronavirus and the government-mandated shutdowns of businesses meant to stop the disease is a completely different animal from a normal recession.  It’s not just that people are staying away from certain economic activities because of the virus: the government is requiring businesses to shut down, magnifying job losses across the country. 

Initial jobless claims averaged 216,000 per week in the four weeks ending on March 7, before the shutdowns.  That’s a total of 863,000, which was very low by historical standards, particularly relative to the size of the labor force.  In the four weeks since then, 17.1 million workers have filed claims, blowing away previous records.

Many of these layoffs were the direct result of the government forcing businesses to shut their doors.  When people are being deprived of their livelihoods by government fiat it resembles a “taking” under the Fifth Amendment of the US Constitution.  In this unique situation, unemployment compensation resembles a “just compensation” for that taking.

The problem is that the boost to unemployment benefits enacted by Congress is over-kill for many workers, leading to perverse incentives.  For example, let’s take a worker in California earning $46,700 per year.  Normally, a layoff would give them six months of unemployment benefits at a rate of $450 per week, which is an annual benefit rate of $23,500, about half of what they were earning when they worked. 

But Congress is now throwing in an extra $600 per week for unemployed workers, for four months.  That means for four months these workers will get $1,050 in benefits per week, which translates into an annual benefit rate of $54,600, which is even more than they were earning when they were working!

Because the extra $600 is a flat extra benefit, the gap between what unemployed workers can get now versus what they were earning when they worked is even larger for lower-earning workers.  And it’s not just deep-blue states like California.  In Texas, for example, unemployed workers who previously earned up to $58,000 per year will be better off unemployed, at least for the first four months.   

Yes, as we’ve noted the extra benefits only last for four months.  But it’s hard to believe there won’t be enormous political pressure to extend the length of those extra benefits come the summer when they’d otherwise expire.  After all, the unemployment rate is still likely to be 10% or more.        

Now think of what this means when we re-open the economy.  Some workers will go back to work because they might fear their job disappearing if they hold-out.  But many won’t want to give up the higher payments and businesses will now be competing with government for workers at the same time they’ll be digging out of a huge financial hole.  In fact, many low margin businesses may not be able to afford those higher wages.  Don’t get us wrong; we like faster wage growth; what we don’t like are government policies that create perverse incentives to avoid work once it becomes more available.

If wages go up because of bad policies that will leave less room for businesses to hire, leading to a more prolonged surge in unemployment and a slower return to the standard of living we had before the virus struck.

Early in the Great Depression, the Hoover Administration urged companies to maintain wages in spite of deflation.  The idea was that if wages were kept high workers would have more purchasing power, boosting output.  But workers who kept their wages were already getting a boost from falling prices.  Meanwhile, firms that kept wages high wouldn’t hire new workers.  It made the Depression worse, not better.  By boosting unemployment benefits, the government has put businesses in a position where they have to boost wages, indirectly making the same mistake as President Hoover.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist       

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Do the Least Harm

April 7, 2020

Doctors think differently than economists.  They put patients with a potential for brain damage in an artificial coma to stop swelling, and when it stops, they bring them out.  This fits with the Hippocratic Oath all doctors take, which states “First, do no harm.”  The idea is to “limit” damage and then “restart” a more normal body with fewer problems.

The economy doesn’t work that way.  You can’t just “turn it off” and then “restart it” as if nothing happened.  When you turn off an economy you create permanent damage.  While this is impossible to prove – there is no precedent in history from which to judge – it is easy to surmise.

We have all heard news stories about small business owners (or know them ourselves) who have been moved to close their businesses for good.  They will never re-open.  Some studies say the median small business has enough cash to last less than a month.  That’s the median.  And there are 30 million small businesses.

Shutdowns of restaurants and bars started in mid-March, and now cover most of the United States.  These shutdowns spread to “non-essential” (as deemed by government) businesses over the past month.  It is now April.  In other words, many of those 30 million small companies are already in serious trouble.  Many will be forced to close their doors for good before this is all over.

Simply put, shutting down the economy has serious consequences.  If the economy were to reopen by Easter, which seems impossible now, it would probably open with, at most, 97% of its original capacity.  It’s like a muscle, without use it atrophies.  And when it does, it needs physical therapy to recover.  The longer it’s sedentary, the worse the atrophy, the more difficult (and painful) the recovery.

If we wait until the end of April, it will be, say, 92%.  The end of May and it’s 85%.  The end of June and it’s even less.  These are just guesstimates, we know that, but it’s what we think is the right framework to look at things.  The longer the shutdown lasts, the more permanent damage to the economy.  Capacity would eventually come back, but it would take time, perhaps years.  Businesses that had just the right mix of managers, workers, and suppliers, can’t just magically re-create that mix by snapping their fingers when this is done.  The US economy is not Sleeping Beauty, ready to wake up at first kiss by the government.           

During the Great Depression, the suicide rate in the US hit the highest level in history.  Recessions are traumatic, both physically and emotionally. Anxiety and depression multiply the problems of being jobless. The consequences are very real, though often hard to track.

The faster the economy opens again, the less the long-term damage.  But this would mean government has to do a cost-benefit analysis of economic damage as well as the health costs of Coronavirus.  So far, that’s not happened.  It’s time government set up a Coronavirus Economic Task Force. 

It’s true that $2 trillion in government bailout money, and trillions more from the Fed, will blunt the damage.  But it won’t stop the atrophy.  It just slows it down.  More importantly, it significantly grows the power of government.  It also boosts demand for goods, while the shutdowns artificially hold back supply, which causes inflation because demand exceeds supply.

One thing to remember is that even leaving parts of the economy open – grocery and drug stores, gas stations, restaurants for take-out, etc. – risks spreading the virus.  So, by choice, we are already taking risk.  Let’s expand that risk assessment and take into account all the risks, including the economic ones.

Things need to change.  Why can’t landscapers work?  Construction crews in many states are still working.  Why can’t factories or machine shops that normally produce 8 hours a day, go to 24-hour production schedules – three, 8-hour shifts with fewer employees?  If I can pick up food, why can’t I eat somewhere 6 feet away from others?  There have to be a million ideas.  Let’s start thinking about them, because the costs of the shutdown must be balanced with the benefits. It may not be possible to “do no harm” in the response to this pandemic, but we can at least try to “do the least harm.” 

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist     

Approved For Public Use

The Coronavirus Threat

March 31, 2020

Total deaths in the US from COVID19 look like they’ll hit at least 3,000 by the end of March.  A potentially brutal April lies ahead.

In the meantime, the measures taken to limit deaths have temporarily tanked the US economy.  Initial claims for jobless benefits soared to 3.283 million per week, easily the highest ever.  The prior record was 695,000 in October 1982; the highest during the Great Recession was 665,000.

Policymakers have reacted to the economic damage with massive measures.  The Federal Reserve has reduced interest rates to nearly zero, has begged banks to use the discount window, embarked on unlimited quantitative easing, and is backstopping an unprecedented array of markets, including commercial paper, money markets, commercial mortgages, and municipal securities.

Meanwhile, we have a newly enacted “stimulus” bill that could total $2 trillion, possibly more.  These include IRS checks, a major expansion in unemployment benefits, as well as a broad combination of grants, loans, and loan guarantees for businesses (large and small), hospitals, schools, and state and local governments.

The federal budget deficit for this fiscal year, previously estimated by the Congressional Budget Office to be about $1.1 trillion, could easily run around $2.5 trillion, and that’s without other major spending bills.  Since World War II, the largest budget deficit relative to GDP was 9.8% in 2009; but a $2.5 trillion deficit this year could be about 11.8% of GDP.

Of course, these monetary and fiscal measures are on top of the massive economic interference – designed to stem the virus -by governments at all levels.  The longer these measures persist, the greater the risk of atrophy setting in for small business across the country, making them less able to reopen in the future.  The loss of intangible capital would be enormous, the internal knowledge of how to get things done.  Slower economic growth in the post-COVID19 world would be the result.

It’s important that the expansion of government is not made permanent.  The New Deal took annual federal spending from about 3% of GDP to about 10% of GDP (before World War II) and we never went back, or even close.  Policymakers need to avoid making COVID19 an excuse for another permanent leap upward in the size of government, which would erode future living standards versus where they would otherwise go.

Once we have a vaccine, some things have to change.  Governments at all levels should consider “strategic health reserves” of masks, ventilators, respirators,…whatever is needed in an emergency, so we don’t have to take drastic measures again.  Our recent response should not be a periodic feature of American life.

Dr. Fauci recently said there could be 100,000 – 200,000 deaths.  The mid-point would be 47 people per 100,000 residents, not much different from the number of people the US lost to the flu in early 1953, late 1957, early 1960, the peak of the 1968-69 Hong Kong Flu, or early 1976.

Those episodes didn’t permanently expand government and neither should this one.  In order to be better prepared in the future, we need a vibrant private sector, not a permanent expansion in government.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist                  

Approved For Public Use