A Financial Crisis Caused by Natural Disaster is Different - COVID19
Like you, I have been trying to make sense of the speed with which the economy, the market and our health have all seemed to have disintegrated so quickly in the last month. Also like you, I am stuck at home and have spent way more time than usual watching the news and talking to family and friends. Given that I am in the investment industry, as you would expect, I have been getting a ton of questions about the financial crisis aspect of COVID19.
I found myself having the same conversation with investors over and over again. I thought I would share it in the hope that it helps others make a bit more sense of what is taking place in the economy and financial markets. I don’t hold this out as being right or the ultimate truth. I am just attempting to recognize some patterns from past financial crises, and hopefully using those patterns to help make decisions during this one.
Every financial crisis is unique. However, all financial crises have patterns that are repeatable and recognizable. This financial crisis is unfolding in the pattern of a natural disaster. The Great Recession financial crisis unfolded in the pattern of a banking crisis. There is a difference and it is meaningful enough to understand. The difference between the two can meaningfully dictate what a recovery could look like, and how long a recovery could take. Understanding the difference can help inform our thinking and actions.
All natural disasters destroy the economy for a limited period of time
To state the obvious - what we are experiencing now is a disaster. In any disaster lives are lost. This happens in manmade disasters like war or terror incidents. It happens as well in natural disasters such as hurricanes, floods, fire, earthquakes, etc. In this particular case the disaster was brought on by a global virus. Most disasters are limited to a specific geographical area. This crisis is different in that the crisis is taking place globally.
With respect to economics, almost all disasters have one thing in common – job losses. When a disaster strikes, the economy in the disaster zone immediately shuts down. The supply of normal goods or services - restaurants, home goods, services, etc. – all go away. At the same time, consumer demand for normal goods and services also immediately goes away. Of course, I am not talking about goods necessary for survival. Here I am referring to the normal goods and services routinely exchanged under normal economic conditions. Therefore, during a disaster, both the supply of and demand for consumer goods and services ceases to exist.
That is what is happening right now. The COVID19 disaster struck, and the government immediately closed all businesses. This effectively shut down both the demand for and supply of routine goods and services. As you would expect, a financial crisis has ensued.
There are recognizable patterns from past natural disasters that we can look for here. In every natural disaster, both the supply of goods and services and the demand for goods and services are kept at a very low level for a specific period of time (depending upon the disaster). However, once the immediate effects of the natural disaster pass, activity levels of both supply and demand tend to pick up quite rapidly.
This happens because both supply and demand are artificially forced to low levels by some outside force (natural disaster). Individuals are impeded from consuming goods and services for a period of time. However, once that artificial force is removed, individuals tend to ‘make up’ for that period of time in which they were unable to consume. You can liken it to a rubber band being pulled wide apart then snapping back quickly.
In many cases, just after a disaster, consumption levels quickly surpass the level just previous to the disaster. Disasters such as hurricane and flood often entail some level of material destruction. In those cases, infrastructure needs to be rebuilt and thus the demand for material goods and services surpasses previous levels. In the case of COVID19, there is no material and infrastructure destruction. However, there has been destruction in the ability to consume goods and services such as travel, hotels and restaurants (among many other things). I would suspect that once the danger of the disaster passes, individuals will greatly increase their consumption of these goods and services due to the pent-up demand.
At this stage of the crisis, I still think that a rather quick rebound in supply and demand of goods and services is the probable outcome for us. People want to work, consume and get out of the house. Businesses want to offer those services.
Strong economies tend to rebound quickly from natural disaster
In a natural disaster the greatest asset individuals and societies can have is the support and backing of a strong economy with abundant assets, labor and resources. The United States has all of these things. However, it is extremely important to help individuals and businesses emerge as quickly as is safely possible. Time is of the essence.
In past disasters (such as World War II, the 9/11 attacks, the San Francisco Earthquake) the United States was able to successfully and quickly rebound because it had abundant resources, abundant labor, and innovative businesses. Industry and economy helped the United States rebound from the loss of life and business that was caused by those disasters. Handled correctly, industry and economy have the ability to help us rebound quickly from this one as well.
However, the trick (and it is tricky) is to get the economy back up and running when it becomes safe again. Knowing when it is safe again is fairly obvious in disasters such as war, hurricane and flood. As we are finding out, it is not so easy to determine safety during a pandemic. Regardless, we have to try to figure it out.
Density seems to play a big role in this pandemic. Cities and states with a higher population density tend to be experiencing more serious effects of the crisis. Those with a lower density population seem to be weathering the storm better – at least at this stage (Yes, I realize that I am simplifying this).
As businesses come back online, I would suspect that density of workforce could come into play. A workforce environment with a less-dense workforce could theoretically get back up and running quicker. High-density workplace environments like bars and restaurants might take longer to get back into service.
I think it is pretty clear that all businesses will not get up and running at once. It will most likely be certain areas of the economy coming on at a staggered pace over the course of a few weeks or months. To make an analogy, it will not be like turning a light switch back on. It will be more like rebooting a computer in which certain systems come on first, followed by others.
Comparisons to the Great Recession (08/09) and Great Depression (1930’s) are inaccurate
Over the last few weeks, I have heard this financial crisis compared to the Great Recession (08/09) and the Great Depression (1930’s). All financial crises are painful, and they all contain levels of job losses. However, I believe that those comparisons are inaccurate. This is a very different financial crisis.
Both the Great Recession and the Great Depression were caused by systemic, long-term problems with the health of the banking system, the economy, and the business cycle. In both cases massive banking system problems arose due to the overuse of debt by both individuals and businesses. In the case of the Great Recession, it was a housing debt problem exacerbated by Wall Street derivatives. In the case of the Great Depression, it was overuse of margin leverage in the stock market accompanied by massive government policy mistakes. The policy mistakes exacerbated the job losses for years. In both cases, the banking and financial system went to the precipice of utter collapse.
That is not the case now – at least not at this stage.
However, this crisis has caused the instantaneous loss of millions of jobs. We did not experience that in the Great Recession (08/09). Because of that, it is only natural that people liken this to the Great Depression. This crisis is affecting everyone. Everyone is feeling discomfort and some level of displacement.
Yes, millions of jobs have been lost – and that is a disaster in and of itself. However, not a single business has failed today due to the overuse of debt or poor health of the economy. Businesses were forced to close due to a natural disaster. This is an important distinction. If past disasters can be used as a guide, in theory, most businesses will immediately open back up once the effects of the disaster pass.
We can rebound from disaster AND get back to work
Unfortunately, it IS possible for a financial crisis caused by disaster, to turn into a larger financial crisis caused by weaknesses in the banking system. That happens when there is permanent, long-lasting destruction of consumer demand for goods and services. To be sure, we are already experiencing levels of that. If we continue to keep the economy shutdown with no definite, planned, and stated date of return, we have a far higher likelihood of creating long-lasting damage to the economy. However, I believe that there is still time to avoid that.
In order to rebound from this disaster, our leaders need to avoid false, binary choices. Saying that we either need to get back to work and put lives at risk, or fully stay at home to avoid loss of life is a false choice. We need to be able to do both of those things. We have the ability to do both of those things.
I know people that have lost friends and family members. It is a disaster and tragedy for them. I know people that have lost their jobs and are facing financial ruin. It is a disaster and tragedy for them too. BOTH of these things are a tragedy. Getting people back to work and protecting people from harm are not mutually exclusive. We CAN do both of those things. We ARE smart enough to figure out how to do both those things. We are that good.
(C) Marc Patterson 2020
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