Economists debating the economic impact of the current pandemic can sound like they are on Sesame Street, and it’s “The Letter of the Day.” The Cookie Monster says V is for V-Shock: a sharp recession and a sharp rebound, with an immediate return to our voracious appetite for rising production and consumption. Elmo rides a W, the waves of economic contraction and recovery resulting from the resurgence of Covid-19 contagion in the fall. And last but not least, Oscar the Grouch presents the letter L: a plunge into depression followed by stagnant growth.
No matter the letter of the alphabet, there are two lessons we need to learn. The first is that growth, or ever-increasing output of goods and services, is a questionable standard to judge our economic health. We must interrogate the real value of the letters GDP. The second is that a resumption of exponential growth assumes that we entered the pandemic with a healthy economy, which is simply not true.
The dire economic consequences we find ourselves in are the result of two simultaneous events: a supply shock and a demand shock. Covid-19 shut down production and most services, while also radically diminishing consumption due to the global lockdown. The letter of the day is supposed to illustrate the impact of these events on our economic growth going forward.
Some economists see another use for V: for victory, thanks to swift monetary and fiscal policy interventions. The US Federal Reserve and the Treasury Department are providing liquidity in core markets by cutting rates, increasing US dollar swap lines with central banks, purchasing Treasury and corporate securities, introducing facilities to support the flow of credit, and establishing both the Paycheck Protection Program (PPP) and the Main Street Lending Program for small- and medium-sized business. Additionally, the CARES Act mobilizes about $2.3 trillion for expanded unemployment benefits, tax rebates, corporate grants and loans, and Small Business Administration (SBA) loans. The goal is to keep payrolls intact so that when the pandemic subsides, we are back at work. We return to growth: an ever-increasing GDP.
Will we return to work? We now have unprecedented unemployment rates, which reflect only claims that have been processed and don’t include those who are no longer seeking jobs. Will these masses of unemployed people be rehired by small and medium businesses? The PPP ensures that, if businesses don’t lay off workers, Congress will pick up payroll, rent, and utilities for eight weeks. But it’s important to note that the PPP loans are forgiven (they become grants) only under certain conditions. Otherwise, they must be paid back. Business owners struggle to access the funds, and while the money covers payroll, it doesn’t solve the problem of zero revenue.
The Main Street Lending Program, intended as a complement to PPP, is even more stringent. First, it’s a loan, not a government transfer. Second, borrowers need to demonstrate that they have no alternative sources of credit and that their business model is viable after recovery from the pandemic. But how can they know that? (Unless you’re a small Zoom operation). And that risk is coupled with the fact that, unlike for PPP, this program is partially backed by the Treasury, which means that the banks aren’t just conduits for transfers, they underwrite the loans and retain some (albeit limited) risk on their balance sheets.
Even before the present shutdown of the economy, most small businesses didn’t have sufficient liquidity to cover two weeks of expenses. That means these provisional loans and grants are Band-Aids, not cures. They might cover payroll expenses for a limited time, but they won’t make these already cash-strapped businesses financially viable in an environment of vastly reduced consumption. And they likely won’t stave off eventual loan defaults and bankruptcies.
And then there are large corporate firms. They need an IV drip. US corporate debt was already at record levels (47% of GDP) prior to the pandemic. Jerome Powell, the Fed’s Chair, flagged this looming risk almost a year ago. Low-interest rates have led investors to seek high yields and hence to take on riskier assets. And that risk extends through financial intermediaries, such as money market mutual funds, hedge funds, and non-bank mortgage servicers. This funding activity is known as “shadow banking.” It is has grown globally by 75% since the end of the Great Recession.
Covid-19 hit this wall of illiquid debt. The Federal Reserve is now backing investment-grade corporate bond issuance and purchasing corporate debt. But it is also making the unprecedented move of buying low-rated bonds, including what we call junk bonds, which are highly leveraged and carry high risk. This corporate risk ends up on government balance sheets, but the Fed’s bond purchases don’t improve the quality of the debt, which is still junk or is subject to credit downgrading in the current environment. This makes the Fed not just a “lender of last resort,” providing liquidity, but also a “participant of last resort.”
This raises bigger, long-term questions. What debt is viable? How will it be valued or priced? The Boston University economist Perry Mehrling says that answers to these questions aren’t about providing liquidity to wait out the pandemic. The future shape of the economy will become clear as assets are repriced globally. This will happen through the reallocation of productive capacity. The pharmaceutical industry, for example, will likely be “on-shored” to domestic production and distribution. And this repricing will occur through the massive devaluation of assets. This is most obvious in the airline industry, which in turn affects a whole global supply chain, including aircraft engine manufacturers and high-tech suppliers of critical components.
Supply chains aren’t just dormant, waiting for orders to reignite by the spark of pent-up demand. They will be dramatically reorganized through the on-shoring of vital industries and concerns for the integrity of things like our food and drug supply. This reallocation of assets and production will mark a sea change in industry—Before Coronavirus (BC) and After Coronavirus (AC), as Mehrling puts it. “Businesses and business models that were great BC may not be so great AC, and businesses and business models that did not even exist BC may be great AC.”
In other words, the post-Covid future can’t be appreciated using pre-Covid models and modes of valuation. It will be shaped by long-term obligations instead of high-risk/high-reward strategies or stopgap measures that merely shift risk and debt between balance sheets. And it’s probably hard to appreciate that long-term horizon through a snapshot of the economy in the form of letter of the alphabet.
The current protracted recession is often presented as the letter V. But it’s also described as the “biggest economic disaster since the Depression.” That’s an L. We all know that a V is not an L. And the Letter of the Day isn’t an answer to the most important questions: who will bear the economic losses and when will that happen? We might come to decide that the gauge of economic health must be represented in terms other than productivity growth. But that’s not a part of our current vocabulary. We still don’t have the letters for it.
Janet Roitman is a professor of anthropology at The New School for Social Research and Eugene Lang College.