Strong Views Lightly Held

Placebos are powerful.  Until they aren’t.  Faith in the Fed’s trillions has sustained markets so far.  But the hard-dollar prop holding up the economy is the merely-billion-dollar flow of fiscal stimulus – especially expanded unemployment benefits.  With Congress likely to start turning those taps off in July, our collective delusion about the power of the Fed might not survive much longer.  Like the Cowardly Lion, Scarecrow, and Tin Man, we’ll have to find our way without our Wonderful Wizard of Oz.  That probably gets ugly before it gets better.

The Fed’s money can’t have juiced the markets because the money never touched the markets.  The Fed did create some $2.3 Trillion in new money. And yes the markets have responded as if that wall of money has hit them. But, outside of some swap lines with foreign central banks, that money has never circulated.  Bank lending has been tight.  The Treasury hasn’t drawn down their account. The Fed has made some promises to buy corporate bonds, but what they’ve actually spent has been inconsequentially tiny.  Most of the Fed’s money never left the Fed.  At least not in reality.  In our heads, however, the placebo effect has been massive.

The Man Who Overdosed on Placebo

Several years ago, a published case study describes a 26-year-old man who was taken to the emergency room. After arguing with his ex-girlfriend, he attempted suicide by swallowing 29 capsules of an experimental drug that he obtained from a clinical trial that was testing a new antidepressant. When he arrived at the hospital, he was sluggish, shaking, and sweating and had rapid breathing. His blood pressure was extremely low at 80/40, and his pulse was 110.

Doctors were successful at raising his blood pressure. Over the course of four hours, they injected him with 6 liters of saline solution. His blood pressure increased to 100/62, which is at the lower end of the normal range, but his pulse remained high at 106.

What finally cured the patient wasn’t anything the emergency room staff did. Instead, a doctor from the clinical trial arrived at the hospital. He told the patient that those antidepressant pills weren’t antidepressants because he had been randomized into the control arm of the trial. Yes, that’s right: He overdosed on placebos.

Oh.

Within 15 minutes, the patient’s blood pressure stabilized at 126/80, and his heart rate dropped to a perfectly normal 80 beats per minute.

We know the Fed’s “wall of liquidity” never hit the markets because we know it never left the building.  It hasn’t gone into the real economy.  It hasn’t gone into the Financial Markets.  It didn’t even make one round-trip.  It has just sat in the “Fed Savings Accounts” of the US Treasury and the banks.  They have just left it parked there.  Un-moved and un-moving.  The data in the article below are accurate up to mid-June…

So far, since March 11, the Fed has pumped in $2.3 trillion to the economy in new dollars. That is mostly QE (the blue column), with an additional $195 billion in loans (the facilities), offset by a reduction in repo of $163 billion.

Where is that $2.3 trillion? We know exactly where it is, because it is in only two places – bank reserves at the Fed, and the US Treasury’s checking account, also at the Fed. Together, these have risen $2.5 trillion, $180 billion more than the Fed’s liquidity injections.

All that has actually happened is that rates have gone down by a decent-but-not massive amount.  That interest rate cut is something.  It should/could boost markets.  But it is hardly a “wall of Fed money.”  Especially if the banks aren’t actually lending at those rates (or any other rate).  Low rates simply don’t explain enough.  Leaving us back at the Placebo effect.

You might argue “the Fed’s money is funding the Treasury’s various fiscal stimulus programs.”  But the Fed’s only role there is to create additional serial numbers for additional dollars already appropriated by Congress.  Going through the fiction of one arm of the US government printing up new serial numbers to exchange for IOU’s from another arm of the US government.  That is all just an internal accounting fiction within a single entity – the US Government.  The money thus created doesn’t “do” anything until it leaves the US Government and hits the real economy.  It hasn’t.

Moreover, that stimulus money flow isn’t some “trillion dollar wall of Fed liquidity hitting markets.”  It is a measly few-billion dollar dribble of monthly unemployment checks and business loans.  The increasingly maligned, at risk expanded unemployment benefits and PPP loan programs.  Plain vanilla fiscal stimulus.  Libtard Keyensian stuff.

In real-economy, real dollar terms, those few billion dollars of money flow are what is standing between us and disaster. If we all understood that reality, those benefits would be renewed (or raised) at the end of July.  But in our collective placebo-effect fantasy, the magical Fed is doing all the work.  The feckless Congress is just spending our hard earned money on undeserving layabouts who are “earning more on unemployment than they would by working.”  Ignoring some inconvenient facts.

1. Those checks are flowing straight through those people’s bank accounts into rent payments, car payments, mortgage payments, and retail spending.  Cut those back and you choke off that upstream flow of payments.  That will create a wave of defaults up the chain.  That “free money to the undeserving” is flowing on to keep ALL of us afloat – rich and poor.
2. There are no jobs for ALL those people to go back to.  Anecdotally and individually perhaps.  Collectively?  No.  They won’t be able to replace the lost benefits with wage income.  It is just a subtraction.
3. Those checks are also supporting people trapped with kids at home.  Someone has to take care of them.  Because there’s this virus thing killing Grandmas and Grandpas…

Stimulus isn’t about efficiency and who “deserves” what.  It is about getting dollars out and circulating.  So that payments get paid.  So we all stay afloat.  The expanded unemployment program is doing a fantastic job as stimulus.  But it looks increasingly likely those benefits will be cut back.  Risking a plunge into crisis. 

• I get a sinking feeling some folk’s are hoping that crisis happens – shaking loose some nice assets at fire-sale prices.  A lot of folks made nice returns out of the 2008 crisis.  Maybe they want another bite at that apple?  Precipitate a crisis, but not so big as to fall into the next Great Depression.  Just like 2008.  That is a very dangerous game.  And post-2008 has sucked for most people.
• Alternatively, we are just too politically blindered to see reality.  Trapped in our information silo echo chambers.  Listening to booming noises about the Fed an imagining it will all be OK even if we cut those programs back.  Which is about as stupid and self-defeating as, say, re-opening the country too early in a mass pandemic.  Are we really that dumb?

I keep coming back to the Wizard of Oz. A study in the power of the Placebo effect.  The Wizard may be a powerless old man, but has a powerful impact on his world.  His simple existence (and their belief in him) pull the Cowardly Lion, the Tin Man, and the Scarecrow along a journey of personal growth.  The good citizens of Oz sleep better at night knowing the Wizard is there to protect them.  It all works until Toto pulls back that curtain.

The Fed today is mostly exercising similar Placebo power.  In reality, it has been pushing on a string since 2008.  Pushing on more of a soggy noodle from 2000 to 2008.  The data show that. The main thing sustaining our faith in the Fed today is no more than… our faith in the Fed.

How will we react when (not if) that collective delusion is shattered?  Eventually, we’ll rise to the occasion.  But we’ll likely flail and thrash through a lot of economic damage along the way.  Or maybe we’ll get lucky and keep that curtain closed…

Mitch McConnell is leaving negotiations over a new stimulus package until mid-July.  With the critical $600 unemployment benefit expiring July 31.  Those unemployment benefits are our most important economic prop.  Leaving the discussion to a last minute scramble up to the deadline seems insane.  So why delay?

I don’t think he has the votes. 

McConnell wants to pass a “Republican” bill.  He can’t do that without a rough Republican consensus on policy.  That consensus doesn’t exist.  There are too many Senators given to grandstanding about debt (Ron Paul).  Even more whose paymasters are presumably moving heaven and earth to kill that $600 benefit and keep wages down  (Tom, Cotton ARK, aka “the Senator from Wal Mart and Tyson Foods”).  And the party as a whole lives in an alternative reality where the Fed is all-powerful and benefits for “those people” are always bad.

Here’s where the fantasy centrists swing into action.  Cue Friedman and Brooks et al.  We’ll just pass a bill with a mix of Republican ad Democratic votes.  Sensible people reaching across the aisle.  Blah Blah Blah.

What incentive do Chuck Schumer, much less Nancy Pelosi have to help Mitch McConnell?  In an election year?  When he is fighting for re-election himself?  Zero.

Think about what McConnell would do if the tables were turned.  He’d choose to obstruct any stimulus, tank the economy, and win the election (his post-2008 playbook exactly).  Pelosi and Schumer aren’t quite so evil, but they aren’t stupid either.  Mitch needs a win more than they do.

If Mitch reaches a hand across the aisle, they will ask for the whole arm.  Schumer and Pelosi will offer a reasonable-sounding “compromise” that can pass with all the Democratic votes and a handful of Republican ones.  Take it or leave it.

Lets say McConnell fights to a compromise.  That will still look like a defeat.  Because any compromise is a defeat in the all-or-nothing mindset that grips the modern Republican party.

But he can’t walk away.  No deal = no stimulus.  That would (or should) tank the markets.  even these wildly optimistic ones.  Also those payouts are supporting a lot of Real Estate that a lot of other rich people own.

Given the two unpalatable choices above, he’s taking the third option.  Delay.  Wait until after the July 4 recess.  Hope the exploding COVID numbers bring enough Republican Senators to their senses.

We’ll see.  But a lot of people seem to share a cozy assumption that further stimulus is assured.  Intermixed with a folk-remedy faith in the Fed* and corresponding lack of appreciation for the stimulus doing the actual heavy lifting (that $600 a week).

The sentence above that worries me most is “But he can’t walk away.”  What if he does?  Does McConnell prioritize his personal political survival over the country?  Does he decide to keep his Senate seat even if it plunges the country into a depression?  Which do you think is more important to him?

* The Fed’s own numbers show the money hasn’t gone anywhere (see this piece here for the numbers).  Money has so far gone to foreign central banks (stabilizing exchange rates), the Treasury, and into the banks.  The banks have NOT lent that money on.  They’ve but just parked it as “Excess Reserves” back at…. the Fed.  All those trillions have led to a (placebo effect) drop in market rates and a (placebo effect) investor faith in “liquidity.”  Placebo effects are real.  But they are faith-based.  That is a pretty thin reed to hold up the economy.  Especially if that $600 a week prop gets kicked away.

PS:  Why is McConnell talking so little about the unemployment benefit and so much about “liability protections for hospitals, businesses, etc…”  Because there is a Republican consensus on liability.  Which is irrelevant to keeping the economy afloat right here and right now.   His silence [on unemployment benefits] points to where consensus is lacking.

We are one or two policy errors from something pretty awful.  The massive policy response so far tells us we face a massive threat and a massive risk of a policy error. Maybe it all works out.  But never lose sight of the risk.  How long will our luck hold?

Your quiet spring day is shattered by a cacophony of sirens.  Seemingly every fire engine and police car in the city are rushing somewhere.  Helicopters appear and hover.  Other cities police and fire trucks zip by.  Eventually trucks full of National Guard troops rumble past.  What do you do?

1. Hunker down.
2. Go back to business figuring “they” have it all under control.

I’m taking my cues from the unprecedented scale, speed, and scope of the economic response so far.  Policy actions tell us we are facing a massive, unprecedented threat.  Meaning without precedent.  Meaning no-one has a playbook for dealing with it.

Lets take a look at those policy actions.  The commonality is that some behind-the-scenes conversation got normally cautious, cowardly, prevaricating politicians to put their own careers at risk.  They acted big.  Something must have scared them big.

1. The Fed and the Treasury pulled out all the stops.  Every action taken since that 50bp rate cut in March has had “panic” written all over it.  The Fed has likely broken the letter of the law by wading so deep into buying up private market assets.  It definitely, knowingly broke the spirit of those laws.  The folks at the Fed aren’t stupid.
2. Congress acted… quickly and decisively!?!  passed a massive spending bill at light speed a few months before an election.  The bill solved the partisanship problem by funding everyone’s priorities.  The Republicans got billions for big companies.  The Democrats got billions for unemployment benefits that will permanently raise US wage levels.  The sum added up to Trillions.  Congress does nothing fast.  Mitch McConnell does nothing bipartisan.  And congress learned from 2008 that “bailouts” are political death down the line.  Congresscritters are not (collectively) that smart.  Something big stiffened their backbones enough to act big, fast and decisively.
3. States rushed to re-open with unseemly haste.  This panic signal seems to have  been mostly missed. The politically smart (ie. cowardly) path for a Governor would be to re-open somewhere in the middle of the pack.  Don’t get singled out for blame by opening “too early” or “too late.”  So why did so many Governors rush to re-open?They knew they were risking blame for out-of-control case counts a few months later (as we are now seeing).  What (or who) scared them into acting with such haste?

In all those decisions, you know the usual voices were advocating the usual caution and half-measures.  So why didn’t we get the usual half measures?  Because someone in the room presented an argument that amounted to an ultimatum;  Do this or else…  That “or else” was clearly terrifying.  Normally spineless creatures stood up straight and marched into danger.

I’ve spent the last few months trying to guess at the full shape of that “or else.”  I suspect it was (and is) a massive debt “house of cards” crisis.   But we don’t really need to know the details.  It was a big, dire, and unprecedented risk of disaster.

Looking ahead, the bet you are taking is that “the authorities” have that potential disaster corralled and under control.  That seems like a pretty complacent bet to make.  We are betting on the courage and competence of a class that is pretty reliably gutless and sloppy.

Or maybe we are just betting the Fed can do all the heavy lifting and save us all.    That also seems like a pretty complacent bet.

To repeat the intro paragraph:

We are one or two policy errors from something pretty awful.  The massive policy response so far tells us we face a massive threat and a massive risk of a policy error. Maybe it all works out.  But never lose sight of the risk.  How long will our luck hold?

Next month, Congress risks making an epic policy error.  Will they let the $600 a week unemployment benefit lapse in July? It only require a failure to act.  And politicians are pretty good at failing to act…

That extra $600 a week is carrying a lot of the economy’s weight right now.  Most obviously supporting consumption.  But also carrying asset markets dependent on consumer rents and debt payments – credit cards, auto debt, mortgage debt, student loans are the biggies.

The weekly checks are doing the heavy lifting, but the Fed is getting the headlines.  I worry the Fed myth is so strong that Congress fails to act.  Pitching us into free fall.  Similar to Congress’s original failure to pass TARP – hoping the Fed could keep doing all the work – in 2008.  I worry Congress will make that error.  Why?

1).  There is so little coverage and focus on that $600.  When it is mentioned, the focus is on the partisan dynamic and/or how many people are “making more on unemployment than they would if they are working.”  The catastrophic, immediate risk of letting it lapse isn’t part of the dialogue.

2).  Faith in the Fed is so strong.  In popular myth, a wall of Fed money has saved us in every past crisis.  So why not just sit back and let the Fed do its magic once more?  Avoid the tough choices?  That is OK if Fed intervention is “working” mostly by impacting the real economy.  It is not OK if Fed intervention is working mostly by lifting animal spirits while that $600 a week benefit keeps the real economy limping along.  If the Fed is just the Wizard of Oz – an old man behind a curtain – the Wizard can’t save us.  We must save ourselves.  Dorothy and the Cowardly Lion figure that out.  But what if we don’t?  See my prior posts for more on Fed impotence.  Or just note that the Fed hasn’t actually done very much real-world buying or lending of any real money so far.  Outside of emergency dollar swaps with other central banks, it has all mostly been moral suasion and animal forces to date.

3).  That $600 benefit is hated and feared by a lot of core Republican paymaster constituencies.

• Business owners hate it because it raises the prevailing wage.  They recognize it is a back-door route to a $15 minimum wage.  Which is a lot closer to a living wage.  Which is a lot more efficient than my paying taxes to top up the meager wages of people who don’t earn a living wage – taxes to fund food stamps, free school meals, section 8 housing vouchers, etc etc. But a lot of businesses would prefer to keep “those people” down, dependent on capricious government programs, and docile.
• A lot of Red states like the out-of-State Federal subsidies (from blue states) that help pay for those programs. This dynamic gets overlooked in the whole “makers vs takers” debate.  But us well meaning liberal types are the ones writing those checks.  To folks who delight in biting the hands that feed them.
• Older, affluent people are terrified of inflation.  Raising the prevailing wage would, eventually, feed through to higher prices.  The economy as a whole would benefit massively from higher inflation.  We are teetering on the precipice of deflation as it is.  But affluent older folks would suffer from inflation.  And older affluent folks vote Republican.
• Racism.  A lot of Republicans just like anything that keeps “them” down.  More to the point, the vicerally attack anything that might help “them.”  And lets not pretend “they” aren’t poor and non-white.   Most Republican’s airbrush out all the white faces in any picture of the poor.

Democrats love that $600 a week because the longer it goes on, the further it drives us further towards a $15 minimum wage. It also validates the need for fiscal policy responses to futre crises.  And helps their core voters most.  All of which are further good reasons for the Republicans to hate it.

But won’t Trump prove the deciding vote?  Just push it through?  He just wants to get re-elected.  Any checks going out now are good checks, right?  Yes, but Trump has been utterly silent on the subject so far.  While at least some of his advisors – serving the interests above – seem inclined to kill it (see below).  Trump doesn’t necessarily listen to his advisors, but if he hasn’t yet figured out how critical it is to his future, we’re on pretty thin ice.

“Kudlow said the $600-a-week bonus payments made to some Americans laid off during the coronavirus pandemic will end as planned on July 31 to prevent a “disincentive” for workers to return the jobs market.“

So that leaves us in a depressingly familiar battle.  On one side, the interests of the economy, Democrats, and the general welfare of most Americans.  On the other side, crony capitalists, affluent older folks, Red State politicians protecting their subsidy streams, and a decent-sized minority of racist deplorables.

Which side wins?  Ask yourself which side has has won in the past?  Now you see why I’m worried.

I’ve been musing about monetary velocity because it points to a possible diagnosis on a that nasty feeling in a lot of guts today.  How much of our current prosperity is built on false hopes?  I’m not the first and definitely not the smartest guy to think about that.  So lets introduce the concept of “the Bezzle.”  The Bezzle the queasy-making part of that gut feeling.  The term comes from JK Galbraith’s history of the Great Depression.

“In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in — or more precisely not in — the country’s businesses and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.  https://www.goodreads.com/quotes/tag/bezzle

The economic magic is that; for a while; maybe for a very long while; we all get to live like that magic million dollars existed.  Until it doesn’t… 

The Bezzle is the monetary equivalent to Schrodinger’s cat. The money exists twice in two different states of reality.  You embezzle a million dollars.  For a time, you live like a millionaire.  But your victim also keeps living like a millionaire.  You are both spending with the confidence that million dollars exists.  And, for a time, it does exists in two different realities.  Until it is observed.  One reality collapses.  A million dollars disappears in a puff of smoke (smelling vaguely of singed cat hair).

The Bezzle concept suffers from two problems.

1. It exists only when un-observed.  It is reliably, necessarily forgotten exactly when it is most relevant.  The Bezzle only exists when people are credulous.  They have to believe that magic million dollars is real.  And that depends on people forgetting about the Bezzle.
2. It isn’t easily quantifiable.  This is the ultimate sin in modern economics.  You can’t build clever models explaining it.  Clever models get you tenure.  And talking about the Bezzle tends to repel folks in finance.  There’s a bit of Bezzle sprinkled into most financial products – especially the more profitable products.

That leaves the Bezzle unloved and un-observed.  Tucked in the same box as Schrodinger’s cat.  Except in the rants of dangerous amateurs (like myself).

The next post will start to tie the prior 3 posts together (loosely as is my wont).  Monetary velocity is declining.  Fed intervention is delivering diminishing returns.  And now have this concept of the Bezzle – magical, imaginary, temporary wealth.  My guess (and it is just a guess) is we can get a rough estimate of the the Bezzle from how much (or how little) money is circulating.  It isn’t huge – a few Trillion.  But that’s enough to do some damage.

Monetary velocity has been steadily declining, with increasing deceleration after every Fed intervention (see chart going back to 1959 here).  That gnaws at me (see prior post here).  Why does it worry me so much?

“How did you go bankrupt?”
Two ways. Gradually, then suddenly.”
― Ernest Hemingway, The Sun Also Rises

The Fed’s Growing Impotence

Over the last 30-40 years, monetary policy (the Fed) became the only politically acceptable tool of economic intervention.  That reached its apogee with popular lionization of “the maestro” Greenspan. When crises hit, Congress got used to sitting back and letting the Fed do the heavy lifting.  Fed intervention worked great in the 1990’s, OK, in the early 200’s and barely at all in 2008….

Why?   Over-use of any economic input leads to diminishing returns – less bang for every incremental buck.  Even if the tool is more actual dollars at ever-lower interest rates.  By leaning harder and harder on one-dimensional Fed intervention, we’ve limited the impact of that intervention.

The evidence?  That steady decline in monetary velocity, with those downward kinks of deceleration after every successive recession (and Fed intervention). We printed more and more money.  We got less and less growth from it.  Some of that declining velocity is from “natural” factors (aging demographics and increased global trade).  But the kinks in the curve – coming after every recession/intervention – tell a clear story of diminishing returns. Velocity deceleration will kink down further/faster after the 2020 recession.  The Fed has cranked out around $6 trillion (~28% of 2019’s $21 Trillion GDP).  Unless/until GDP grows, velocity (just “GDP” over “money supply”) will plummet.

Pumping out more and more money to less and less effect.  That growing impotence was already growing increasingly obvious – see my October 2019 post “The Fed Isn’t Manipulating Mr. Market. Mr. Market is Manipulating the Fed.”  The poor Fed has ended up like the Wizard of Oz – trapped into sustaining a naive folk belief in its limitless power.  Every time we face a crisis, the Wonderful Wizard will solve all our problems!  Painlessly! No effort or loss or tough choices! See this post for more.  Or just watch the video below.  With sympathy for the poor guy behind the curtain…  🙂

The Fed’s recent interventions may have had more moral effect than practical effect. The Fed has huge impact on Keynes’s “Animal Spirits.” But it might be more placebo effect than anything else.  Fed Chair Ben Bernanke made a joke out of it once; “The problem with QE is it works in practice but it doesn’t work in theory.”  The uncomfortable implication is that it only worked because people believed it would work. 

The data suggest “don’t fight the Fed” may be more of a folk belief than a quantifiable economic effect. At least in real economy terms.  The evidence has pointed that way since 2008.

If that is correct, the main prop supporting the pandemic economy may not be the Fed’s mega-massive interventions.   It is probably the “temporary” $600 a week unemployment benefit.  Which is looking increasingly at risk. 

Excessive faith in monetary intervention might lead Congress to assume they can turn off the fiscal taps.  Rely on the Fed.  Like we have learned to do over the last few cycles.  Concentrating the benefit among asset holders.  Why mess with success?

Because someday monetary interventions may not work in theory OR practice.  Monetary velocity suggests that day may be now.

Money used to circulate around 2x a quarter. Now it is only circulates around 1.2x.  This is, roughly speaking, a measure of the Fed’s growing impotence.  More and more money supply is having less and less effect.

I keep finding my way back to the monetary velocity chart below.  Its message is clear.  We keep pushing more and more money into circulation, but we get less and less economy to show for it.  What isn’t clear is why.

The chart shows US “monetary velocity”  – how much economic activity do we get for each dollar of money in circulation?  GDP divided by the money supply (MZM).   If we have a GDP of $100 and $100 of money, velocity = 1.  Every dollar changes hands once in a cycle.    If we have $100 of GDP and $50 of money, velocity equals 2.  Every dollar changes hands twice.

Declining velocity means money is changing hands more slowly.  Instead of flowing in a rushing steam of commerce, it is collecting in increasingly stagnant pools and eddies of inactivity.  Money is really only worth something when it is used to buy something else…

So the chart tells us most of the Fed’s post 2008 “money printing” never really found its way into the real economy.  A problem that really started in 2001, just about when faith in the Fed became absolute.  Monetary base keeps going up but GDP increasingly didn’t follow. We print a lot of money, but it fails to circulate.

Something is clearly busted.  But what?  What exactly is broken?  That is less clear. What does it imply for the future? That is even less clear.  I’ve got some thoughts I’ll try to write out in series over the next week.  But take the time to click on the link and look at that chart.  There is something rotten in there somewhere.

MZM Monetary Velocity: https://fred.stlouisfed.org/graph/?g=rtws

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Summary:  Facing a grinding, random virus threat, people will self-regulate to keep crowd density at “comfortable” levels.  Meaning sparse retail traffic.  Meaning anemic economic activity.  Continuing until an effective vaccine has been widely administered (not just invented).

The Virus Will Remain a Random, Omnipresent Menace.

Lets set the stage with this likely scenario from the “Epsilon Theory” blog.  I’ll take this to mean that “everyone” will eventually at least know someone who’s either died or gotten horribly sick.  Or gotten sick themselves.  But with herd immunity elusive.  Like a horror movie where some unseen, stalking menace picks off members of the party one by one.

Covid-19 is now endemic in the United States. That means it is everywhere. That means it is something to live with rather than something to eliminate. That means Covid-19 is now being “handled” as a chronic disease rather than an acute infectious emergency, a chronic disease where – every day while it remains endemic – 15,000 to 20,000 Americans will get so miserably sick that they will seek treatment and be officially diagnosed, and 500 to 1,000 Americans will die.

15,000 to 20,000 Americans really sick. 500 to 1,000 Americans dead.  Every day.

Paris Metro Pricing Tells Us How People Will Respond.

A brilliant friend (Andrew Odlyzko) wrote up the human/economic phenomena of “Paris Metro Pricing” ages ago in the context of a possible Internet “quality of service” pricing scheme (PDF Here).  It hit me today Paris Metro pricing also perfectly captures the likely dynamic we’ll see in retail stores.  Quoting Odlyzko

Until [1991] the Paris Metro operated in a simple fashion, with 1st and 2nd class cars that were identical in number and quality of seats. The only difference was that 1st class tickets cost twice as much as 2nd class ones. (The Paris regional RER lines still operate on this basis.) The result was that 1st class cars were less congested, since only people who cared about being able to get a seat, etc., paid for 1st class. The system was self-regulating, in that whenever 1st class cars became too popular, some people decided they were not worth the extra cost, and traveled 2nd class, reducing congestion in 1st class and restoring the differential in quality of service between 1st and 2nd class cars.

This seems to be a perfect model for behavior in an endemic epidemic.  Self-regulating  congestion management driving sparse retail traffic.  If a store/bar/restaurant seems “too crowded,” people simply won’t enter.  If a place starts to feel “too crowded,” people will head for the exits.  Self-managing ourselves into an informal, low-level, self-policing quarantine.

That means crowds will remain sparse.  At least in any sort of discretionary retail activity.   Non-discretionary shopping (grocery stores, etc) might end up retaining their metered entry congestion management systems.  Or opening at longer and odder hours to spread out crowding.

Likely a Price Premium

Less crowded retail tends to be more expensive retail.  Shops, restaurants, bars, airplanes, etc… If nothing else, paying the same rent per square foot costs more for fewer people vs more people.  Meaning a higher ticket price per person.

Some of that price “premium” will come via stealth by lower discounting.  Once retailers offload unsold pre-virus stock, they likely take advantage of the traffic dynamic to charge full price.  Consumers will be more inclined to just buy whats on the shelf versus shopping around for the best deal.

Antibody Carriers Are Likely Spoilers

The already-infected crowd will (presumably) feel less constrained by this dynamic (glossing over whether prior infection does actually lead to immunity).  They will presumably not care if stores or bars are crowded.

In the Paris Metro model, they will just barge their way into the First Class car – indifferent to the crowding effect.  That behavior will further depress traffic from those who haven’t yet had it. Eventually, the number of antibody carriers will get large enough to return traffic to “normal.”  Although lets hope a vaccine comes along before that.

On current infection patterns, antibody carriers are more likely to be less affluent and non-white.  Unfortunately those folks are the least important drivers of the consumer spending equation. The more affluent, work-from-home crowd will be the last to return to “crowded” shopping and eating out. Those folks being the most important drivers of consumer spending.

I’ve just wrapped up a 7 day RV trip across the US (surprisingly enjoyable even with a 2 1/2 year old and a 5 month old).  Currently at the in-laws in Virginia.  I’ve got a whole bunch of thoughts percolating so stay tuned.

We saw a burst of hope on Monday around Modena’s vaccine being ready in volume by early 2021.  That news will change people’s individual economic calculus.  The collective impact of those individual choices probably keeps the economy limping along in a self-imposed lockdown until the vaccine is widely available.

Absent hope for a vaccine, people would have slowly adjusted to a “new normal” and acquiesced to the risk of the virus.  “We’re all going to get it anyway I might as well get back out there.”

Hope for a vaccine changes that calculus to “I don’t want to be the last person to die before the vaccine comes out.  I’ll just hunker down and wait until I get my jab.”

Individually, that is the right thing to do.  Collectively, that means we likely stay in a self-imposed semi-lockdown for the duration.

A Fast Vaccine Probably Keeps Us In an Economic Deep Freeze:  Hope for Modena’s vaccine being ready in volume by early 2021 changes people’s personal economic calculus.  The collective impact probably keeps the economy in self-imposed lockdown until then.

Absent hope for a vaccine, people would have slowly adjusted to a “new normal” and acquiesced to the risk of the virus.  “We’re all going to get it anyway I might as well get back out there.”

Hope for a vaccine changes that calculus to “I don’t want to be the last person to die before the vaccine comes out.  I’ll just hunker down and wait until I get my jab.”

Individually, that is the right thing to do.  Collectively, that means we likely stay in a self-imposed semi-lockdown for the duration.  Anything that can be put of until “after the vaccine” will be put off.  No CEO wants to be the guy who pushed his people back to work in the face of a temporary and ultimately avoidable danger.

• Companies will feel compelled to extend WFH “until the vaccine is available.”
• NBA, Baseball and other athletes might push to start seasons “after we have the vaccine.”
• Conventions, events, etc…  will do the same.

Economically, that shifts the calculus to “who can hold out until 2021.”  The market seems to be pretty rationally pricing in those odds for a lot of companies.  .  Atlassian, Cloudflare, Amazon, etc will do just fine.

I am less convinced the market is pricing in the full impact of a 8-12 month economic deep freeze.  Absent a debt holiday, a lot of “Main Street” sources of wealth that depend on steady flow income (McDonalds franchisees, car dealers, strip mall owners who rent to restaurants, etc…) might not be able to hunker down for that long.  A debt holiday makes a lot of practical sense, but can it get done in an election year?  Absent that, we’ll see a cascade of Main Street bankruptcies.  A scenario we haven’t seen before and that no-one seems to have been able to model (as far as I’ve seen).  I have no idea how levered those Main Street folks are.  Or how their likely liquidation of personal assets/portfolios might impact their lenders and the markets (they presumably have decent-sized stock portfolios).  With roughly 40% of some regional banks loan books anchored on Commercial Real Estate, I am also concerned about the impact of a wave of defaults in a previously stable sector.  I haven’t seen any useful analysis on those questions so far.  Partly I think because that sector’s stability has been taken for granted (so no-one has gathered the data or perspective to do that analysis).  We’ve got lots of regulators watching things like derivatives, but I’d guess the Fed never asked banks to model in a total collapse of retail rent payments (until a few months ago, which may be why Powell is sounding so glum).  So it remains to be seen if that is a localized crisis or if it spins up into something uglier.

That said, 2021 probably sees a bacchanal of spending on travel and etc.  Those who have kept their jobs will have a year of enforced savings and a lot of cooped-up frustration to blow off.  So people who can hold on will do well.  I’m a tech analyst so figuring out who wins and loses is above my pay grade and/or expertise.

The operative term for me (and concern) remains that phrase.  “Those who have kept their jobs.”  My gut tells me there are a lot HR departments waiting to NOT be the first company to announce mass white collar restructuring – never let a good crisis go to waste.  Which means there are a lot of dead men walking out there in the WFH class.

Anything that can be put of until “after the vaccine” will be put off.  No CEO wants to be the guy who pushed his people back to work in the face of a temporary and ultimately avoidable danger.

• Companies will feel compelled to extend WFH “until the vaccine is available.”
• NBA, Baseball and other athletes might push to start seasons “after we have the vaccine.”
• Conventions, events, etc…  will do the same.

Economically, that shifts the calculus to “who can hold out until 2021.”  The market seems to be pretty rationally pricing in those odds for a lot of companies.  .  Atlassian, Cloudflare, Amazon, etc will do just fine.

I am less convinced the market is pricing in the full impact of a 8-12 month economic deep freeze.  Absent a debt holiday, a lot of “Main Street” sources of wealth that depend on steady flow income (McDonalds franchisees, car dealers, strip mall owners who rent to restaurants, etc…) might not be able to hunker down for that long.  A debt holiday makes a lot of practical sense, but can it get done in an election year?  Absent that, we’ll see a cascade of Main Street bankruptcies.  A scenario we haven’t seen before and that no-one seems to have been able to model (as far as I’ve seen).  I have no idea how levered those Main Street folks are.  Or how their likely liquidation of personal assets/portfolios might impact their lenders and the markets (they presumably have decent-sized stock portfolios).  With roughly 40% of some regional banks loan books anchored on Commercial Real Estate, I am also concerned about the impact of a wave of defaults in a previously stable sector.  I haven’t seen any useful analysis on those questions so far.  Partly I think because that sector’s stability has been taken for granted (so no-one has gathered the data or perspective to do that analysis).  We’ve got lots of regulators watching things like derivatives, but I’d guess the Fed never asked banks to model in a total collapse of retail rent payments (until a few months ago, which may be why Powell is sounding so glum).  So it remains to be seen if that is a localized crisis or if it spins up into something uglier.

That said, 2021 probably sees a bacchanal of spending on travel and etc.  Those who have kept their jobs will have a year of enforced savings and a lot of cooped-up frustration to blow off.  So people who can hold on will do well.  I’m a tech analyst so figuring out who wins and loses is above my pay grade and/or expertise.

The operative term for me (and concern) remains that phrase.  “Those who have kept their jobs.”  My gut tells me there are a lot HR departments waiting to NOT be the first company to announce mass white collar restructuring – never let a good crisis go to waste.  Which means there are a lot of dead men walking out there in the WFH class.

I keep seeing line graphs trumpeting “no coronavirus case re-acceleration yet!!!”  This is often connected to some sort of positive economic outlook or commentary.

That makes no sense.

The absence of a case rise tells us one thing.  People are still social distancing even with the legal lockdowns lifted.  If more people aren’t getting sick, then more people aren’t going out (much).  If they were going out, we’d be seeing them getting sick (much).   Less contagion must be driven by less social  mixing.  Unless the virus has somehow gotten less contagious?  (it hasn’t).

The above logic also squares with activity and economic data from Georgia, Sweden etc…  The lockdown isn’t driving the economic slowdown, the virus is.  People aren’t stupid.  They aren’t taking unnecessary risks.  Anecdotal newspaper stories about people bars and restaurants notwithstanding.

It was hard to not see the whole “lift the lockdown!” push as a pretty naked effort to risk the lives of a lot of folks to save the financial prospects of a much smaller number of folks with mortgage payments on retail and commercial property coming due.

The key, cynical, false assumption of “lift the lockdown!”  was the masses were dumb enough to go back out once restrictions were lifted.  Especially if loudly encouraged by media outlets owned by wealthier folks (working from home).

The absence of a case uptick is yet another sign that the masses aren’t that dumb.  They are staying home too.  This is great news from a health perspective.  It is much less good news from an economic perspective.