By their very nature, so-called black swan events are difficult to prepare for given their rarity and unpredictability. Their uncertainty makes risk assessment daunting. Market participants must bear this risk since it is systemic in nature and unable to be discounted. Pandemics present a particular challenge as they disrupt human interaction, the very fabric of commerce. Today’s modern service economies face few events more destructive.
The current COVID-19 virus threatens human health and commerce, striking at the core of global growth. The election by governments to shut down the global economy shows a lack of preparedness for pandemics despite a long history of warnings and false alarms. Throughout history, humans have confronted pandemics with very crude tools. Isolation, testing and herd immunity can all be effective responses but come at a considerable cost for modern economies.
Returning to normal requires a vaccine that, along with better testing and discovery of effective drug therapies, will allow for re-opening the economy with confidence. Yet, knowing what needs to occur does not automatically bring a solution. We might need to consider an alternative scenario. We may have to adjust to a new normal as the definition of “normal” evolves as facts change. Homo sapiens sit atop the food chain not by being the fastest or strongest but through cunning. The existential threat posed by COVID-19 will be contained and mitigated over time by our ability to adapt. However, in the short run, the necessary changes in behaviors imperil our existing political, economic and social structures.
At the moment, we do not know enough about the virus to overcome it. The prospect of a medical solution is optimistically months away. Lacking a vaccine or cure, governments have chosen to shut down the global economy to save lives. The economic results of such actions are painfully clear. It means a depression in which high unemployment and lost income destroy demand. Governments have attempted to fill the void through unprecedented fiscal and monetary programs. For the most part, they have acted swiftly and with significant conviction. Only through the lens of history will it be evident whether these policies were successful. At present, we can only assess the impact on the margin.
The role of governments and the emphasis on collective behavior has come at the cost of the individual. The allocation of resources, as well as the means of production, are firmly in the hands of the policymakers. There will undoubtedly be policy errors, and one should expect the restart of economic activity and recovery to be erratic at best. There is no established playbook to determine the timing of the restart and what will be the cost to human life ultimately.
It seems likely that there will be additional shutdowns and protocols that restrict individual freedom. Travel might be limited, either voluntarily or involuntarily. The loss of small businesses means industries are likely to be dominated by large, well-capitalized firms. Governments will consider tracking their constituents in the name of public health. The delivery system for public health will change, necessitating even larger allocations of national budgets to health care. Nationalism will continue to gain popularity, further jeopardizing global trade. Meanwhile, the inevitable contraction in global trade will disrupt supply chains.
The prospect of a quick V-shaped recovery appears naive. The second and third quarters are going to be severely negative. The prospect of a strong finish to the year, while possible, would require a dramatic improvement in health conditions, which elude us at the moment. The more likely scenario is that the recovery will take months, if not years. Yet, as we move towards recovery, policymakers will have a difficult time withdrawing liquidity. There is likely to be a significant political backlash from poorly administered fiscal policies. Fairness is never the objective of money printing. For every winner will be many more losers.
Over the near term, wealthier nations will do better than those in developing countries. The expectant decline in global GDP will likely weigh heavier on emerging and frontier market economies, which had experienced improving standards of living. This progress is likely to stall temporarily and perhaps converge somewhat as the developing countries have less to fall. The fact that these countries are generally less indebted then developed countries might offset the negative impact of declining trade. Their ability to raise capital in this environment will prove to be a constraint, however. Problematic access to health care resources and the overall state of their health care systems means developing countries could be harder hit by the virus. It is possible that demographics, notably younger populations, could spare them from the infection and mortality rates experienced in the developed world.
We will eventually get to the other side, but it is likely to look and feel different. The crisis will forever mark us. It will take time to recover the social behaviors and freedoms that we previously enjoyed. Governments are likely going to play an even larger role in our lives. Technology will continue to provide solutions to the problems that we face. Medical breakthroughs and better analytics will make us better prepared for future pandemics. But we will never escape the hardships that economic cycles bring despite policymakers attempts to smooth them over.
To download the PDF version, click here: 2020-04 Getting to the Other Side
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