A Recession Like No Other

By John Mauldin

We just spent the better part of a decade wondering when the next recession would strike. The last two months we stopped wondering. It’s here and a grand council of esteemed economists has confirmed it.

On June 8, the Business Cycle Dating Committee of the National Bureau of Economic Research found monthly economic activity had peaked in February 2020. On a quarterly basis, the peak was in Q4 2019, but in either case, a recession is now underway.

It’s important to recognize how they define “recession.”

A recession is a significant decline in economic activity spread across the economy, normally visible in production, employment, and other indicators. A recession begins when the economy reaches a peak of economic activity and ends when the economy reaches its trough.

If the trough isn’t here yet, when will it arrive? We don’t know. The NBER committee identifies these in hindsight. If all goes well, they may look back and say March or April was the bottom, making this one of the shortest recessions ever. But it will also be the strangest recession ever, because even if we are “recovering” we will still be further away from the previous peak than ever before, with unemployment well above 10 million.

NBER also said this time is different:

The committee recognizes that the pandemic and the public health response have resulted in a downturn with different characteristics and dynamics than prior recessions.

Considering exactly how this recession is different gives us some insight into how long it may last.

Corona Recession

Many economists thought a recession was close even before the pandemic.
The expansion had run longer than any other.
Cracks were forming and the main question was what would trigger a decline.

I thought we were headed for a credit crisis, centered on corporate debt rather than mortgages, as happened in 2008. The Fed’s decades-long easy money policies have many businesses leveraged to the hilt.
That remains the case and could still become a bigger problem but for now, we are in something unique: a supply-and-demand-driven recession. Specifically, service supply dried up almost overnight due to virus fears and lockdown orders. Then consumer demand collapsed as people lost those service jobs and, as we will see, those with more money started to save dramatically more, further reducing demand.

My friend (and valued mentor), economist Woody Brock, draws a helpful comparison between this recession and others. I am going to rely upon his June Client Memo for some of these insights and blend them with other analysis and my own views.

Source: Woody Brock

Normally, some kind of trigger or “shock” makes business activity contract. Tighter credit or higher interest rates are often the culprit, not simply falling sales. Unable to finance continued operations, businesses close and lay off workers, who then reduce their consumption. The effects cascade through the economy and recession begins.

This time, the shock came with the coronavirus and our reaction to it. Note, it wasn’t just government-ordered shutdowns. Data now shows consumer spending started falling weeks before governors acted. Retail and service businesses saw store traffic falling and, with risks to employees and customers rising, many closed even when not required to. But the result was the same: Business activity contracted and triggered recession.

Woody observes, and I agree, this hit our economy’s weak spot like a laser-guided missile. Unlike the 1800s or the 1930s or as recently as the 1980s, manufacturing and agriculture no longer dominate. Now the service sector accounts for the vast majority of jobs and GDP. The sudden stop was catastrophic. As Woody outlines (his emphasis):

The good news over the past hundred years (as we have often documented) is that the impact of most any shock on consumption has dropped by some 90%. There are two main reasons for this remarkable decline. First, the advent of unemployment insurance and of two-income families blunted the impact of layoffs on consumption.

Second and more important, the percentage of jobs in cyclical industries and farming has collapsed by some 70%, a decline offset by the increase in jobs in the service sector where some 86% of us now earn our living. What matters, of course, is that the service sector is as stable and cycle-free as the other two sectors are not. This is the main reason why the decade-by-decade volatility of GDP has fallen by 85% during the past century. In particular, post-war business cycles have thus been much less severe than they were before the war.

According to this analysis of traditional recessions, both the unemployment rate and the drop in consumption should have and did increase after the initial shock (e.g., a spike in interest rates) occurs—not concurrently. The unemployment rate also peaked after a recovery had already begun.

Note: this is why the current recession is unlike others. Most economic analysis that I read doesn’t distinguish between this service sector implosion and prior recessions of the last 200+ years. Which is why we get all this silly talk of a V-shaped recovery.
They are looking at historical models when nothing in history resembles this recession.

This shock, as bad as it is, is only the beginning. More from Woody:

At a causal level, this initial shock caused the unemployment rate immediately to soar to unimaginable levels prior to any formal recession. For the face-to-face contact required to produce many goods and services in the service sector came to an abrupt end once people decided to stay home.

What the market may be missing here is that this initial service sector implosion/shock will cause a more classical recession to follow: thousands of non-service sector businesses will cut back (mining, engineering, auto production) regardless of generous fiscal and monetary assistance. Many firms will fail. As businesses suffer and cut back, they will start laying off workers in the usual manner, and we end up with a proper recession in which layoffs continue until well after an economic recovery arrives.

Thus we will have to add several million more late-stage layoffs to the 32,000,000 early-stage layoffs tabulated to date. The adverse impact of all this on consumer confidence is hard to estimate, but it will surely cause ever further reductions in consumption spending than we have seen to date. The impact on business confidence and investment spending should also be severe.

Theoretically, this new double-decker recession should cause both GDP growth and employment to drop much further and faster than in any other recession on record. And this is exactly what has happened.

If COVID-19 was only the initial trigger, then we still have to deal with the preexisting conditions even if the virus threat goes away. That doesn’t seem likely this year, at least in the US.

In short, a demand-driven recession can’t end until demand returns. It doesn’t necessarily need to be the same kind of demand. Indeed, it probably won’t be. But something must restore consumer spending. A lot of entrepreneurs are spending late nights (and days) trying to figure out how to restore consumer spending.

Choosing Not to Spend

Other problems aside, there is plenty of reason to think the virus-sparked downturn is not over. We know almost 48 million Americans lost jobs since March (the number of unemployment claims filed). Most haven’t felt a severe income loss thanks to government programs and stimulus payments. Some are even making more now.

This isn’t simply a benefit to unemployed workers. The extra payments let them keep paying their bills, which helps their landlords, lenders, and the stores where they shop. (Anecdotally, one friend relayed to me that he was told by the CEO of the company that over 95% of their 50,000 apartments are still paying their rent, but only 50% of their commercial rentals were being paid).
That being said, 30% of mortgage holders failed to make payments in June.
Even so, cash is still flowing through the economy. That has helped.

At the same time, less cash is flowing into commerce. The difference shows up in the savings rate and bank deposits.
The personal savings rate reached an unprecedented 32% in April. It was still 23% after spending rose in May.

Source: CNBC

Much of this money now flowing into banks would have been spent in restaurants, hotels, and other suffering service businesses. In some cases, it is getting recycled back to those businesses as the banks buy Treasury bonds and the government pumps cash into various programs. But not all of it, and maybe not for long. Some of the CARES Act stimulus measures are set to expire in the next few months.

Mortgage and other lenders have been granting forbearance on debt payments. Courts in many places paused eviction proceedings for renters. Credit card issuers have been generously extending terms. All these help, but they aren’t sustainable indefinitely. They, too, will end at some point, perhaps soon. Then what?

The Wealthy Assume the Fetal Position

One of my most important “reads” every day is Neil Howe and Hedgeye Demography. This morning he starts out by noting a New York Times article and then provides color.

It’s the richest Americans who have cut their spending the most during the pandemic, which is limiting the economic recovery to a larger degree than in past recessions. Unlike other recessions, this one has decimated the service sector, which depends increasingly on consumption by those at the top.

He goes on to relate much of the same analysis as we discussed above.

It has been triggered, in the first instance, by a supply shock: Firms cannot produce or sell to customers. The first firms to get hit are mainly small companies (or sole proprietors) in the service sector—personal services especially. And the first workers to get hit are low-income earners in affluent, urban areas very near to where wealthy people live.

Services, driven by millions of small firms (restaurants alone comprise nearly 15% of all US employers), typically help power our economy through a recessionary patch. This time, services are getting hammered.

Source: Hedgeye

But then we get to the part that really gives us truly valuable insight. The data below is daily credit card receipts which can be tracked by ZIP Code. A Harvard think tank called Opportunity Insights breaks down the data by average household income within a particular ZIP Code.
No surprise, the data tracked remarkably closely, both before and after the recognition of the pandemic and lockdowns. But notice what happens after the first stimulus checks are received. Those getting those checks, presumably not the wealthy, spend them. The top 25% of wealth-related ZIP codes spend dramatically less. And that is the problem.

A few years ago, former Dallas Fed president Richard Fisher, speaking at my conference, was asked how he had positioned his own portfolio. He quipped, “The fetal position.” That is precisely what we are seeing today: extraordinarily high savings rates and less spending from those who are uncertain about the economy.

Source: Hedgeye

Not surprisingly, that means that small businesses in those neighborhoods have had the biggest drops in revenue.

Source: Hedgeye

What kind of businesses are we talking about? Mainly small firms, contractors, and professionals who provide services to wealthy people in relatively wealthy neighborhoods: high-end restaurants, boutique and fashion shops, spas, gyms, therapists, theaters, florists, and so on. Businesses in Manhattan, especially on the upper east side, have been flattened—while businesses in Harlem and South Bronx have been relatively unscathed.

So what are the rich doing with their money? For now, at least, they're not spending it. Past recessions have usually been accompanied by some rise in the personal savings rate—with a disproportionate share of that rise coming from the affluent. This time, we're seeing a grotesquely exaggerated response. The average personal savings rate has skyrocketed to an unprecedented 33% in April. And nearly all of this gain has come from the affluent. According to the Harvard researchers, over half of the consumption decline in April and May came from the top quartile of households. Meanwhile, the lowest quartile has seen virtually no overall decline in consumption. And that is in part thanks to PPP and UI bonus dollars flowing to the very workers who work (or used to work) in Beverly Hills or Sausalito or along Chicago's Mag Mile.

Over half the spending decline in the current recession is coming from the top 20% income group. The lowest group has only seen aggregate spending drop 5%, thanks to unemployment insurance. Government programs have helped the economy stumble along.

My friend Lance Roberts at Real Investment Advice posted the charts below on Twitter. Note that social benefits (government checks of one form or another) almost doubled to 37% of disposable income in the last few months. The unanswered and difficult question is what will happen if those programs are cut back?

Source: Lance Roberts

The next phase of this recession will be when demand stays low because people lack spending power. The open question is how widespread it will be, and that depends largely on health-driven behavioral decisions.

Inevitable and Unacceptable

Spending won’t recover to prior levels unless people feel safe. I emphasize “feel” because perception is what counts. Controlling the coronavirus is necessary but not sufficient.

Last week I explained how widespread mask-wearing is the best and least expensive economic stimulus program available to us. Older people, those with health conditions that make them vulnerable, and many others simply won’t go back to normal when they see large numbers of unmasked people walking around in public.

Unfortunately, that is easier said than done. Legal mandates and social shaming (you cannot imagine how I hate writing those words) may help but not enough, and can even backfire by breeding resentment. This is a real problem for businesses in which crowds and small spaces are unavoidable.

The airline industry is in turmoil. Traffic counts are coming back but are still way below breakeven rates. Hotels are even worse. Not to mention all the businesses that need airlines and hotels to bring customers. Conventions and tourism are a substantial part of the economy, representing millions of jobs. They can’t come back under these conditions. That alone is enough to keep the economy in recession for a long time. You can be optimistic about much of the economy (I certainly am) but a 90% recovery is just not enough.

But that’s really the best-case outlook. If the outbreaks that are currently intensifying in Arizona, Florida, Texas, and elsewhere get bad enough to make consumers stay home and businesses close again (whether ordered to or not), all bets are off. Texas has already paused its reopening plans, with the governor ordering bars closed again.

Efforts to control the virus, while necessary, have an economic cost. It looks like the European Union will refuse entry to American travelers, as well as others from areas where they deem the virus is insufficiently controlled. The same is happening within the US as recovering states like New York require quarantines for travelers from other states where cases are growing.

International and interstate travel is pretty low anyway, but these measures will reduce it further. Now even some urgent, no-other-way trips can’t happen. This will have unpredictable but potentially severe impact on some businesses. If your factory is closed because you need a machine repaired, and the only person who can repair it can’t enter your state, you are in deep trouble. So are your employees, suppliers, customers, and shareholders.

When NBER said this recession would have “different characteristics and dynamics” than others, the committee wasn’t kidding. This is unlike anything we have seen before. At least 20 million people have been out of work for eight weeks. (H/T Mike Shedlock) Initial claims are still about 1.5 million per week, though down from almost 7 million. Again, 47 million of our neighbors have lost a job. Some are now slowly going back to work. But by all accounts, that work looks significantly different.

Source: MishTalk

I think governments everywhere, but especially in the US prior to the election, will continue their stimulus programs. But at some point, we cannot maintain the current level of spending. I think it is likely we taper off rather than simply cut them wholesale, but no one really knows.

And remember, TANSTAAFL (There ain’t no such thing as a free lunch) is still an economic law. We may pay for it via lower growth and thus fewer opportunities for everyone, or inflation, other ways, or combinations thereof. That being said, doing nothing would mean an economy worse than the Great Depression. We have no good choices. We’re simply picking the best of some pretty bad choices. Ugh.

When economists talk about the shape of a recovery, relying upon the past data, my best advice is to ignore them. We are in the Stumble-Through Economy. Everything is going to be different in the future. The old playbook won’t get us out of trouble this time. Every business, every family, every investor will have to create a brand-new playbook.

Think of it this way. From time to time the gods of football change the rules. Coaches and players adapt. Now imagine every rule change of the past 40 years was enacted in one month, in the middle of the season, and the referees instructed to rigorously enforce them.

It is time to throw out the old playbook and create a whole new game plan. Nearly everything in the world is going to be repriced. Some of those changes will be minor but some will be significant. In the middle of all this, governments and central banks will to continue to change rules just to make the challenge a little more difficult.

In future letters, I will begin to explore options. I can’t promise they will all be pretty, as I know they won’t be, but they will be as real as I can make them. I can also say that some are going to be pretty fantastic. And for what it’s worth, I am in the same boat with you. Stay tuned…

Puerto Rico and Dust Bowls

I grew up on the edge of West Texas where dust storms were a regular feature. It turns out that the storms are also an annual feature in Puerto Rico, and indeed the southeast US.

For whatever meteorological reason, about this time of the year a massive amount of sand from the Sahara Desert is sucked up into the high atmosphere and gets blown across the Atlantic, over Puerto Rico, and then onto the southeast and even into Texas. The locals explained the phenomenon to me, pointing out this was a particularly bad year.

The good news is that theoretically the sand reduces the ocean temperature which may reduce the hurricane season’s severity.
It was weird to have the sun look like a bright moon at 3:00 in the afternoon in the tropics. It lasted for a few days and now is apparently reaching the mainland.sucked up into the

Source: WRAL Weather

My daughter Tiffani sent me this tweet:

Source: Twitter

One person replied, “In West Texas, we call this Tuesday.” You have to love gallows humor. And you should be following me on Twitter, and if you like this letter, go back to the top and tweet out your own comment with this link. Thanks. You have a great week!

Your making a new personal playbook analyst,

John Mauldin
Co-Founder, Mauldin Economics

How Covid-19 will change the world

The society that will emerge will probably be even less co-operative and effective

Martin Wolf

James Ferguson illustration of Martin Wolf’s column  ‘How Covid-19 will change the world’
© James Ferguson

In less than six months, Covid-19 has transformed the world. But what might its impact ultimately be? Our ignorance on this is quite comprehensive. But it is far from absolute. So let us take stock.

The world was, we must remember, troubled even before the pandemic. Only 12 years ago, the biggest financial crisis since the 1930s shook the global economy. Affected by how that was handled, the subsequent economic malaise and the perception that capitalism was rigged against them, the public in a number of high-income countries became angry.

This anger revealed itself in the UK’s Brexit referendum and the election of Donald Trump as US president in 2016. The latter, in turn, shifted the US in favour of protectionism.

This change in the American view of the world was accelerated by the transformation of China into an assertive superpower. What many have dubbed “a new cold war” began.

Then Covid-19 erupted. So what do we already know about it?

Bar chart of Forecast employment growth in 2020 (%) showing Policy differences explain the huge divergence in employment declines

We know that we are in the midst of the deepest recession in peacetime history over the past 150 years. As the World Bank’s Global Economic Prospects and the latest Economic Outlook from the OECD demonstrate, the impact is devastating, across the world. (See charts.)

The effect has not been equal, however. Some countries have been hit far more powerfully by Covid-19 than others, whether because of incompetence, indifference or ill luck. Some businesses and people have also been hit far harder than others, because their activities depend on close physical contact or because of their age or skills. This is far from the same crisis for all.

We know now that pandemics can indeed happen. We know that states at least try to take charge when they do. We know, not least, that mustering a concerted and effective global response is nigh on impossible in a world of blustering demagogues and self-confident autocrats.

We know, too that there will be economic scarring, in the form of collapsed businesses, outmoded capital and lost skills, and therefore long-term losses in output and productivity. We know, not least, that many countries will emerge from the pandemic with much higher deficits and debts than previously expected and that central banks will own huge proportions of that debt.

Line chart showing Real income per head in the median OECD economy (2019 = 100)

Yet there is also much we do not know.

We do not know when, how or even whether a vaccine or some other solution will bring the pandemic under full control. We do not know what the path of economic recovery is going to look like.

We do not know how bad the impact of the pandemic will ultimately be on trade, trade policy and international relations.

What might the world after the pandemic be like? On this we know least. But a few things seem plausible.

 Line chart showing real net productive investment in the median OECD economy (% of GDP)

A first probable development is a shift away from the globalisation of things, in favour of more (though also contested) virtual globalisation. The integration of supply chains was declining before the pandemic. Now policy is moving more strongly in that direction.

A second is the accelerated adoption of technologies that promise enhanced safety along with opportunities for greater social control. China is taking the lead. But other states are likely to feel entitled, perhaps even expected, to follow suit.

Line chart showing world trade volumes (Q4 2019 = 100)

A third is more polarised politics. The already established conflict between a more nationalist and protectionist right and a more socialist and “progressive” left seems likely to be exacerbated, at least in high-income democracies. These sides will fight over what a more assertive state should be doing.

A fourth reality is that public debt and deficits will be far greater. There will also be little tolerance for another round of “austerity” or reductions in the level or growth of public spending. A greater likelihood is higher taxes, especially on the more prosperous, and persistent deficits, financed, either explicitly or implicitly, by central banks.

The final and most important reality is dreadful international relations. China has had a surprisingly good crisis, given that this is where the virus emerged. But China is also openly autocratic and internationally assertive. Friction with a divided and enfeebled US seems set to become worse, for the indefinite future.

Column chart of Trade as a % of global GDP showing The rise and fall of trade in global value chains

In other areas, however, we are relatively ignorant. Will people go back to the lives they led before, once the disease has been brought fully under control? My guess is that they will return to restaurants, shops, offices and international travel, but not entirely. We have experienced working at home and some of it works.

Another open question is what will be done about the role and influence of the tech giants. My guess is that Facebook, Google, Amazon and the like will be brought under political control: states do not like such concentrations of private power.

And how far will the breakdown of international relations go? Will there be pervasive and systematic hostility or occasionally co-operative relations between China and the US? Where will Europe fit in?

Line chart showing % change in weekly unique visitors from previous year for selected remote meeting sites

Finally, how much of the integrated global economy will survive?

And will the crisis accelerate, retard, or leave much as it was the world’s inadequate progress towards managing the climate and other global environmental challenges?

The pandemic is creating enormous economic and political turmoil. Unless there is an early cure, the world that will emerge seems likely to be different, in important ways, and even less co-operative and effective than the one that went into it.

Yet this need not be the case. We have choices. We can always make the right ones.

The Car Industry’s $1.1 Trillion Debt Problem

Pandemic shutdowns have hit auto makers and their suppliers at a point when balance sheets were already under pressure

By Stephen Wilmot

The acute phase of the coronavirus crisis has passed for automakers. The chronic phase may be just beginning.

No auto maker has gone bust in this recession. None seems likely to either, given the ready availability of cash. The combination of ample central-bank liquidity and a functioning financial system have forestalled the kind of existential drama that rocked the industry in 2009.

But this is only good news up to a point. More cash now means more debt later—debt that manufacturers can ill afford, given the mounting cost of new technologies.

More cash now means more debt later—debt that manufacturers can ill afford. / Photo: pool new/Reuters .

As of June 16, car manufacturers and their suppliers had raised $21.7 billion in extra long-term debt as a result of the Covid shutdowns, according to calculations by consulting firm AlixPartners.

That further increases the total industry debt load to at least $1.1 trillion or 3.4 times earnings before interest, taxes, depreciation and amortization. At the end of last year the leverage multiple stood at 3.0 times.

“This downturn has been unusual because markets were open and liquid. That lowers bankruptcy risk but has implications later on,” says Mark Wakefield, co-leader of the automotive and industrial practice at AlixPartners.

This year’s shutdowns have severely aggravated an existing trend. Leverage in the car industry rose steadily in 2018 and 2019 as returns on capital fell. Massive investments in new technologies, notably electric vehicles, were the main reason—though stagnant or falling sales in the big three markets of China, the U.S. and Europe didn’t help.

The bill for EVs isn’t yet close to being paid. Before the pandemic, auto makers and suppliers had committed a total of $234 billion to electrification projects for the five-year period starting in 2020, according to Alix’s research, equivalent to roughly an entire year’s capital spending for the industry.

Some projects will probably be pushed out. With Tesla shares hitting new highs and no letup in Europe’s strict emissions regime, though, rolling out EVs will remain a top priority.

The problem with EVs isn’t just the cost of investing in new platforms and products. As Tesla’s finances demonstrate, each unit sold will also be less profitable than its gas-engined equivalent, because of the still-high cost of batteries.

That means earnings will likely come under more pressure—and leverage ratios will increase further—as EVs take a more meaningful share of industry sales. In Europe plug-ins accounted for 6.8% of first-quarter sales, up from 2.5% in the same period last year.

Many auto makers, such as General Motors, BMWand Daimler, have launched big restructuring programs in the past couple of years to recoup some of the cash flows being absorbed by new technologies.

Many have also turned to unprecedented levels of collaboration, including Ford and Volkswagen, BMW and Daimler, GM and Honda and, less happily, Renault, Nissan and Mitsubishi.The recent sales collapse injects fresh urgency into these cost-cutting efforts, which will play out over years.

Ford is the most widely held stock on the Robinhood stock-trading platform. Those betting on a V-shaped auto recovery have done nicely so far, but they shouldn’t confuse 2020 with 2009.

Back then the industry, purged by bankruptcy, had a fresh start.

This time, even the best-case scenario for sales will leave it with a lasting leverage problem.

Investors need to know when to get out.

What’s in a Recession?

After months of plummeting output and employment, the National Bureau of Economic Research has determined its official start date for the current recession in the United States. Far from being late to the disaster, the NBER is early by its usual standards – and has provided the most definitive ruling one can hope for.

Jeffrey Frankel

frankel112_Spencer PlattGetty Images_USrecessionclosedstore

CAMBRIDGE – On June 8, the Business Cycle Dating Committee of the National Bureau of Economic Research declared that economic activity in the United States had peaked in February 2020, formally marking the start of a recession. But we already knew that we were in a recession that had likely begun around that date. So, why does the NBER’s formal declaration matter?

America finds itself in the grips of two epidemics, each of which has exposed deep inequalities across races and levels of educational attainment. Between rising "deaths of despair" among working-class whites and higher COVID-19 mortality rates among African-Americans, the stunning secular decline in US life expectancy will continue.

It is no secret that measures of employment fell sharply from February to March. Real (inflation-adjusted) personal consumption expenditure (PCE) and real personal income before transfers both peaked in February as well. Official measures of GDP are released only quarterly, but the economic free-fall in late March was enough to pull first-quarter GDP growth down to an annualized rate of -4.8% (relative to the last quarter of 2019).

Though the NBER is a private non-profit research institution, its chronology holds official status, as affirmed by the US Department of Commerce’s Bureau of Economic Analysis (BEA). And every time its Business Cycle Dating Committee declares a turning point for the US economy, people wonder what took it so long.

But the four-month lag between the event and the committee’s latest declaration was the shortest since its founding in 1978. For the US economy’s ten cyclical turning points since 1980, the average time lag had been 11.7 months. The committee’s relative speediness this time is a testament to the unprecedented suddenness of the pandemic-induced collapse.

Readers are often surprised to learn that the task of declaring a recession in the US falls to a panel of economists who consider a wide variety of indicators. Most other advanced economies, after all, define a recession as simply two consecutive quarters of negative GDP growth. But the US isn’t the only country to go beyond the two-quarters rule.

The Japanese government also considers other indicators in its official business-cycle chronology. And private committees in other domains – including the eurozone, Canada, Spain, and Brazil – date business cycles by looking at a wider variety of economic indicators, though without garnering as much attention from the media or official government bodies.

In any case, the two criticisms – “why the lag?” and “why not the two-quarter rule?” – tend to be at odds with each other. GDP statistics are always gathered with a lag and subsequently revised (particularly each July, when the BEA updates its National Income and Product Accounts). Thus, to go only by the GDP numbers could require waiting even longer between the actual start of a recession and its official designation.

The NBER’s latest declaration is an example of how it helps to be free of the GDP rule. We can be confident that data from the second quarter of 2020 will show a plunge in US output that is even larger than that of the first quarter (perhaps 40% when annualized).

But this second quarter of negative growth will not be verified until the BEA’s update on July 30. And even that number will be only an advanced estimate.

The lens through which one looks at the business cycle can make a big difference over time.

Nobody questions the NBER’s ruling that there was a recession in 2001, even though the two quarters of negative GDP growth that year were not consecutive. By the same token, everyone accepts that, until recently, the longest US expansion on record was the ten-year period (120 months) from March 1991 to March 2001.

Nobody tries to claim that because the two quarters of negative growth in 2001 were not consecutive, the expansion actually lasted until December 2007 (201 months). If that were the case, the just-completed 128-month expansion (from June 2009 to February 2020) would lose its claim to being the longest US expansion on record.

The NBER’s lens also mattered in its chronology of the so-called Great Recession. When the committee declared that a recession had begun with a peak in December 2007, the US government’s estimates still showed the official GDP measure to be higher in both the first and second quarters of 2008 than in the last quarter of 2007.

The NBER’s announcement of the beginning of the recession was greeted as long overdue. Had it applied the two-quarters rule, however, it would have had to wait another year and a half for the BEA’s crucial update to the data.

Compared to the NBER’s less mechanical approach, the two-quarter rule has both pros and cons. One advantage is that a simple, transparent, and automatic procedure appears more objective than the rulings of a committee of unelected, unaccountable academic economists. A major disadvantage, however, is that insofar as GDP statistics are subject to subsequent revision, they may require a retroactive revision of the cyclical turning points.

For example, a 2011-12 “recession” in the United Kingdom was subsequently erased from the record when the official GDP numbers were updated in June 2013. Any claims that politicians, researchers, and others had made about a recession in 2012 were rendered false, even though they were issued in good faith at the time.

For this reason, before dating a trough or peak, the NBER waits until it can be reasonably sure that it will not have to revise the call in the future, after the dates have already entered the official chronology. There are already plenty of other observers trying to assess the odds of recessions like the current one in real time. The NBER committee’s priority is not to be the fastest, but to be definitive.

Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

Urban living

Great cities after the pandemic

How much harm has covid-19 done to large Western cities?

UNTIL RECENTLY big cities were unstoppable. Year after year places like New York, London and Paris grew richer and busier. Since the turn of the century they have shrugged off a dotcom crash, a financial crisis, terrorist attacks and political populism caused partly by resentment at their prosperity and arrogance. Could their magical run possibly be coming to an end?

There are reasons to worry. Covid-19 struck the most exciting, global cities hardest—the ones you find on the side of bags full of designer clothes. With 3% of America’s population, New York has suffered 19% of deaths attributed to the disease (see Briefing). One in four French deaths was in Paris and its region. Even as lockdowns lift, international travel restrictions and fear of infection will linger: London is only 15% as busy as normal.

Such quietness poses a grave threat to cities, especially the big, global ones. Much of the joy of suburban life derives from the houses and gardens that are more affordable there. The pleasure of village life is the peace and the countryside.

But cities thrive on their busy streets, restaurants and theatres, which are now quiet or closed.

That is a loss for urban consumers, and a calamity for the many people, often immigrants, who sell services.

The virus has attacked the core of what makes these cities vibrant and successful. They prosper not so much because of what they do for businesses, but because they cram together talented people who are fizzing with ideas. Americans in cities with more than 1m people are 50% more productive than those elsewhere.

But crowding people in offices and bars now seems irresponsible. And, in contrast to when Spanish flu struck a century ago, many workers have alternatives. People are learning to toil from home; some have discovered that they like it.

Facebook, until recently a heroic office-builder, has announced that it will let many employees keep working remotely even after the virus is seen off. Commercial- and residential-property markets could slump as jobs move out of cities, even if only for part of the week. High-street shops and cafés are likely to go under as they adjust to the cut in office workers, tourists and students.

If they lose people, cities will run into a fiscal crunch, too. Their income from things like hotel taxes and bus fares has evaporated. New York’s independent budget office reports “absolute gloom and uncertainty” and frets that tax revenues may fall by $9bn in the next two fiscal years. The great danger is that cities enter a spiral of budget cuts, deteriorating services, rising crime and middle-class flight. It would be the 1970s all over again.

And yet cities are stronger and more resilient than they seem. As with so much else, the fate of cities hangs on the development of treatments and vaccines. But their magic cannot be woven from afar as easily as some suppose.

Cities remain invaluable as places where people can build networks and learn how to collaborate. The brain-workers now logging into Zoom meetings from commuter towns and country cottages can do their jobs because they formed relationships and imbibed cultures in corporate offices.

Their heads are still in the city, though their feet are not. Even a socially distanced, half-full office is essential for teaching new hires how a company works. If offices facilitate chit-chat and gossip, they are functioning well. Answering emails can be done from home.

The hope is that, even if bankers and programmers stop coming into town, cities will adjust. Young people, who are at less risk from covid-19 and less worried about crime, could suddenly discover that life in the big smoke is affordable again.

To encourage that, cities need to run themselves for the post-covid era. They are already grappling with how to move millions of people when nobody wants to squeeze onto crowded buses and trains. Some have bold plans for expanded networks of bike paths, and have erected plastic barriers to encourage walkers to occupy the roads.

This is encouraging. But cities that fear commuters will drop trains and buses for private cars, clogging the roads, would do even better to manage demand by pricing driving and parking more highly.

Cities also need more autonomy. New York’s hapless mayor, Bill de Blasio, has been a poor advertisement for muscular local government. But Seoul’s world-beating coronavirus response has been organised largely by the metropolitan government and by local officials. By contrast, the mayor of London, Sadiq Khan, had to lobby the national government to insist on face masks on public transport. It agreed two months too late.

Bright lights

National governments and states will need persuading that cities should have more power, especially as many will also be begging for money. They should step back anyway. Great cities are obnoxious, but they are normally big contributors to national budgets.

And the trick they perform for their countries is not just economic. Cities are where people learn to live in a modern, open society.

They are machines for creating citizens.

More W than V

Doug Nolan

The much vaunted “V” recovery is improbable. To simplify, a somewhat “w”-looking scenario is a higher probability. After such an abrupt and extraordinary collapse in economic activity, a decent bounce was virtually assured.

Millions would be returning to work after temporary shutdowns to a substantial chunk of the U.S. services economy. There would be pent-up demand, especially for big ticket home and automobile purchases. A massive effort to develop vaccines would ensure promising headlines.

With incredible amounts of liquidity sloshing around, constructive data supporting the “V” premise was all the markets needed. The enormous scope of hedging and shorting activities back in the March and April timeframe ensured the availability of more than ample firepower to fuel a rally. An equities revival would then spur a general restoration of confidence and spending – in a self-reinforcing “V” dynamic.

Inevitably, highly speculative Bubble Markets inflated way beyond anything even remotely justified by the fundamental backdrop – actually coming to believe the “V” hype. The rapid recovery phase, however, will prove dreadfully short-lived. Scores of companies won’t survive, and millions of job losses will prove permanent.

Fearful consumers have made lasting changes in spending patterns, with many retrenching.

Tons of fiscal stimulus will be burned through with astonishing rapidity. And a raving Credit market luxuriating in Fed monetary inflation will confront Credit losses at a breadth and scale much beyond the last crisis.

My concern has been the COVID dislocation would be with us for a while. It’s surprising we haven’t seen at least some relief as summer unfolds. I was not expecting major outbreaks in Arizona, Florida, Texas and Southern California this time of year.

At this point, it’s clear that as a nation we haven’t approached pandemic risks with sufficient urgency and resolve. We all watched the crisis play out in New York and the northeast. We witnessed their “curves” brought down dramatically.

We convinced ourselves it was more of a major city issue. We watched the European “curves” drop precipitously as well. We extrapolated to the entire U.S. Human nature took over. Too many of us became impatient and dismissive.

Total U.S. new COVID infections surpassed 44,000 Friday – handily smashing Thursday’s record. From CNN: “So far, 32 states are reporting an increase in new coronavirus cases this week as compared to the prior week. Eleven of them report a 50% increase or greater.

They include Montana, Idaho, Vermont, Nevada, Arizona, Texas, Florida, Georgia, Michigan, Missouri and Mississippi” and “at least nine other states have announced they are not moving ahead to the next phase of reopening.”

According to the Washington Post, six states set record new cases Friday, with 12 posting highs for seven-day average new infections. A record 8,942 new cases were reported in Florida, 62% ahead of Wednesday’s previous daily record and a 170% rise from last Friday. Average cases are up 526% since Memorial Day (from Washington Post). The rate of new positive tests surged to an alarming 13.1%. Florida banned the sale of alcohol at bars.

Texas reported 18,000 new COVID cases in three days, with a record 6,584 suffered on Wednesday. Texas paused reopening on Thursday, and then closed bars and limited restaurant capacity to 50% on Friday. Texas’s positive test rate jumped to a worrying 11%.

Seeing a record 879 cases in one day and fearing an overwhelmed hospital system, Houston declared its highest level one emergency. Houston Mayor Sylvester Turner: “The community’s infection rate is three times higher today than it was three months ago.” There are increasing calls for a return to a statewide lockdown.

California reported 5,812 new cases Friday, with total infections surpassing 200,000. The state’s positive rate has increased to 5.3%. California governor Gavin Newsom warned his government was prepared to reinstate a state-wide lockdown. He called for counties with rising infections to consider adjusting reopening plans. San Francisco Friday delayed the next phase of reopening.

New daily records were set Friday as well in Arizona (3,428), Tennessee (1,410), Arkansas (669), Georgia (1,900), and Utah (676). The New York Times quoted Ohio Governor Mike DeWine: “This is a very dangerous time. I think what is happening in Texas and Florida and several other states should be a warning to everyone. We have to be very careful.”

June 26 – CNBC: “A JPMorgan study found that increased restaurant spending in a state predicted a rise in new infections there three weeks later. Analyst Jesse Edgerton analyzed data from 30 million Chase credit and debit card holders and from Johns Hopkins University’s case tracker. He said in-person restaurant spending was ‘particularly predictive.’”

M2 money supply surged an unprecedented $2.821 TN over the past 16 weeks - to $18.329 TN. For perspective, M2 expanded on average $641 billion annually over the past decade. For the entire decade of the nineties, M2 gained $1.484 TN. Over the past 16 weeks, Federal Reserve Assets jumped $2.841 TN. During this crisis period, M2 and Fed Assets inflated notably similar amounts.

Between September 3rd and December 10th, 2008, Federal Reserve Assets jumped $1.344 TN (to $2.25 TN). Over this period, M2 money supply expanded $466 billion to $8.217 TN – gaining about a third of the growth in Fed Assets. Moreover, Institutional Money Fund Assets (not included in M2) rose $200 billion during Q4 2008’s QE adoption – versus about a $1.0 TN surge over the past few months.

There are various factors that might explain why M2 growth (along with Institutional Money Fund assets) corresponded much more closely to the Fed’s balance sheet recently, in contrast to the 2008 crisis period. Unparalleled fiscal spending has surely played a major role in expanding bank deposits. It’s not as apparent how Washington spending has impacted Institutional Money Funds.

Analysis points to crucial differences between QE1 and the latest evolution of Fed QE operations. For starters, it was over a year between the 2007 subprime blowup and the Fed resorting to a $1.0 TN experiment QE. Stocks and corporate Credit had been correcting - speculative impulses and Bubble Dynamics had been deflating - for months prior to QE1. The maladjusted U.S. Bubble economy had already commenced restructuring.

This cycle’s dynamics are in stark contrast. The crisis – and Fed response – hit with stocks and corporate Credit just days beyond record highs. Rates were almost immediately slashed to zero - and Fed Credit was expanded almost $2.5 TN in a couple months. Speculative dynamics were quickly reenergized - speculators were further emboldened. Dysfunctional Market Structures – including the massive ETF and derivatives complexes – were reinforced.

Importantly, QE1 in 2008 worked to accommodate speculative de-leveraging. In short, holdings were shifted from various levered players (i.e. hedge funds, Lehman, Wall Street firms, banks, insurance cos., etc.) onto the Fed’s balance sheet. The Fed’s balance sheet was used to ease the deflation of a market Bubble.

There was an enormous increase in Fed Credit that offset the contraction of securities Credit used in leveraged speculation (as levered positions were unwound). As such, Fed “money printing” was not significantly boosting general liquidity in the securities markets or real economy.

This cycle has experienced profoundly different dynamics. For one, it is important to appreciate that the Fed’s recent QE program actually commenced back in September. Late-cycle “repo” market instability – an indication of problematic excess in leveraged speculation – provoked so-called “insurance” monetary inflation from the Fed. This only exacerbated speculative excess – leverage and manic trading activity – in stocks and corporate Credit, in particular.

Markets were demonstrating acute speculative excess when Wuhan went into lockdown. As the global pandemic was unleashed, U.S. stock and corporate Credit traded to all-time highs on February 19th. Crisis unfolded quickly. Marketplace illiquidity and then the Fed’s rapid adoption of massive QE ensured only modest speculative deleveraging. Instead, Trillions of QE incited a massive short squeeze, unwind of bearish hedges and a manic period of speculative excess – all in the face of an unfolding global pandemic. Incredible.

The “V” was more crazy market rationalization and speculation than reality. And with COVID cases again rising rapidly, the harsh reality of a prolonged period of economic depression is coming into clearer view. And again I’m focused on the risk of a bursting speculative Bubble – a Bubble that appears even more dangerous today than in February.

I ponder ramifications for the Fed’s latest $3 TN of QE. Rather than accommodating de-risking/deleveraging it inflated bank and money fund deposits. It exacerbated Bubbles in equities and corporate Credit. It spurred a rally that basically invalidated market hedges. It wreaked bloody havoc for all types of strategies. And as economic prospects continue to deflate, the divergence to inflated securities prices becomes only more perilous.

As we’ve witnessed, these Trillions of Fed “money” sure can get the speculative juices flowing. I’m just not so sure this “money” will support the markets during the next serious bout of de-risking/deleveraging.

The way I see it, the Fed has significantly boosted the odds of a replay of serious market illiquidity and dislocation. It’s worth noting a record $1.1 TN increase in M2 over the preceding 12 months didn’t stop markets from collapsing into illiquidity in March. Did it contribute?

Global markets remain haunted by the specter of an unwind of unprecedented speculative leverage. When markets break to the downside, there is clear potential for another episode of derivative-related selling to panic buyers.

There will be an additional bout of aggressive hedging and shorting. And Market Structure will ensure an avalanche of selling that will again completely overwhelm marketplace liquidity. And all the “money” on the sidelines will be content to remain sidelined.

A serious bout of de-risking/deleveraging will require another few Trillions of Fed liquidity support. And it’s not obvious to me which would be the more destabilizing Fed response: The Federal Reserve precipitously “printing” Trillions more “money” to pacify the markets - or their reticence to engage in another historic round of monetary inflation only months from their previous historic engagement.


The reasons behind the spectacular rally in metal prices

Quite a lot of the story seems to be about China

Too soon. That is the judgment a lot of investors apply to the recent across-the-board surge in asset prices. For it is not just the stockmarket that has rallied.

The prices of industrial raw materials have also risen sharply in the past month or so. Iron ore has increased from $80 a tonne to over $100. Copper prices are also up 25%.

This is remarkable. The global economy is only just reopening. It feels a bit early for a commodity boom.

It is tempting to see parables here. Perhaps the metals rally is a template for the post-virus economy, in which supply bottlenecks push prices up as activity gets going again. Perhaps it shows how mindlessly the ocean of liquidity created by the Federal Reserve and the European Central Bank has washed into financial markets of all kinds.

For the “too-soon” school it is a sign that optimism is running ahead of reality. Perhaps it is.

But quite a lot of the commodity story seems to be about China.

China’s role is both curious and obvious. It is curious because China’s economy is meant to have become more reliant on consumer spending and less on building booms financed by ever-larger dollops of debt.

It is obvious because, notwithstanding this stated goal, China is still the world’s biggest buyer of industrial commodities. Almost all the seaborne trade in iron ore goes there. If metal prices are going up, it is a fair bet that something is happening in China.

And so it is. Steel mills are working flat out. In the first week of June, China’s steel blast furnaces were operating at 92% of capacity. That is a good deal above the 80-85% rates considered normal.

Much of the steel manufactured in China is for buildings and for infrastructure, such as bridges, railways and subway lines. Sure enough, indicators of construction activity look strong.

Sales of excavators are up by a fifth so far this year, compared to a year earlier. A pipeline of orders had already been building before the pandemic struck. In its aftermath, construction has been given an extra push by the government’s efforts to gin up the economy.

China-watchers say lessons have been learned. There has been a greater focus than in the past on selecting worthwhile projects, says Sean Darby, a Hong Kong based analyst for Jefferies, an investment bank.

The supply response to this has been led by Australia, the world’s largest exporter of iron ore. It swiftly took steps to contain the virus at the outset. It has managed, at the same time, to keep its mines in the ore-rich Pilbara region open. Exports of ore have risen this year.

This contrasts with Brazil, where the spread of the virus has crippled production. Such bottlenecks are one reason for higher prices. And there is a bigger picture. The mining industry suffered a brutal reckoning in 2014-16, after a decade-long boom fuelled, yes, by China. Investment was cut; mines were closed; debts were paid.

The result is that the industry does not have the chronic over-capacity of many other cyclically sensitive ones—think European banks or global carmakers.

There is a speculative element to the rise in metal prices, too. Buying or selling copper futures is a popular way to express a view about the world economy. Indeed copper can be all about belief, says Max Layton of Citigroup, a bank. Many of the bets laid on it are by trading algorithms, which mechanically respond to financial signals that have worked well in the past.

The dollar, which has fallen by 6% against a basket of currencies since March, is usually part of the semaphore. A weaker dollar allows for easier terms of finance in emerging markets.

Anything that helps emerging-market economies is generally good for commodity prices. So the algorithms buy.

The complex of price changes becomes self-reinforcing. Higher ore prices bring higher-cost producers back to the market. But their profit margins are then squeezed as their home currency appreciates, because that raises the cost of labour in dollars, in which commodities are priced.

To restore margins, prices must go up. Moreover, marginal costs rise when the prices of steel (used for mining parts) and oil (used for energy and chemicals) go up. These higher costs push up prices further, says Mr Layton.

A pattern in markets is that a lot happens by rote. China’s response to a weak economy is to build; investors’ response to the Fed’s easing is to buy stocks; the algorithms’ response to a weaker dollar is to buy commodities.

Higher prices beget higher prices. The sceptics, the too-sooners, note that this also works in reverse. Quite so. But the momentum is now with the believers.