Schumpeter's Business Cycle Analysis

Doug Nolan

The work of the great economist Joseph Schumpeter (1883-1950) has always resonated. When I ponder analytical frameworks pertinent to these extraordinary times, none are more germane than Schumpeter’s Business Cycle Analysis.

Best known for “creative destruction,” Schumpeter’s seminal work materialized after experiencing the spectacular “Roaring Twenties” boom collapse into the Great Depression.

Contrary to Milton Friedman and Ben Bernanke, Schumpeter didn’t view the twenties as the “golden age of Capitalism.” Depression was a consequence of egregious boom-time excess rather than the Fed’s post-crash failure to print sufficient money. Schumpeter possessed a deep understanding of Credit; he keenly appreciated the roles entrepreneurship and risk-taking played during booms. Schumpeter also understood Capitalism’s vulnerabilities.

“Whenever a new production function has been set up successfully and the trade beholds the new thing done and its major problems solved, it becomes much easier for other people to do the same thing and even to improve upon it. In fact, they are driven to copying it if they can, and some people will do so forthwith.

It should be observed that it becomes easier not only to do the same thing, but also to do similar things in similar lines… This seems to offer perfectly simple and realistic interpretations of two outstanding facts of observation: First, that innovations do not remain isolated events, and are not evenly distributed in time, but that on the contrary they tend to cluster, to come about in bunches, simply because first some, and then most, firms follow in the wake of successful innovation; second, that innovations are not at any time distributed over the whole economic system at random, but tend to concentrate in certain sectors and their surroundings.” Joseph A. Schumpeter, Business Cycles, 1939

“The American debt situation and the American bank epidemics… are in a class by themselves. Given the way in which both firms and households had run into debt during the twenties, the accumulated load… was instrumental in precipitating depression. In particular, it set into motion a vicious spiral within which everybody’s efforts to reduce that loan for a time, only availed to increase it.

There is thus no objection to the debt-deflation theory of the American crisis, provided it does not mean more than this. The element it stresses is part of the mechanism of any serious depression. But increase of total indebtedness at the rate at which it had occurred in this country is neither a normal element of the mechanisms of Kondratieff downgrades nor in itself an ‘understandable’ incident, like speculative excesses and the debts induced by these.

It must be attributed to the humor of the times, to cheap money policies, and to the practices of concerns eager to push their sales; and it enters the class of understandable incidents only if we include specifically American conditions among our data. Similarly, bank failures are of course very regular occurrences in the course of any major crisis and invariably an important cause of secondary phenomena…

Those epidemics cannot, however, be considered as wholly explained by the ordinary mechanism of crises or by the mechanism plus the fact of excessive indebtedness all round or even by all that plus the stock exchange crash.

The American epidemics become fully understandable only if account be taken of the weaknesses peculiar to the American banking structure…” Joseph A. Schumpeter, Business Cycles, 1939

We live in extraordinary, unprecedented times.

The timing of the COVID-19 pandemic – on the heels of an unparalleled period of synchronized global economic growth, a record-setting U.S. economic expansion, and worldwide financial and asset price booms – ensures far-reaching financial, economic, social, political and geopolitical ramifications.

COVID Strikes Mercilessly at Peak Fragility.

Fragilities have been mounting across economic and financial systems – at home and abroad.

The pandemic is pushing many over the edge. Not only are central banks and governments fighting the effects of the coronavirus, they are these days in epic battle against Business Cycle Dynamics.

In particular, bursting Bubbles have central banks more determined than ever to do “whatever it takes” to fulfill their so-called “price stability” mandate.

There were deflation worries following the 1987 stock market crash. Deflationary risks were key to the Greenspan Fed’s aggressive early-nineties stimulus measures (and championing of “Wall Street finance”).

Global deflation fears were acute during the 1997 bursting of the “Asian Tiger Bubbles” and even more so the next year with the Russia/LTCM collapse. Dr. Bernanke joined the Fed in 2002 after the “tech” Bubble collapse, as the Fed formulated a major push against the scourge of deflation. After the bursting of the mortgage finance Bubble, global bazookas were mobilized for an all-out assault against deflationary forces.

Of late, a nuclear arsenal has supplanted the impotent bazookas. I’m convinced policymakers are “fighting the last war” with perilously misguided armaments. The Schumpeterian framework supports my case.

The past 25 years accomplished the greatest period of innovation and technological advancement since the “Roaring Twenties.”

Concurrently, the world experienced an unparalleled period of financial innovation – specifically a historic shift from traditional bank lending to a system dominated by market-based finance and central bank intervention.

Real economy innovation fueled finance, and financial excess stoked entrepreneurship and risk-taking. In combination, innovation in both real economies and finance fueled historic changes in financial and economic structure.

The Federal Reserve has essentially employed highly accommodative monetary policy for the past thirty years. After beginning the nineties at about 450, the Nasdaq Composite traded this past February to an all-time high 9,838 (closing Friday at 9,121).

Except for a few fleeting periods of instability, free-flowing finance has supported (“cluster” upon historic “cluster” of) innovation. The Credit expansion has been unrelenting, with Non-Financial Debt surging from $10.5 TN to begin the nineties to today’s $55 TN.

Central bankers are these days keener than ever to fixate on their inflation mandate and targets. That inflation dynamics have evolved profoundly over recent decades is apparently not worthy of discussion. The impetus is to stimulate more aggressively than ever.

Schumpeterian “clusters” – explosive innovation and adoption of new technologies - have altered the nature of contemporary output, economic structure and inflation dynamics. The incredible expansion of technology hardware, software, digitized output and related services fundamentally altered the economy’s structural capacity to readily expand the supply of output.

What started with the low-cost personal computers mushroomed with the adoption of the Internet. A decade of unprecedented monetary stimulus and booming markets saw frenzied multiplication of innovation “clusters” (i.e. Internet-based products, “cloud”-related services, “Internet of things,” robotics, biotech and pharmaceuticals, alternative energy, the “sharing economy,” autonomous vehicles, and so on).

Technological innovation and adoption help explain why aggressive monetary stimulus and system-wide “loose money” have not been associated with higher consumer price inflation. A veritable endless supply of “tech” output readily absorbs whatever additional purchasing power finding its way into the real economy.

Meanwhile, mounting Credit and speculative excess primarily fueled inflation in asset prices and Bubbles. Moreover, this combination of booming Credit and asset markets provided major impetus to U.S. economic structural mutation.

Deindustrialization took root, with American manufacturing suffering at the hands of cheaper imports. Meanwhile, booming financial markets and surging household wealth propelled a structural shift to a services-based economy.

A confluence of U.S. financial innovation and excess, policy experimentation, economic restructuring and resulting massive Current Account Deficits propelled “globalization” – and, with it, systemic Global Bubble Dynamics. In the process, inflation dynamics were fundamentally and momentously transformed.

If things seem too good to be true, they probably are. There are critical issues associated with current inflation, financial, economic and policy structures. The COVID-19 pandemic is illuminating many.

Let’s start with inflation.

With global Bubbles bursting, there will be associated downward pressures on some price levels (i.e. energy and commodities). Demand will wane for many products and services. Yet broken supply chains are pushing some prices higher.

Meanwhile, the world is afflicted by unprecedented debt burdens.

Central bankers are fully committed to doing “whatever it takes” to drive aggregate consumer inflation up to target. The nature of inflation has evolved profoundly, yet central banks adhere to the doctrine of a general price level that they can manipulate higher through monetary stimulus.

This capacity for policy measures to inflate THE general price level is fundamental to the view that consequences of Credit excess and market Bubbles can be readily mitigated. And this gets the heart of this dangerous flaw in contemporary economic doctrine: that boomtime Credit and financial excess can, for the most part, be disregarded.

Asset inflation and Bubbles are to be ignored (promoted?), focusing instead on preparation for aggressive faltering-Bubble reflationary measures.

In reality, deflation is a symptom – a consequence.

The problem is excessive debt, speculative leverage, asset market Bubbles and deep economic structural maladjustment. There is today no general price level to manipulate higher to inflate out of debt and structural problems.

Aggressive reflationary efforts will instead only add to unmanageable debt loads, while further straining financial and economic structures. As we’re already witnessing,

Trillions of Fed “money” creation ensure market and price level instabilities.

Moreover, stimulus measures at this point dangerously exacerbate wealth inequality, along with social, political and geopolitical instability.

From the New York Times (Nelson D. Schwartz, Ben Casselman and Ella Koeze): “People with the least education have been hardest hit in the downturn… The unemployment rate for workers without a high school diploma stood at 21.2% in April, compared with 8.4% for those with a college degree… Workers earning under $15 an hour account for more than one-third of job losses, far beyond their share of the work force.”

And from the Washington Post (Heather Long): “What’s clear so far is that Hispanics, African-Americans and low-wage workers in restaurants and retail have been the hardest hit by the job crisis. Many of these workers were already living paycheck-to-paycheck and had the least cushion before the pandemic hit. ‘Low-wage workers are experiencing their own Great Depression right now,’ said Ahu Yildirmaz, co-head of the ADP Research Institute… The unemployment rate in April jumped to a record 18.9% for Hispanics, 16.7% for African-Americans and 14.2% for whites.”

We’re witnessing a down-cycle at Pandemic Mach One. Twenty million jobs lost in April. Yet the S&P500 returned almost 13% during the month.

The Nasdaq Composite surged 15.5%. Much would remain ambiguous in a typically gradual downturn.

No so with COVID-19. There are no subtleties and little complexity– it’s clear for all to see.

How can much of society not be convinced Federal Reserve support primarily benefits Wall Street and the wealthy?

If you are employed in the service sector, odds are you’re facing terrible hardship. If you are fortunate enough to work for Amazon, Microsoft, Google, Apple, Tesla, Netflix, Zoom, or most tech or biotech companies – with your stock and option grants you’ve likely rarely done better.

Covid-19 is laying bare the stark inequity of the current structure. The “trickle down” argument, having remained tenable during the long boom, has in six weeks been blown completely out of the water. “Dow Ends Week 455 Points Higher, Shaking off the Worst U.S. Unemployment Rate Since the Great Depression.”

Federal Reserve Credit rose another $65.5bn last week to a record $6.664 TN, pushing the nine-week gain to a staggering $2.519 TN. M2 “money supply” (with a week’s lag) expanded another $333bn, with a nine-week rise of $2.059 TN. Institutional Money Fund Assets (not included in M2) added $25bn, boosting its nine-week expansion to $946bn.

Meanwhile, a magnitude 5.2 earthquake struck this week along the European Fault Line.

May 6 – UK Telegraph (Ambrose Evans-Pritchard): “Germany’s top court has fired a cannon shot across the bows of the European Central Bank and accused the European Court of breaching EU treaty law, marking an epic clash of rival judicial supremacy.

In an explosive judgement, the German constitutional court ruled that the ECB had exceeded its legal mandate and ‘manifestly’ breached the principle of proportionality with mass bond purchases, now topping €2.2 trillion and set to rise dramatically.

The bank had strayed from the monetary realm into broad economic policy-making. The court said the German Bundesbank may continue to buy bonds during a three-month transition but must then desist from any further role in the ‘implementation and execution’ of the offending measures, until the ECB can justify its actions and meet the court’s objections. It also said the Bundesbank must clarify how it is going to sell the bonds it already owns.

‘For the first time in history, the constitutional court has found that the actions and decisions of European bodies overstep their legitimate competence, and therefore have no validity in Germany,’ said the court’s president, Andreas Vosskuhle.

No country has dared to do this before since the creation of the Community in 1957. It is a revolutionary moment for the European project. Olaf Scholz, the German finance minister, said the court had set ‘very clear boundaries’ and that Europe would henceforth have to find other ways to keep monetary union on the road.”

May 5 – Bloomberg (Stephanie Bodoni): “The European Union’s top court faced the most stinging attack in its 68-year history -- not from Brexiteers, but from its German counterpart. In a long-awaited ruling on the European Central Bank’s quantitative easing program, Germany’s constitutional court in Karlsruhe accused the EU Court of Justice of overstepping its powers when it backed the ECB’s controversial policy.

The German court said the EU judges’ December 2018 ruling that QE was in line with EU rules was ‘objectively arbitrary’ and is ‘methodologically no longer justifiable.’ It gave the ECB a three-month ultimatum to fix flaws in the measure. ‘This is a declaration of war on the ECJ, and it will have consequences,’ said Joachim Wieland, a law professor at the University of Administrative Sciences, who sees the real challenge in the future relationship between the EU court and national constitutional tribunals. ‘It’s an invitation for other countries to simply ignore decisions that they don’t like.’”

May 8 – Reuters (Gabriela Baczynska): “The European Union’s top court said on Friday it alone has the power to decide whether EU bodies are breaching the bloc’s rules, in a rebuke to Germany’s highest court, which this week rejected its judgment approving the ECB’s trillion-euro bond purchases… ‘In order to ensure that EU law is applied uniformly, the Court of Justice alone – which was created for that purpose by the member states – has jurisdiction to rule that an act of an EU institution is contrary to EU law,’ the court said in a statement.”

May 7 – Financial Times (Martin Arnold): “Christine Lagarde has fended off criticism of the European Central Bank’s government bond purchases, saying she was ‘undeterred’ by an order from Germany’s highest court to produce a justification of its action. Speaking publicly for the first time since its flagship bond-buying policy was challenged by the German constitutional court, the ECB president said the pandemic meant the Frankfurt-based institution — as well as other central banks — ‘have to go beyond the normal tools to use exceptional measures . . . to avoid a tightening [of financing costs] and to ensure our monetary policy is transmitted across the euro area’. ‘We are an independent institution, answerable to the European Parliament, and driven by our mandate,” she said… ‘We will continue to do whatever is needed, whatever is necessary, to deliver on that mandate. Undeterred.’”

Christine Lagarde is undeterred. For the most part, markets remain undeterred (though European yields rose this week).

Likely business as usual for the Bundesbank for the next three months. But then significant uncertainty.

Once again, COVID-19 timing is awe-inspiring.

While Germany’s Constitutional Court ruled previous QE was not categorically illegal monetary financing, the latest $800 billion Pandemic Emergency Purchase Program (PEPP) clearly crosses the line.

Things appear headed in the direction of a real mess. Timing unclear.

German Constitutional Court vs. European Court of Justice (ECJ). Additional lawsuits out of Germany challenging “whatever it takes” PEPP ECB QE. Other national courts – and governments – emboldened to flaunt sovereignty and challenge a weakened European Union.

Germany’s Bundesbank is in a tough spot, split between the German Constitutional Court (along with its sound money principles) and its role as the largest member of the ECB.

Does the ECB continue “disproportional” support for Italian debt markets, inviting a confrontation with Germany’s Constitutional Court?

Does the Italian debt market begin fretting a world with less certainty of unlimited ECB buying?

This week saw a meaningful chink in the armor of European monetary integration.

“It is of the utmost importance to realize this: given the actual facts which it was then possible for either businessman or economists to observe, those diagnoses – or even the prognosis that, with the existing structure of debt, those facts plus a drastic fall in price level would cause major trouble but that nothing else would – were not simply wrong.

What nobody saw, though some people may have felt it, was that those fundamental data from which diagnoses and prognoses were made, were themselves in a state of flux and that they would be swamped by the torrents of a process of readjustment corresponding in magnitude to the extent of the industrial revolution of the preceding 30 years.

People, for the most part, stood their ground firmly.

But that ground itself was about to give way.”

Joseph A. Schumpeter, Business Cycles, 1939

US banks pull back from lending to European companies

JPMorgan, Goldman and BofA have become more cautious over loans, say executives and bankers

Olaf Storbeck in Frankfurt, Stephen Morris in London and Laura Noonan in New York

Bank of America lent half as much as the other six international banks that underwrote a €3bn state-backed loan to sportswear giant Adidas
Bank of America lent half as much as the other six international banks that underwrote a €3bn state-backed loan to sportswear giant Adidas © Reuters

US banks are pulling back from lending to European companies during the coronavirus pandemic, fuelling concerns that Wall Street may be quietly withdrawing to its home market in a repeat of the last financial crisis.

Bankers, advisers and company executives said American lenders had become more cautious in underwriting bilateral and syndicated loans to large corporate clients across the region in recent weeks.

In Germany, JPMorgan recently pulled out of talks over an additional credit line for BASF, the world’s largest chemicals group, according to people involved in the transaction. Similarly, Bank of America lent half as much as the other six international banks that underwrote a €3bn state-backed loan to sportswear giant Adidas.

Goldman Sachs — which helped underwrite a €3.5bn syndicated loan for Italian-American carmaker Fiat Chrysler this month — did not take part in a similar €12bn facility for German rival and long-standing client Daimler, leaving other lenders to make up the difference.
 “We are increasingly observing an ‘America first’ attitude among large US banks,” said an adviser directly involved in negotiations between banks and corporates in Germany. “Those are not just idiosyncratic cases: there is a clear pattern.”

In the first quarter, the five large US banks’ combined market share in syndicated loans in Germany fell by more than a third to 14.6 per cent, according to Refinitiv data. This period captures only the start of the pandemic.

“Every bank is under the cosh of its national regulators, who in times of crisis show a huge home bias,” said Jan Pieter Krahnen, director of the Center for Financial Studies at the University of Frankfurt. “This heavily influences risk management and regional exposure, which comes at the expense of clients abroad.”

The trend has attracted the attention of European regulators. “We have received many signals that foreign lenders are starting to retreat from the German market,” said a senior supervisory official. “We cannot force them to lend.”

In the UK, JPMorgan pulled out of a recent £324m debt and equity rescue package for airport concession operator SSP, despite being the company’s corporate broker. Only British banks were left in the consortium.

At events and publishing group Informa, JPMorgan and BofA turned down a request for a short-term loan and were not among underwriters on a £1bn share placement, even though the latter had been broker to the UK company for 10 years. BofA also turned down a potential capital raise for struggling cinema chain Cineworld.
 The decline in lending has caused concerns in Europe about the reliability of US banks in a crisis. One reason Berlin politicians last year endorsed merger talks between Deutsche Bank and domestic rival Commerzbank was the desire for a “national champion” that would continue to lend at times of stress.

German companies that want to tap large government-backed loans are in a particular bind because they need the support of their existing lending group to access funds from state-owned development bank KfW.

KfW can shoulder as much as 80 per cent of new syndicated loans. But KfW insists private-sector banks take on the remaining 20 per cent, as well as guaranteeing existing credit lines, which need to be drawn first.

“If one bank in an existing consortium steps out of line, it’s not only that the others have to fill in the blank, but some of them may also start to get second thoughts,” said one person familiar with such negotiations.

While travel group Tui and sportswear maker Adidas have secured big state-backed syndicated loans, as many as 20 different blue-chip companies are still in talks, said people familiar with the negotiations.

Negotiations over a KfW-backed syndicated loan for steelmaker Thyssenkrupp have been held up, waiting for commitments from JPMorgan and Goldman, according to two people familiar with the matter. Thyssenkrupp declined to comment.

BofA, Goldman Sachs and JPMorgan declined to comment on specific clients, but stressed they had increased lending globally in recent weeks. While the data shows BofA’s share of syndicated loans has declined, the US bank pointed out it ranked second in league tables of euro-denominated bonds since March 18, when debt markets reopened after the initial coronavirus shock.

JPMorgan said: “We extended over $25bn in new credit to clients in March alone, and nearly half of that was in Europe. Our commitment to companies in the region remains unwavering.”

Senior US bank executives said that compared with American clients, European companies had drawn down more of their credit lines, reducing banks’ appetite for further lending. They also typically wanted to borrow money over longer time horizons whereas US companies saw bank loans more as a “bridge to markets”.

A European executive at a US bank said: “We have the same standards and procedures for all of our clients, and geography does not play any role.” However, the executive added that profit margins on loans were much higher in the US than in Europe, demand for credit was rocketing everywhere and that banks’ balance sheets were an increasingly scarce resource. “Every credit decision needs to be properly justified internally.”

Some US bankers said European lenders were acting “recklessly”, loading up their weak balance sheets with more risky loans that could turn into problems in years to come.

“I don’t understand why the Europeans want to do these things,” said a senior investment banker.

This Is the Future of the Pandemic

Covid-19 isn’t going away soon. Two recent studies mapped out the possible shapes of its trajectory.

By Siobhan Roberts

Circles at Gare du Nord train station in Paris marked safe social distances on Wednesday.Credit...Ian Langsdon/EPA, via Shutterstock

By now we know — contrary to false predictions — that the novel coronavirus will be with us for a rather long time.

“Exactly how long remains to be seen,” said Marc Lipsitch, an infectious disease epidemiologist at Harvard’s T.H. Chan School of Public Health. “It’s going to be a matter of managing it over months to a couple of years. It’s not a matter of getting past the peak, as some people seem to believe.”

A single round of social distancing — closing schools and workplaces, limiting the sizes of gatherings, lockdowns of varying intensities and durations — will not be sufficient in the long term.

In the interest of managing our expectations and governing ourselves accordingly, it might be helpful, for our pandemic state of mind, to envision this predicament — existentially, at least — as a soliton wave: a wave that just keeps rolling and rolling, carrying on under its own power for a great distance.

The Scottish engineer and naval architect John Scott Russell first spotted a soliton in 1834 as it traveled along the Union Canal. He followed on horseback and, as he wrote in his “Report on Waves,” overtook it rolling along at about eight miles an hour, at thirty feet long and a foot or so in height. “Its height gradually diminished, and after a chase of one or two miles I lost it in the windings of the channel.”

The pandemic wave, similarly, will be with us for the foreseeable future before it diminishes. But, depending on one’s geographic location and the policies in place, it will exhibit variegated dimensions and dynamics traveling through time and space.

“There is an analogy between weather forecasting and disease modeling,” Dr. Lipsitch said.

Both, he noted, are simple mathematical descriptions of how a system works: drawing upon physics and chemistry in the case of meteorology; and on behavior, virology and epidemiology in the case of infectious-disease modeling. Of course, he said, “we can’t change the weather.”

But we can change the course of the pandemic — with our behavior, by balancing and coordinating psychological, sociological, economic and political factors.

Dr. Lipsitch is a co-author of two recent analyses — one from the Center for Infectious Disease Research and Policy at the University of Minnesota, the other from the Chan School published in Science — that describe a variety of shapes the pandemic wave might take in the coming months.

The Minnesota study describes three possibilities:

Scenario No. 1 depicts an initial wave of cases — the current one — followed by a consistently bumpy ride of “peaks and valleys” that will gradually diminish over a year or two.
Scenario No. 2 supposes that the current wave will be followed by a larger “fall peak,” or perhaps a winter peak, with subsequent smaller waves thereafter, similar to what transpired during the 1918-1919 flu pandemic.

Scenario No. 3 shows an intense spring peak followed by a “slow burn” with less-pronounced ups and downs.

The authors conclude that whichever reality materializes (assuming ongoing mitigation measures, as we await a vaccine), “we must be prepared for at least another 18 to 24 months of significant Covid-19 activity, with hot spots popping up periodically in diverse geographic areas.”

In the Science paper, the Harvard team — infectious-disease epidemiologist Yonatan Grad, his postdoctoral fellow Stephen Kissler, Dr. Lipsitch, his doctoral student Christine Tedijanto and their colleague Edward Goldstein — took a closer look at various scenarios by simulating the transmission dynamics using the latest Covid-19 data and data from related viruses.

The authors conveyed the results in a series of graphs — composed by Dr. Kissler and Ms. Tedijanto — that project a similarly wavy future characterized by peaks and valleys.

One figure from the paper, reinterpreted below, depicts possible scenarios (the details would differ geographically) and shows the red trajectory of Covid-19 infections in response to “intermittent social distancing” regimes represented by the blue bands.

Social distancing is turned “on” when the number of Covid-19 cases reaches a certain prevalence in the population — for instance, 35 cases per 10,000, although the thresholds would be set locally, monitored with widespread testing.

It is turned “off” when cases drop to a lower threshold, perhaps 5 cases per 10,000. Because critical cases that require hospitalization lag behind the general prevalence, this strategy aims to prevent the health care system from being overwhelmed.

The green graph represents the corresponding, if very gradual, increase in population immunity.

“The ‘herd immunity threshold’ in the model is 55 percent of the population, or the level of immunity that would be needed for the disease to stop spreading in the population without other measures,” Dr. Kissler said.

Another iteration shows the effects of seasonality — a slower spread of the virus during warmer months. Theoretically, seasonal effects allow for larger intervals between periods of social distancing.

This year, however, the seasonal effects will likely be minimal, since a large proportion of the population will still be susceptible to the virus come summer. And there are other unknowns, since the underlying mechanisms of seasonality — such as temperature, humidity and school schedules — have been studied for some respiratory infections, like influenza, but not for coronaviruses. So, alas, we cannot depend on seasonality alone to stave off another outbreak over the coming summer months.

Yet another scenario takes into account not only seasonality but also a doubling of the critical-care capacity in hospitals. This, in turn, allows for social distancing to kick in at a higher threshold — say, at a prevalence of 70 cases per 10,000 — and for even longer breaks between social distancing periods:

What is clear overall is that a one-time social distancing effort will not be sufficient to control the epidemic in the long term, and that it will take a long time to reach herd immunity.

“This is because when we are successful in doing social distancing — so that we don’t overwhelm the health care system — fewer people get the infection, which is exactly the goal,” said Ms. Tedijanto. “But if infection leads to immunity, successful social distancing also means that more people remain susceptible to the disease. As a result, once we lift the social distancing measures, the virus will quite possibly spread again as easily as it did before the lockdowns.”

So, lacking a vaccine, our pandemic state of mind may persist well into 2021 or 2022 — which surprised even the experts.

“We anticipated a prolonged period of social distancing would be necessary, but didn’t initially realize that it could be this long,” Dr. Kissler said.

Uppers and downers

A perky stockmarket v a glum economy

Explaining the stockmarket rally

FINANCIAL MARKETS look forward. Yesterday’s news is stale. What matters is the future, in particular the returns that today’s buyer of securities can expect.

So there is some reason to think the S&P 500 share index might trace the near future of America’s economy.

Share prices in America have followed a dramatic V-shape recently. A brutal sell off has given way to a lively recovery (chart 1).

Yet a V-shaped path for the economy—a brief recession, followed by a swift recovery—seems unlikely.

The scale of job losses suggests the economy is in a hole too deep to climb out of quickly. Claims for unemployment insurance have dwarfed peaks in previous recessions (chart 2).

So why has the stockmarket rallied so hard?

In part this reflects the Federal Reserve’s efforts to backstop the economy. It has bought bonds on an unprecedented scale, swelling its balance-sheet (chart 3).

Bond yields have also become even paltrier (chart 4). Equities are appealing, if only by comparison.

The pattern of share-price changes is revealing.

America’s have risen faster than Europe’s.

The industry make-up of each market explains much of this. Europe’s bourses are weighed down by cyclical industries—banks, carmakers and energy companies.

America’s has a bigger tilt toward technology companies, the relative winners of the covid-19 crash.

The five largest tech stocks continue to be market darlings (chart 5).

Healthcare stocks and consumer staples have also proved resilient (chart 6).

Investors are not looking much beyond stocks they judge to be recession-proof.

The market’s recent “V” is not for victory.

Jobless Numbers Are ‘Eye-Watering’ but Understate the Crisis

With 4.4 million added last week, the five-week total passed 26 million. The struggle by states to field claims has hampered economic recovery.

By Patricia Cohen

An unemployment office in Arkansas. State agencies have scrambled to deal with a deluge of claims.Credit...Houston Cofield for The New York Times

Nearly a month after Washington rushed through an emergency package to aid jobless Americans, millions of laid-off workers have still not been able to apply for those benefits — let alone receive them — because of overwhelmed state unemployment systems.

Across the country, states have frantically scrambled to handle a flood of applications and apply a new set of federal rules even as more and more people line up for help. On Thursday, the Labor Department reported that another 4.4 million people filed initial unemployment claims last week, bringing the five-week total to more than 26 million.

“At all levels, it’s eye-watering numbers,” Torsten Slok, chief international economist at Deutsche Bank Securities, said. Nearly one in six American workers has lost a job in recent weeks.

Delays in delivering benefits, though, are as troubling as the sheer magnitude of the figures, he said. Such problems not only create immediate hardships, but also affect the shape of the recovery when the pandemic eases.

Laid-off workers need money quickly so that they can continue to pay rent and credit card bills and buy groceries. If they can’t, Mr. Slok said, the hole that the larger economy has fallen into “gets deeper and deeper, and more difficult to crawl out of.”

Hours after the Labor Department report, the House passed a $484 billion coronavirus relief package to replenish a depleted small-business loan program and fund hospitals and testing. The Senate approved the bill earlier this week.

Even as Congress continues to provide aid, distribution has remained challenging. According to the Labor Department, only 10 states have started making payments under the federal Pandemic Unemployment Assistance program, which extends coverage to freelancers, self-employed workers and part-timers. Most states have not even completed the system needed to start the process.

Ohio, for example, will not start processing claims under the expanded federal eligibility criteria until May 15. Recipients whose state benefits ran out, but who can apply for extended federal benefits, will not begin to have their claims processed until May 1.

Pennsylvania opened its website for residents to file for the federal program a few days ago, but some applicants were mistakenly told that they were ineligible after filling out the forms. The state has given no timetable for when benefits might be paid.

Reports of delays, interruptions and glitches continue to come in from workers who have been unable to get into the system, from others who filed for regular state benefits but have yet to receive them, and from applicants who say they have been unfairly turned down and unable to appeal.

Florida has paid just 17 percent of the claims filed since March 15, according to the state’s Department of Economic Opportunity.

“Speed matters” when it comes to government assistance, said Carl Tannenbaum, chief economist at Northern Trust. Speed can mean the difference between a company’s survival and its failure, or between making a home mortgage payment and facing foreclosure.

There is “a race between policy and a pandemic,” Mr. Tannenbaum said, and in many places, it is clear that the response has been “very uneven.”

Using data reported by the Labor Department for March 14 to April 11, the Economic Policy Institute, a liberal research group, estimated that seven in 10 applicants were receiving benefits. That left seven million other jobless workers who had filed claims but were still waiting for relief.

States manage their own unemployment insurance programs and set the level of benefits and eligibility rules. Now they are responsible for administering federal emergency benefits that provide payments for an additional 13 weeks, cover previously ineligible workers and add $600 to the regular weekly check.

So far, 44 states have begun to send the $600 supplement to jobless workers who qualified under state rules, the Labor Department said. Only two — Kentucky and Minnesota — have extended federal benefits to workers who have used up their state allotment.

With government phones and websites clogged and drop-in centers closed, legal aid lawyers around the country are fielding complaints from people who say they don’t know where else to turn.

“Our office has received thousands of calls,” said John Tirpak, a lawyer with the Unemployment Law Project, a nonprofit group in Washington.

People with disabilities and nonnative English speakers have had particular problems, he said.

Even those able to file initially say they have had trouble getting back into the system as required weekly to recertify their claims.

Colin Harris of Marysville, Wash., got a letter on March 31 from the state’s unemployment insurance office saying he was eligible for benefits after being laid off as a quality inspector at Safran Cabin, an aerospace company. He submitted claims two weeks in a row and heard nothing. When he submitted his next claim, he was told that he had been disqualified. He has tried calling more than 200 times since then, with no luck.

“And that’s still where I am right now,” he said, “unable to talk to somebody to find out what the issue is.” If he had not received a $1,200 stimulus check from the federal government, he said, he would not have been able to make his mortgage payment.

Last week’s tally of new claims was lower than each of the previous three weeks. But millions of additional claims are still expected to stream in from around the country over the next month, while hiring remains piddling.

States are frantically trying to catch up. California, which has processed 2.7 million claims over the last four weeks, opened a second call center on Monday. New York, which has deployed 3,100 people to answer the telephone, said this week that it had reduced the backlog that accumulated by April 8 to 4,305 from 275,000.

Florida had the largest increase in initial claims last week, although the state figures, unlike the national total, are not seasonally adjusted. That increase could be a sign that jobless workers finally got access to the system after delays, but it is impossible to assess how many potential applicants have still failed to get in.

The 10 states that have started making Pandemic Unemployment Assistance payments to workers who would not normally qualify under state guidelines are Alabama, Colorado, Iowa, Kentucky, Louisiana, Massachusetts, Rhode Island, Tennessee, Texas and Utah.

Pain is everywhere, but it is most widespread among the most vulnerable.

In a survey that the Pew Research Center released on Tuesday, 52 percent of low-income households — below $37,500 a year for a family of three — said someone in the household had lost a job because of the coronavirus, compared with 32 percent of upper-income ones (with earnings over $112,600). Forty-two percent of families in the middle have been affected as well.

Those without a college education have taken a disproportionate hit, as have Hispanics and African-Americans, the survey found.

An outsize share of jobless claims have also been filed by women, according to an analysis from the Fuller Project, a nonprofit journalism organization that focuses on women.

Josalyn Taylor, 31, learned that she was out of a job on March 16. “I clocked in at 3 o’clock, and by 3:30 my boss called me and told me we were going to shut down for three weeks,” said Ms. Taylor, an assistant manager at Cicis Pizza in Galveston, Tex. The restaurant has yet to reopen.

Two days later, she applied for unemployment insurance, but she kept receiving a message that a claim was already active for her Social Security number and that she could not file. She has tried to clear up the matter hundreds of times — online, by phone and through the Texas Workforce Commission’s site on Facebook — with no luck.

“I used my stimulus check to pay my light bill, and I’m using that to keep groceries and stuff in the house,” said Ms. Taylor, who is five months pregnant. “But other than that, I don’t have any other income, and I’m almost out of money.”

The first wave of layoffs most heavily whacked the restaurant, travel, personal care, retail and manufacturing industries, but the damage has spread to a much broader range of sectors.

At the online job site Indeed, for example, postings for software development jobs are down nearly 30 percent from last year, while listings for finance and banking openings are down more than 40 percent.

New layoffs are expected to ease over the next couple of months, but the damage to the economy is likely to last much longer. In a matter of weeks, the shutdown has more than erased 10 years of net job gains — more than 19 million jobs.

Health and education are going to revive relatively quickly, said Rick Rieder, chief investment officer for global fixed income at BlackRock, but leisure and hospitality are going to take a lot longer.

“A lot of the people who have been furloughed won’t come back,” he said. “Companies will either close or decide not to take back those workers.”

Over the past decade, the employment landscape has shifted substantially as new types of jobs have appeared and old categories have disappeared. The U.S. economy, Mr. Rieder said, is “going to go through another period of evolution.”

Tara Siegel Bernard contributed reporting.

Don’t Try to Prepare for the Next Black Swan. You Can’t.

In the age of Covid-19, companies that amassed cash buffers and investors who insured against a market drop are looking smart. The risk is they start believing they can predict the unpredictable.

By Jon Sindreu

Illustration: Mikel Jaso

Covid-19 has posed a mind-bending question for companies, investors and policy makers: How to protect against the next extreme “black swan” event?

The temptation to find a concrete answer is best resisted.

This is the financial teaser at the heart of political questions such as whether airlines are victims of the pandemic or undeserving recipients of taxpayer money.

Last week, U.S. carriers reached an agreement to receive $25 billion in grants from the federal government despite the fact that, over the past decade, they have returned to shareholders essentially all of the free cash flow they earned—rather than investing or saving it.

Detractors say that carriers should have been forced to file for bankruptcy. Some analysts, such as UBS’s Victoria Kalb, have warned that regulators and socially minded fund managers may penalize buybacks and dividends, even after the Covid-19 crisis is over.

Limiting payouts during emergencies makes sense, and executive compensation should get more scrutiny.

Yet except at debt-ridden American Airlines, the extra cash U.S. airlines sent to investors was the result of soaring profitability, and was disbursed only after ramping up capital investments.

Data also suggests that S&P 500 sectors that pay more money back to shareholders tend to be more financially resilient. Western companies have actually increased their cash buffers substantially over the past two decades. 
The debate boils down to the question of whether there is a certain level of preparedness that policy makers should enforce to help companies deal with unexpected events.

Economists Frank Knight, John Maynard Keynes, as well as mathematician Nassim Nicholas Taleb—who famously coined the term “black swan” to refer to events that are impossible to foresee—have all underscored the difference between “risk,” which can be measured to a reasonable degree based on past probabilities, and “uncertainty.”

When betting on a coin flip, risk is the 50% chance of losing.

Uncertainty is the immeasurable chance of being killed by a falling piano before collecting the prize.

The point was nicely underlined when behemoth hedge fund Long-Term Capital Management, which used mathematical models of risk to place leveraged trades, was undone by the black swan of the late-1990s Asian financial crisis.

Cash isn’t the only hedge against uncertainty.

In addition to recommending cryptocurrencies, Mr. Taleb advises Universa Investments, a fund that uses options contracts to constantly bet on a stock-market disaster.

Client letters show that Universa made a 4,000% return in the first quarter.

The Eurekahedge Tail Risk Hedge Fund Index, which looks at similar, less extreme strategies, is up 66% this year.

The very idea that a price can be put on uncertainty, though, is a contradiction worth exploring.

Some data does point to markets structurally underpricing uncertainty: Shares in companies with stable profits and less debt historically outperform.

Yet ever since the fall of LTCM, options markets do clearly price in an insurance premium for uncertainty.

Remaining invested in the Eurekahedge Tail Risk index since 2007 would have delivered a loss for investors—in much the same way that, over long stretches of time, insurers tend to make money at the expense of the insured.

Of course, lots of money can be made by buying protection at the right time, just like with any other financial asset.

Late last year, Ray Dalio’s hedge fund Bridgewater was among those to spot that options hedges were cheap relative to an overconfident equity market. Universa’s success may even suggest that the chance of extreme events was underpriced.

But this doesn’t mean that it will always be.

The nature of uncertainty is that investors will never know ahead of time whether they should hedge more. Nor will companies.

Global airlines had enough cash to survive three months without income, which would have been enough to navigate most crises that didn’t involve an unprecedented 70% fall in air traffic. Even if their buffers were multiplied by 10 it might not be enough for the next pandemic.

So how should investors and officials take uncertainty into account? Individually, weak companies should indeed be encouraged to hold more cash. For industries as a whole, however, the strength of public institutions is what matters.

Western governments are right not to rely on prolonged bankruptcy procedures during a systemic crisis, and would benefit from setting up faster mechanisms to bail out firms and households—in addition to expanding medical resources ahead of the next pandemic.

Yes, such moves would encourage risk taking, but that is what advanced economies are built on. Emerging markets, which often don’t have institutions capable of stepping in when needed, typically trade at a discount.

What investors should avoid is putting too much trust in hedges against uncertainty that are provided by the market itself.

They could all too easily turn into the very black swan they are hoping to avoid.

Why Russia Will Be Slow to Recover

By: Ekaterina Zolotova

The Russian economy is in trouble. As in virtually every country on the planet, economic activity has slowed due to the coronavirus pandemic. The subsequent lockdown has deprived the country of 17.9 trillion rubles (nearly $228 billion), according to Russia’s National Rating Agency, and Moscow expects as much as a 5 percent contraction for 2020.

More than 15 million people could lose their jobs; those who don’t could see their incomes fall by 5 percent if the lockdown continues for another 2-3 months.

Russia will be slow to recover. The speed and effectiveness of efforts toward that end will depend on how much Moscow can prop up the economy. But herein lies the problem. Financial assistance comes from a state budget that has taken a beating in the slump in oil prices, on which the Russian economy so heavily relies.

Indeed, raw materials such oil, natural gas, coal, metals and other minerals accounted for nearly 14 percent of Russia’s gross domestic product in 2018 — about 50 percent more than they did in 2014. In 2018, mining constituted 39 percent of total industrial production; in 2010, it accounted for just 34 percent.

The share of oil and gas revenues in the budget almost doubled from 2016 to 2018, peaking at about 46 percent. This is separate from Russia’s National Welfare Fund, which is funded by additional federal budget revenues from oil and gas. Money from the sale of oil abroad in excess of the base price is sent to the National Wealth Fund, and when the size of the liquid part of the fund exceeds 7 percent of GDP, Moscow can use it for new investments in projects.

That’s all good and well when oil is expensive, but the pandemic has sent prices spiraling downward. Due to high supply and weak demand, the price of Urals fell to $11.50 per barrel in April, the lowest it has been since 1999 and below the “risk scenario” tier set by the central bank.

OPEC’s failure to reach an agreement to stabilize prices only made matters worse; in fact, Russia and Saudi Arabia even decided to increase production.

A reduction agreement was finally reached in mid-April, whereby OPEC+ members would lower production by nearly 10 million barrels per day. That’s not nothing, but it has yet to stabilize prices as its authors had hoped.

Price of Urals Crude Oil

It’s a problem that is somewhat unique to Russia. While many countries are rightly concerned about insufficient storage capacity, prices are Moscow’s utmost priority.

Partly this is because Russia’s oil industry is structured differently from that of other exporters. Energy is generally secured by long-term contracts in places like Europe and China and delivered through systems that Russia owns, primarily via pipelines linked to European and Belarusian refineries.

Sometimes this leads to some surprising market behavior. For example, while futures contracts dived toward zero in the U.S., the low price of Urals led to increased exports. China reportedly purchased an unprecedented 1.6 million tons of Russian oil in April, while Belarus announced in early April that it wants to buy 2 million tons (priced at $4 per barrel).

Of course, this wasn’t especially profitable for Russia, but Russia was at least able to offload a bunch of excess oil onto the market, replenish Belarusian oil refineries and partially mitigate the brewing conflict between the two over energy prices.

But this is just a short-term benefit. Exports are inherently limited by demand, and demand is low among Moscow’s primary buyers. If that doesn’t come up, it will be impossible to finalize new contracts.

Moreover, production will be dictated by the new OPEC+ agreement, so, assuming Russia adheres to it, it will be impossible to adjust prices by adjusting production. Oversupply will continue to hamstring markets and producers for the next few months, perhaps none more so than Russia.

Coronavirus in Russia

The reduction in export earnings due to price volatility is a drain on the Russian economy.

Russia needs the income from oil exports to mitigate the effects of the coronavirus on the economy. Despite strict quarantine, the number of infections in Russia continues to grow.

The government is not planning to ease the lockdown, and in fact is discussing extending it until mid-May.

To cope with the strain of a prolonged lockdown, the government will likely start to think about a new economic assistance package to prevent more severe damage and to eventually lift the economy out of the crisis. Moscow has already adopted two support packages totaling 2.1 trillion rubles, about 2.8 percent of GDP.

These include some help for small and medium-sized enterprises as well as assistance for vulnerable segments of the population. President Vladimir Putin also proposed allocating 200 billion rubles to the regions to ensure their "sustainability and balanced budgets,” and announced the need to spend 23 billion rubles to support airlines.

The challenge is where to find the funds for a new round of economic measures at a time when low oil prices are sinking the federal budget. The 2020 budget was drafted so that the federal government would be in surplus if oil prices were above $42.45 per barrel. According to reports, the latest government forecast, however, was for a federal budget deficit of 5.6 trillion rubles instead of the previously planned 900 billion-ruble surplus.

The pandemic has depleted not only tax revenues from economic activity but also revenues from the mineral extraction tax, which accounts for up to 50 percent of the federal budget (46 percent in 2019). According to Ministry of Finance calculations, in March alone, the total volume of lost oil and gas revenues amounted to 22 billion rubles.

And because of the fall in oil prices, the Russian budget in April will receive less than 55.8 billion rubles in oil and gas revenues. In total, the government is already estimated to have lost 4.2 trillion rubles in taxes, insurance premiums and fees.

The new budget revenue projection is 15.2 trillion rubles, while planned expenditures are 20.8 trillion rubles — compared to an initial budget that foresaw 20.6 trillion rubles in revenues and 19.7 trillion rubles in spending. The Ministry of Finance planned to prepare a new version of the financial plan but the process has been delayed, so these estimates may go even lower.

Size of Russia's National Wealth Fund

In early April, the Russian government announced that it had accumulated reserves in the amount of 18 trillion rubles, but low oil prices complicate the use of other foreign currency deposits. The government’s liquid assets — that is, ruble and foreign currency deposits — total 15.3 trillion rubles, while regional governments have an additional 2.4 trillion rubles.

Separately, the National Wealth Fund (NWF) held 12.85 trillion rubles at the beginning of April, equal to 11.3 percent of GDP. The government plans to use part of the NWF to support the economy and social programs, which may reduce the fund to 6.5 percent of GDP, but this is the most that the state can afford.

According to the Kremlin’s calculations, if oil prices stay low and the government continues to rely on the NWF, the fund would be empty before 2024. This would put the government in a very unstable position. Since the NWF is also used to fund some social programs, in the event of a deeper recession, the government would lose the ability to support, for example, pensioners and the unemployed, which could lead to massive social discontent.

Russia's International Reserves

Besides these concerns, the Kremlin’s ability to use these funds from the NWF is limited by budgetary rules. When oil prices are below $42.40, the law requires the Ministry of Finance to sell foreign currency reserves to compensate for the missing revenues from the oil and gas sector.

In addition, injecting oil money into the economy could increase the ruble’s dependence on oil.

The Kremlin is not planning to use reserves to finance the projected budget deficit: The government will take only 2 trillion rubles from the NWF, and more than 1 trillion rubles from other sources, and the rest will be borrowed in the market. In 2020, the Ministry of Finance expected to borrow 1.7 trillion rubles in the domestic market and 207 billion rubles ($3.15 billion at the exchange rate at the time) in the foreign market.

Faced with a crisis in oil markets, Russia is not ready either to take additional measures to stop the fall in oil prices or to assist the economy further. Although the government is confident, or is pretending to be confident, that it has enough resources to withstand any crisis — Russia has accumulated huge reserves and has very low external debt — the fact remains that a barrel of Russian Urals is below $20, and supporting the economy has already cost trillions of rubles.

With or without a lockdown, the Russian economy will have to revise its ambitions at current oil prices.