Rising markets and inequality grow from the same root

Covid-19 puts workers under immense strain, while asset owners feel much less pain

Robert Armstrong

WASHINGTON, DC - JUNE 07: Thousands of protestors lie in the middle of the recently renamed Black Lives Matter Plaza near the White House during demonstrations over the death of George Floyd while in police custody on June 7, 2020 in Washington, D.C. This is the 13th day of protests since Floyd died in Minneapolis police custody on May 25. (Photo by Samuel Corum/Getty Images)
It is wrong to dismiss worries about the disconnect between the stock price gains and political unrest © Samuel Corum/Getty

Was the market right all along?

Until last Friday, it looked as if stock markets had lost all track of reality. In the world, we saw spiralling unemployment and political disarray.

In the markets, especially the huge American market, exuberance.

Within finance, the consensus on this disconnect was that the market was pricing in a lot of good news about a fast recovery from the Covid-19 crisis. This is a bit worrisome, but not too bad, because the market is never a simple barometer of the economy. And as for the political issues, the market is amoral, focusing solely on profits. No need for concern there, either.

Then came a much better than expected US jobs report, showing a gain of 2.5m jobs in May.

The consensus was reframed.

The market had not assumed the good news, it knew it was coming, and it has proved itself, once again, to be an amazing economic barometer. It still doesn’t care about justice, of course, so China’s latest crackdown in Hong Kong, a US president threatening to set the military on his citizens and the Brexit shambles remain irrelevant to future market rises.

The new consensus is wrong.

The jobs report was unexpectedly terrific, but the unemployment rate, at 13.3 per cent, remains well above the worst part of the 2008 financial crisis and there are concerns that the numbers were affected by classification errors. Consumer spending has plummeted.

The course of the virus is unknown. We need to see more swallows before we declare it summer.

The market, however, is already acting like it is the fourth of July.

The S&P 500 has risen to within 5 per cent of its all-time high.

Most importantly, it is wrong to dismiss worries about the disconnect between the stock and political unrest. Observers are shocked by the market’s insouciance not because they misunderstand how markets work but because they see it as a symptom of how society works.

Covid-19 has put working- and middle-class people under immense strain, while the asset-owning classes have felt relatively little pain: the big equity drops in March came after a decade of historic increases in asset values. Although the middle-class participates in markets through pensions, this does not offset the imbalance.

In the US, almost 90 per cent of equities are owned by the wealthiest 10 per cent of households, according to the Federal Reserve. Not only do market gains flow overwhelmingly to the wealthiest, but the link also runs in the other direction: inequality contributes to the gravity-defying rise in markets, in a self-reinforcing cycle.

The richest 11 per cent of the world population holding more than 80 per cent of its wealth, Credit Suisse estimates.

This means the rich have a lot of excess savings. There is, after all, only so much anyone can consume. This “savings glut of the rich” (as Atif Mian, Ludwig Straub, and Amir Sufi call it) is a pile of capital that has to go somewhere. The cash flows towards open capital markets, especially America’s.

Ideally, it would then be channelled to productive investment.

But US investment is stagnant, for reasons that are debated. (It could be that slowing innovation means there are fewer good investment opportunities, or that oligopolistic industries have grown lazy, or that management incentives encourage dividends and buybacks over capital spending).

Whatever the reason, instead of spurring investment, the savings are lent to governments, companies and households.

The surge in debt issuance drives long-term interest rates down. The lower rates make future corporate profits more valuable, driving stock prices up. The rich end up with more wealth still, and the cycle repeats.This hurts economic growth, too.

When the rich receive incremental wealth, they generally save rather than spend, which saps demand. Ordinary households and taxpayers meanwhile are stuck paying interest on mounting consumer and government debt.

Even at today’s low rates, that represents another drip-drip transfer of capital from the lower classes to the upper.

If this picture is correct, and if inequality helps fuel the political strains we see across the world today, then those strains are hardly irrelevant to the rise of the stock market. The two grow from the same root.

An unequal and unbalanced global economy should ensure that, for a few years yet, US stocks will remain a good bet. But it should also make investors wonder if, in the long run, political change could reveal their gains to be fool’s gold.

Unlocking the economy will divide societies

The virus picks us off un­evenly, and an effective response must recognise that

Tim Harford

Could we countenance a plan to allow the under-40s back into pubs and restaurants, while the rest of us stick to Zoom and Ocado? © iStock/Getty

It is the end of the beginning: lockdowns after the first wave of coronavirus are being tentatively lifted. It is not a step we are taking with any great confidence of success. Rather, we’re easing the lockdowns because we can’t bear to wait any longer.

That will mean some difficult decisions ahead, in particular about how we look out for each other in a world where our experiences and the risks we face are dramatically diverging.

It is clear enough that the virus could easily rebound: a systematic study conducted by the Office for National Statistics suggested that 100,000 to 200,000 people in England alone were still infected with the virus in early May. The lockdown has merely bought us time.

One hope is that we can now contain the virus through widespread testing, contact tracing and the supported isolation of infected people. One cogent plan for this comes from the Safra Center at Harvard University.

But the UK seems in no position to implement anything like this plan. Boris Johnson, the prime minister, has promised a contact-tracing system by June 1 that will be “world-beating” — an obnoxious synonym for “excellent”. I do not believe him, particularly since his government has repeatedly misrepresented its record on testing.

The Safra Center plan calls for 2 per cent to 6 per cent of the population being tested every day. In the UK, that would be 1.3m to 4m people daily; we are currently testing well under 100,000 a day.For now, then, we are stuck trying to maximise the benefits of reopening while minimising the risk. That suggests drawing bright lines between those who should unlock and those who should not.

We have long accepted that a supermarket is more of a priority than a restaurant, but other dividing lines would be uncomfortable. Would we be happy for London to reopen while Manchester stays closed, or vice versa?

There is a powerful moral case that we should all be going through the same sacrifices at the same time, but if we seek to save the greatest number of lives while destroying the fewest livelihoods, we may have to start drawing distinctions that make us squirm.

The most obvious such distinction would be to ease the lockdown only for the young.

In the five weeks from late March to the start of May, nearly 29,000 people over the age of 65 died from Covid-19 in England and Wales. Only 375 people aged under 45 died in the same period. Late boomers and Gen-Xers like me, aged 45-64, are in the middle: nearly 3,500 of us died.

Could we countenance a plan to allow the under-40s back into pubs and restaurants, while the rest of us stick to Zoom and Ocado? Then if signs of herd immunity emerged, we could send in the reserves — the 40-somethings like me.Is this really a good idea?

I am genuinely unsure. Perhaps the practical objection is insuperable: it might be impossible to protect vulnerable people while allowing the virus to run riot in the young.

But I suspect the real objection is not practical, but moral. Something about sending half the population out while the other half stays indoors feels unfair. That is true even if it is not entirely clear which side of the age divide is worse off — the ones enduring boredom and isolation inside, or the ones facing the virus.

And what of people who find themselves able to drink in public one day, then banned from their own 40th birthday party the next? Clear distinctions on a spreadsheet or graph start to seem absurd in everyday life. And it could be much worse.

Ethnic minorities are at greater risk; are we to advocate whites-only restaurants and whites-only public transport on the grounds that it is not safe for those with dark skin?

The idea is self-evidently repugnant.

Yet the virus does not care about our moral intuitions. It picks us off un­evenly, and an effective response must recognise that. We are going to have to develop a language of social solidarity even as our individual experiences diverge.

Even during the lockdown, many people have continued to experience the freedoms and anxieties of going to work as normal. The very nature of the lockdown means it is easy to forget that other people are leading very different lives.

One doctor friend of mine, on a video call a fortnight ago, asked: “So . . . have the rest of you really just been at home, seeing only your families, for the last six weeks?” Yes. We really have.

We must develop new ethical codes. “Stay at home, protect the NHS” was a start, but over the coming months we must look for principles that offer the same moral force but far more practical subtlety.

“Grandparents: stay home so that your grandchildren can go back to school.”

“Home workers are heroes too,” because they reduce density in the big cities.

We are all in this together.

And yet increasingly, we are all in this separately.

That is a challenge we have yet fully to confront.

Climate Targets and Industry Participation in the Recovery

Though governments around the world are busy confronting the economic and health emergencies brought on by the COVID-19 pandemic, they must not lose sight of the historic opportunity that has presented itself. Now is the time to create the conditions for a society-wide transition to a low-carbon sustainable future.

Henrik Poulsen, Mads Nipper, Lars Fruergaard Jørgensen

poulsen1_Marc StuderEyeEm Getty Images_windturbines

COPENHAGEN – The COVID-19 pandemic must not lead governments to lower their climate ambitions. Accelerating the transition to a low-carbon sustainable economy can both drive the recovery and build resilience for the future.

Other countries could look to Denmark for inspiration on climate initiatives that will also contribute to economic recovery. The country is currently taking real action to achieve its target of reducing carbon dioxide emissions by 70% by 2030 and reaching zero net emissions by 2050.

As the CEOs of Danish corporations with a global presence in renewable energy, water technology, and pharmaceuticals, respectively, we have been appointed by the Danish government to chair public-private “climate partnerships” created to pursue climate-policy goals. Our job has been to develop comprehensive roadmaps for reaching emissions-reduction targets within our respective sectors in the most cost-efficient way.

Having chaired these partnerships for the past seven months, we believe governments around the world would benefit greatly both from this model of collaboration and from our specific findings on how to make the manufacturing, energy, and life science and biotech sectors nearly carbon-neutral by 2030. As countries spend trillions of dollars to protect jobs and livelihoods during the pandemic, it is crucial that they shape such stimulus in ways that will ensure a long-term sustainable recovery.

The World Health Organization estimates that the annual capital needed to meet the Paris climate agreement’s emissions-reduction targets amounts to some 1% of global GDP per year. Governments thus should capitalize on the current opening to direct their mid- and long-term recovery plans toward the dual objective of financial stimulus and decarbonization.

Pursuing these goals simultaneously is not merely a moral imperative. It also makes economic sense. Governments urgently need to unlock the private sector’s capacity for innovation and investment, starting with concrete and ambitious emissions-reduction targets for 2030 and 2050. Once such targets are in place, governments should involve businesses in developing sector-specific roadmaps for decarbonization.

The logic of leveraging the private sector is simple. Business leaders are in the best position to identify economically sound carbon-reduction pathways within their own sectors, and they have firsthand knowledge of what is needed from governments to unlock private-sector investments. This is what we call the Danish formula for public-private collaboration.

The analyses we have conducted in our climate partnerships have revealed opportunities for decarbonization that many would have thought impossible just a few years ago. By applying and scaling up existing technologies in a cost-efficient way, the manufacturing, energy, and life science and biotech sectors could become nearly carbon neutral as soon as 2030. In addition, these sectors also provide technologies and services that have the potential to drive emission reductions across other sectors. This includes energy-saving products and services, and replacing fossil fuels with green electricity to decarbonize transportation and other industries.

Hence, our recommendations have global applications, both for countries in a nascent stage of decarbonization and for those that are already well on their way. The first key takeaway is that governments should set ambitious national emissions-reduction targets for each economic sector, thereby providing transparency and long-term certainty for companies and investors.

Second, all countries need to create conditions for a significant increase in renewable-energy production, green electrification, and improved energy efficiency. Green business is good business: wind and solar power are now the cheapest options for two-thirds of the world, and energy efficiency improves economic competitiveness while benefiting consumers.

Third, governments should adjust their regulatory frameworks to maximize investment in innovative technologies – such as heat pumps, renewable hydrogen, and biofuels – through increased public and private research, development, and deployment.

Similarly, public procurement and fiscal policies should be reformed to strengthen incentives that encourage low-carbon activities and investments. And businesses around the world need to take responsibility beyond their own direct emissions, by pushing for similar reductions across their global value chains.

Beyond these broad recommendations, we are keen to share with governments and other businesses insights from our specific action plans on how to decarbonize manufacturing, energy, and life science and biotech as cost-efficiently as possible. We encourage policymakers and industry leaders to build on these lessons as they shape the economic recovery and accelerate the green transition.

Collectively, we need to make sure that the COVID-19 pandemic does not lead us back to the same “business as usual” that brought on the climate crisis in the first place. By applying the model and principles we have enunciated, all societies can do more than just recover; they can make themselves future-fit, too. That is the right approach both environmentally and economically.

Henrik Poulsen is CEO of Ørsted., Mads Nipper is CEO of Grundfos., Lars Fruergaard Jørgensen is CEO of Novo Nordisk.

The Politics of Pandemics: Why Some Countries Respond Better Than Others

The capacity of a state and the degree of economic inequality among its residents will determine how successful it is in coping effectively with a pandemic like COVID-19. Whether it is a democracy or a dictatorship matters relatively less, according to recent research by Wharton management professor Mauro Guillen.

Titled, “The Politics of Pandemics: Democracy, State Capacity, and Economic Inequality,” Guillen’s working paper tracks epidemic outbreaks in 146 countries since 1995. It is the first study to explore the effects of democracy, state capacity, and income inequality on epidemic dynamics.

“In democracies, greater transparency, accountability, and public trust reduce the frequency and lethality of epidemics, shorten response time, and enhance people’s compliance with public health measures,” Guillen wrote in his paper. However, “democracy has no effects on the likelihood and lethality of epidemics.”

According to the paper, inequality increases the frequency and scale of an epidemic, and it undermines people’s compliance with epidemic containment policies such as social distancing and sheltering in place because people at the low end of the socioeconomic scale cannot afford to stay at home—they must go to work.

But strong state and government structures could help offset most of the shortcomings. “State capacity is a bulwark against the occurrence and ill effects of crises and emergencies, while economic inequality exacerbates them,” Guillen wrote.

Takeaways for Governments

“The most important result in my analysis is that you have to have the resources, the capacity and the [requisite] state structures in place to deal with these national emergencies,” said Guillen.

“Countries that score higher in state capacity, because they have more resourceful governments, regardless which party is running it, have fewer of these epidemics. And if they have one, they tend to have fewer deaths and cases.”

The second takeaway from the study is that “for the most part, it doesn’t really matter whether you’re a democracy or a dictatorship,” he added. “But inequality can make the consequences of all of this much, much worse, especially in terms of the number of people affected.”

He explained that a high degree of economic inequality means that people don’t have good nutrition or access to health care, and they don’t have savings or other resources.

“Even during a pandemic, they have to continue working and use public transportation. So they don’t observe social distancing or sheltering-in-place and therefore they become more exposed to the potential consequences of the virus.”
 ‘Mosaic of Experiences’

What interested Guillen about the pandemic is “the mosaic of experiences around the world” — both in the way in which countries are affected by it and how their governments respond. He noted that while the pandemic is global, it is felt in very different ways around the world, and also that it didn’t start in every country at the same time. There is also a wide variation in the responses by governments and by people in different countries.

He said he was “specifically interested in seeing whether politics has anything to do with how effectively countries deal with these kinds of situations or crises.” He also noticed in the debates on the pandemic that “there were some misconceptions about the relative ability of different types of political regimes to intervene.”

Guillen identified “three big debates” around the pandemic. One is about whether democracies do a better job or a worse job than dictatorships in managing health crises. (He clarified that he used the term dictatorships to refer to non-democracies of various types, including those that are totalitarian or authoritarian.)

The second is over whether the governments are prepared with the requisite capacity to deal with health emergencies. The third debate is on how economic inequality makes a country vulnerable to relatively harsher consequences than others that are better off on that score. Guillen decided to delve into the data to bring more clarity to those three debates.

He conducted three studies to ascertain the impact of political regime, state capacity and economic inequality on “epidemic dynamics.” The first reviewed the occurrence and lethality of epidemic outbreaks worldwide between 1990 and 2019.

The second analyzed the speed with which a government-mandated lockdown came into being during COVID-19 “as the most dramatic policy to curb the spread of a contagious disease.” The third study examined people’s compliance with social distancing and sheltering-in-place measures across countries during 60 days of the pandemic.

Guillen also looked at how the form of government interacts with state capacity to cope with a health emergency or with economic inequality. Being a democracy and having state capacity are not always correlated, said Guillen. Some democracies are newly independent countries and relatively poor, and they don’t have strong government programs.

“Over the last 20 years, we’ve seen a lot of these countries — for example, in Africa — becoming democracies. But they lack resources and they lack strong government programs. Those are the most vulnerable, and this is why we see that so many epidemics ravage the developing world.”

It gets worse for poor countries that remain dictatorships. “They face a double whammy because they don’t have resources, and they don’t have strong government programs,” said Guillen. Further, in dictatorships, the population typically does not have much trust in the government and its responses to an epidemic, he added. “That’s the worst of all situations.”

The study found that countries with high population densities are generally more vulnerable to epidemics and have a lower ability to bring them under control. They need to put more systems in place to prevent epidemic outbreaks, said Guillen.

However, some countries that have very high population densities are also very rich — like Japan, Singapore or Holland, Guillen pointed out. “They don’t have epidemics because they compensate with very strong government programs,” he said, adding that they can afford those programs because they are wealthy.

As the COVID-19 pandemic continues its spread, it is far too early to take stock and identify winners and losers among countries. However, South Korea, Taiwan and Singapore are among a few countries stand out for having state capacity and strong government programs in place to deal with such emergencies, said Guillen.

Those countries had strong government programs in public health in particular because they are rich countries, and also because they became wiser after having encountered health emergencies like SARS in the past, he noted. The strength of their state capacity and public health programs mattered more than the form of government, he added.

South Korea, Taiwan and Iceland also showed low economic inequality in Guillen’s research. That buttressed his finding that the greater the economic inequality, the more the likelihood of an epidemic outbreak, and with more consequences than countries with better scores on that measure.

At the other end of the spectrum, inadequate or fragmented state capacity was the reason why countries in Southern Europe like Spain and Italy have suffered heavily in the pandemic. It didn’t seem to matter that they are democracies – their governments have been “completely disorganized” in their response to the pandemic, Guillen said.

“The problem there has been that they don’t have the resources that some of those other countries in Europe had in place.” To boot, the degree of economic inequality in Southern Europe is also higher than in Northern and Central Europe, he noted.

“Being a democracy helps in general, because it’s easier for you as a government to generate trust among the population in order to cope with a pandemic,” said Guillen. “But if you don’t have strong government resources or capabilities, then you’re going to be at a disadvantage.”
Pointers from the Past

Drawing upon previous research by Guillen and other experts, the paper traced the quality of government responses in earlier crises such as the East Asian financial crisis in 1997, the Arab Spring in 2010 and the 2008-2010 global financial crisis.

The outcomes of those crises were mixed. In the East Asian crisis, for instance, South Korea had preexisting ties with its business and financial sectors, which enabled it able to respond more effectively than Thailand did. Semi-authoritarian regimes like Malaysia or dictatorial regimes like Indonesia took action more swiftly, but with less consistency, and with uncertain outcomes due to favoritism and corruption, Guillen’s research showed.

The 2008-2010 global financial crisis primarily affected high-income democracies. Although “several governments on both sides of the Atlantic were defeated at the polls, democracy itself survived and economic growth resumed relatively quickly in most countries,” according to research by Guillen and another study by Stanford University political science professor Larry Diamond.

By contrast, the Arab Spring led to “the downfall of several governments, the overthrow of political regimes, a continued economic slide, and, in some cases, civil war,” Guillen’s paper noted, citing a United Nations survey of 2015-2016.

Who Fares Better: Dictatorships or Democracies?

While democracies fared relatively better than dictatorships in previous crises, they may face different challenges with the COVID-19 pandemic “in terms of the sacrifices that it demands from the population in order to contain it,” Guillen noted in his paper.

Dictatorships can respond “more swiftly and resolutely” in imposing quarantines and enforcing other steps that infringe on individual liberties.

On the other hand, greater transparency in democracies may allow them to respond promptly to a public-health emergency, and secure public trust and collaboration. The paper notes that research by The Economist on epidemics since 1960 found lower mortality rates in democracies than in dictatorships. All considered, Guillen’s research suggests that democracies structurally lend themselves to more effective responses to epidemics than dictatorships.

The upshot from those previous episodes: With democracy, economies have the opportunity to recover after a crisis. Without democracy, economies may continue to slide, favoritism and corruption may rule the day, and governments may fall.
Guillen agreed that governments in democracies face constraints such as the need for building a consensus, or have to make trade-offs in multiparty politics that result in less than optimal policy responses. “That’s one of the potential dysfunctions of democracy,” he said.

“But on the other hand, in a democracy, the government can be voted out,” Guillen continued. “The government wants to have at least majority support among the population, and so it has an interest in delivering a certain standard of well-being to a majority of the population.”

Most dictatorships, however, tend to ensure that they will continue to run the country by allocating subsidies and rents to a few important groups that support it, he added.

Guillen’s research produced some surprises, too. He did expect countries with income inequality to have reduced compliance in social distancing because they would have more people who live “from paycheck to paycheck, who need to go to work.” But he was surprised that democracy didn’t have an effect on social distancing.

He had thought that those measures are easier to implement in democracies where people have more trust in their governments than in dictatorships. “But I didn’t find that effect at all,” he said. “I found no difference between democracies and dictatorships when it came to compliance with social distancing and sheltering-in-place [guidelines].”

International Cooperation

For sure, countries suddenly facing a pandemic cannot overnight fill gaps in government capacity or economic resilience, or economic inequalities among their populations. Here, international cooperation could help overcome shortcomings.

“Every infectious disease outbreak is a problem for the entire world, not just for one country, especially when it becomes a pandemic,” said Guillen. “So, it’s extremely unfortunate that right now very few countries are talking to each other.

Part of this is because we came from a period of turmoil in the world, not knowing what the role of the U.S. was, for example, and having trade wars and other kinds of frictions in the world. It’s unfortunate that the pandemic came the moment when global cooperation on key issues, such as climate change, was at an all-time low.”

That is unfortunate because in a pandemic, it is essential that governments exchange information about the spread of the disease and about what works and doesn’t work in containing the spread of the virus, he noted.

The World Health Organization has been trying to forge international collaborations to try and develop effective therapeutic treatments and a vaccine for COVID-19.

“It is unfortunate that the one organization that we have that can help coordinate global actions in the midst of a pandemic is under attack.”

Things Were Different In 1918, But Comparisons With 2020 Uncover A Crucial Question

by: Jim Sloan
- The 1918 economy was so different from 2020 that important economists see no profit in comparison, but it has one important common factor: the impact of a sudden event.

- Traditional economists saw the mild 1918-19 recession and the deep 2020-21 depression as separate events; modern revisionists make the case that they are parts of one event lasting five years.

- Revisionists have advanced a new model of a "sudden shock" which produces powerful lingering effects akin to those of the Reinhart-Rogoff model; three 1980-2008 crises in Mexico serve as examples.

- The Fed must take care in fighting the crisis not to undercut the principles of price discovery and creative destruction; prudent investors should follow elder statesmen in not taking precipitous actions.

- The impact of the 1918 pandemic on individuals is captured in the book cited below - a small masterpiece written 60 years later which may suggest the lingering emotional scars.

"It happened too suddenly, with no warning, and we none of us could believe it or bear it ... the beautiful, imaginative, protected world of my childhood swept away."
- So Long, See You Tomorrow,
William Maxwell´
The 1918-1919 "Spanish" Flu pandemic is the closest event in U.S. history to the current coronavirus pandemic notwithstanding a number of major specific differences. The American economy was very different then. The Dow Jones Industrials - then 20 stocks - contained sixteen companies involved in either commodities or basic manufacturing, plus AT&T, Western Union, and Studebaker (Ford being a privately owned company).
In 1918 a third of the American working population were farmers (versus 1 or 2% today). Farmers could not observe anything like a lock down. Another 28% of the economy was manufacturing (versus 8% today). The Amazon (AMZN) of the day was Sears with its catalogues.
Instead of dollar stores there were dime stores. The country was 50% urban and 50% rural versus 83% urban today. The service economy, now the largest sector, consisted mainly of small local businesses. Aside from the ongoing war in Europe, government made up just 1% of the economy.
A key takeaway is that most of the 1918 economy served relatively simple and immediate human needs, and much of it was local. Shut downs were primarily done by cities, with just a few states getting involved. The length of the average shut down was about a month, and the directed full or partial closures included churches, theaters, barber shops, and saloons.
There was little in the way of national media, and newspapers were the major source of information outside one's immediate neighborhood. Information about the outside world came slowly to much of the population. There was nothing like CNN or Fox News telling their followers how to frame their thinking. The New York Times still served as an objective national newspaper of record.
When the pandemic began American troops were arriving in Europe at the rate of 10,000 a day and rushing to the front where their presence helped to halt the last desperate German offensive. As the second wave of the pandemic began in late summer American troops were making their weight felt in the counterattack which eventually forced the unexpectedly quick German surrender. American lives lost in the war amounted to 116,000, of which around 40% were from battle wounds and 60% from illness, many from the Spanish Flu.
The above were the major facts of life in 1918 and the important events of the world as experienced at the time. We all know how the world looks today. That is, we each have our own model of it depending on our allegiance to Fox or CNN, or to our abilities to stand back and look for reliable facts then frame our own individual opinions.
One seldom mentioned but important economic fact about 1918 was that the war ended suddenly.
Most people at the time believed it might go on for years - it had already gone on for four years of stalemate on the Western Front - but starting in September the German army suddenly and unexpectedly collapsed. In Germany this led to the folk myth of betrayal by the leadership at home - and ultimately to Hitler.
In the U.S. it left an extraordinary inventory of raw materials along with a mix of wartime price controls which suddenly needed to be unwound. It also meant the return of several million soldiers, many of whom had no jobs to return to. This single fact of the war's sudden end may be a possible bridge between the views of economists who believe the 1918-19 recession was mild, insignificant and quickly over and revisionists who believe its impact extended as far into the future as 1923.
That argument has major importance today as we attempt to frame a model for the sudden and intentionally engineered economic shut down of 2020.
Two Schools Of Thought On The 1918 Event
The years from 1917 to 1923 are among the least vivid in the memory of most Americans, historians included. This is strange considering the number of important events which took place over that period. Considering its importance, very little serious research has been done about the economic impact of the 1918 pandemic - until a recent outburst, that is.
Most economists have been satisfied to accept the view that the pandemic probably triggered a minor and very brief recession which one has to look closely to identify on most charts. Among the factors discouraging serious research was the fact that in 1919 national high-frequency economic data was rudimentary. National Income Accounting as we know it today was not invented until 1932 (by Simon Kuznets), and naturally turned its immediate attention to the 1920s and 1930s.
With the arrival of the 2020 pandemic there has been a recent surge in papers about 1918 and its aftermath, although no less a figure than Carmen Reinhart (coauthor with Kenneth Rogoff of the authoritative This Time Is Different: Eight Centuries of Financial Folly) recently stated that the times were so different that 1918 is not helpful in thinking about 2020. Other economists beg to differ.
Two distinct schools of thought have emerged, and their major point of contention has been the proper period to examine. Is it the simple duration of the pandemic, the course of which was mainly between spring of 1918 and spring of 1919?
Or does the period include the "Forgotten Depression" of 1920-21 and its aftermath?
The answer to that question has very major significance for those trying to model the future of the present economy.
The first view to come to my attention was Chicago Fed Working Paper No. 2020-11, "What Happened to the US Economy During the 1918 Influenza Pandemic? A View Through High-Frequency Data," by Francois Velde.
Velde's focus is on the economy over the brief period of the pandemic itself (mainly spring 1918 through spring 1919). His paper provides detailed data, including some that I used in the introductory passages, as well as anecdotal reports from newspapers. Much of his data was pulled together laboriously by assembling the available data from cities and states.
Here is Velde's abstract:
Burns and Mitchell (1946, 109) found a recession of “exceptional brevity and moderate amplitude.” I confirm their judgment by examining a variety of high-frequency data. Industrial output fell sharply but rebounded within months. Retail seemed little affected and there is no evidence of increased business failures or stressed financial system.  
Cross-sectional data from the coal industry documents the short-lived impact of the epidemic on labor supply. The Armistice possibly prolonged the 1918 recession, short as it was, by injecting momentary uncertainty. Interventions to hinder the contagion were brief (typically a month) and there is some evidence that interventions made a difference for economic outcomes.
Velde sees a distinct separation between events in 1918-19 and events in 1920-21, largely because the minor dips in various economic trends appeared to recover fully within that period.
The stock market, as he shows, dropped 33% in 1917, recovered and significantly exceeded the point from which it dropped, then dropped 47% in 18 months from the beginning of 1920 to July 1921. At the bottom of the second drop the market reached a PE ratio of less than 6, one of the lowest DJI PEs ever recorded.
The fact that the two bear markets took place within such a short period doesn't appear to disturb Velde. This point of view is not hard to understand because the second bear market is so readily explained as the result of well-understood factors. In 1919 there was a common form of post-war inflation in which consumer demand ran ahead of production and prices jumped roughly 14%.
This alarmed the Federal reserve, which was still in its infancy and had not yet been tested by a serious crisis. The Fed tightened money quickly and radically, driving rates from 4.75% to 7% by June of 1920, the sharpest increase in history aside from the Volcker actions which ended the inflationary 1970s.
Meanwhile the demobilization of the armed forces from 3 million in 1918 to 380 thousand in 1920 created massive unemployment and a deep and highly deflationary Depression. What happened next - surprisingly - was... nothing. As James Grant was delighted to point out in his book The Forgotten Depression: 1921: The Crash That Cured Itself, the invisible hand of laissez faire inaction took over.
The economy righted itself, the former soldiers found jobs, and the Roaring Twenties were off and running. This way of looking at the 1920-21 downturn defined it as an entirely separate event deriving from the crosscurrents and dislocations presented by the war.
Among the Velde charts, however, was the following depiction of annual real GNP including both the standard series and revisionist models by Romer (1988) and Balke-Gordon (1989). Although not noted by Velde, the Balke-Gordon series (represented by the red line) suggests to me that the decline in real GNP actually began in 1918 and continued into 1921. This presents the outline of an argument that the two economic declines were in fact sequential elements of the same event.
The revisionist Balke-Gordon view was greatly expanded upon by Sergio Correia, Stephen Luck, and Emil Verner in their recent paper "Pandemics Depress the Economy, Public Health Interventions Do Not: Evidence from the 1918 Flu" (March 30, 2020).
Correia et al are at pains to demonstrate that NPIs (Non Pharmaceutical Interventions such as lock downs) are positive for both health and the economy, but their more interesting argument, as demonstrated in the graphs below, is that the lingering effects of the 1918 event continued through 1923. This is an argument of utmost importance and some concern with respect to the current coronavirus event.
Correia et al therefore stand in stark contrast with the view of Velde and previous economists writing long before the present virus who argued that the damage from both the virus and NPIs was limited to the period of the virus itself.
This is not good news for those who are beginning to treat the appearance of a vaccine or effective treatment as marking the end of damage from the virus. Velde, however, had seen the Correia et al paper prior to publication of his paper and addressed it in the final line of his own work:
My conclusion contrasts with the recent evidence on long-run outcomes (Correia, Luck, and Verner 2020). The challenge in reconciling the two sets of findings is to identify a state variable through which the disturbance of 1918 could have propagated all the way to 1923.
That is the crux of the matter. Defining the variable connecting the second event (1920-21) to the first (1918-19) would completely change the thinking about economic effects following the 1918 pandemic. Another paper may provide the answer.
The "Sudden Stop" Model Typified By Mexico
A paper written in 2017 ("On the Legacy of Financial Crises: Lessons from Mexico’s Sudden Stop History," Gianluca Benigno, Andrew Forster, Christopher Otrok, Alessandro Rebucci, 19 April 2020) may provide a new way for defining and comparing exceptional events such as 1918 and 2020.
The basic premise of Benigno et al is that economic crises resulting from a "sudden stop" are altogether different from crises which unfold "normally" over time because of underlying economic trends. To illustrate the impact and duration of "sudden stop" crises the authors focused on Mexico.
Mexico has been especially prone to "sudden stop" crises because of its dependency upon debt denominated in other currencies, mainly the dollar. I personally remember the first of the three crises in the charts below because a friend of mine noticed the arrival of a bank examiner he knew entering the Continental bank and called to let me know, resulting in the best 24 hour short in my career.
The second, called the "tequila crisis" resulted in part from the assassination of a presidential candidate followed by a peso collapse which brought the Clinton cabinet to the edge of a nervous breakdown. The third was Mexico's participation in the global crisis of 2008, which fell more heavily on Mexico because of its lack of ready access to capital.
Comparing the three events in the chart below, Benigno et al described a general model of what happens when an economy suffers a "sudden shock" from an unanticipated event. Images come to mind: a passenger without seatbelt going through the windshield when a speeding car hits a telephone pole or a rider taking an "arser," as the British say, when a galloping horse balks a barrier. You get the idea.
Figure 1 Mexico's model-identified crisis episodes
Notes: The black line is the estimated model-implied probability of being in a crisis. The grey bars correspond to the tally index. The red bars indicate model-identified crisis peaks. The vertical dash lines mark the beginning and the end of the estimated crisis episodes.
This paragraph from Benigno et al provides their description of the aftermath.
The economy rebounds quickly from these episodes, but only partially, making up only half of the ground lost during the crisis episode, or about four percentage points in these simulations. After the initial bounce, a combination of persistently adverse circumstances produces a protracted output decline, as we can see in the Mexican data after the debt crisis ...and also in line with empirical evidence on the long-term consequences of financial crises in other emerging and advanced economies (Reinhart and Rogoff 2009).  
The international cost of borrowing remains elevated for an extended period, even though spreads revert after the crisis. The productivity decline is sizable and very long-lasting, with technology reaching a level that is below the one at the beginning of the boom. During the post-crisis period, investment and to a lesser extent consumption also stagnate below their pre-crisis levels. As a result, credit flows remain above (below) their pre-crisis level long after the crisis has ended, although the economy is no longer financially constrained."
In other words, the contamination caused by a "sudden stop" has a more or less predictable half-life extending meaningfully for at least five years.
There is no question that the current economic situation can be described as a "sudden stop" - perhaps the most abrupt and severe sudden stop in history. You have to be an economy as sophisticated as ours with a capital intensive service sector like our airlines, cruise lines, casinos, restaurants, and hospitality to hit the wall with such an enormous thud. The way we live now and Fed policies encouraging the use of debt set us up for this.
The 1918 event was also a "sudden stop" of sorts, but to think of it in those terms it is necessary to fuse the end of World War I and the pandemic into a single event, which in terms of time and commingled effect they certainly were.
The "sudden" part of it is more attributable to the War than to the pandemic, as no one at the time anticipated anything like it - no one except the German generals who experienced the sudden defeats starting in September 1918. Although they still occupied Allied territory, Hindenburg and Ludendorff visualized an endless pipeline of war materials and fresh American divisions and informed the Kaiser, who then abdicated. After four years of stalemate the war came to a sudden stop.
What followed was a series of wild swings between inflation and deflation, scarcity and abundance, and triumph accompanied by tragedy. The remarkable thing was that the declines in the economy remained relatively shallow despite lasting until 1923. The main reason was the incredibly robust growth in the American economy at that time driven by a number of new technologies.
The "persistently adverse circumstances" which Benigno et al did not attempt to describe in detail had mainly to do with what economists call "imbalances," wild swings between too much supply and too much demand plus a suddenly expanded labor force. It took five years for the wild oscillations to diminish.
The present shock to the economy is probably closer to the Mexican crises in its suddenness, absoluteness, and depth. The stock market rally may resemble the huge bull market of 1919, in which the Dow Industrials nearly doubled as the financial world felt the worst was past, only to fall by 47% in 1920-21. The state of the economy going into the present crisis appeared reasonably good but its fragility was displayed immediately by the number of companies and households for which debt problems were severe and immediate.
If these broad descriptions are right, the Federal Reserve has years of heavy lifting to do. The basic "sudden shock" model suggests that recovery as the economy reopens will at first go swiftly but stall out when it has recovered about half the ground to its level at the onset of the crisis. To get all the way back will take a minimum of five years. Jay Powell has hinted at that. In a recent interview shared with Reinhart, Ken Rogoff opined that five years was the best case we could hope for.
It's not my intention to frighten anyone, and things may conceivably go better than that, but the "sudden shock" estimate of 50% recovery, a stall, and at least five years to get back to par seems to me the reasonable starting model for the economic future. Like all such models it should be updated regularly in response to actions or reported results different from those predicted. This isn't far from my 60% probability model in this earlier piece from May 4. Since then both the Fed and the Congressional leadership have done reasonably well, so the model in this article may be ever so slightly more positive in tone.
What Are The Investment Implications
Readers are probably tired of articles with no very clear investment implications, and I regret having to write them, but I suspect all of us would do better to be worried about articles that pick around the edges of the markets with specific buy recommendations in an economy where the macro uncertainty is so great that it overwhelms all other arguments.
The true answer is that we just don't know. People like Howard Marks, David Tepper, and Stephen Druckenmiller - and Buffett of course - who have repeatedly said to trim your sails and and sit tight are doing you a service.
One thing we have to note is that the Fed has to thread a needle here. It has to put out fires that would pull the system under but avoid in doing so the even worse outcome of destroying fundamental tenets of the capitalist system. Price discovery in stocks, bonds, and commodities is essential to the workings of the system, and sooner or later we have to step back, grit our teeth, and let it happen.
Creative destruction, the Schumpeter term, is also an essential part of the system. Capitalism requires periodic failures which clear the way for new growth like forest fires. The Fed must take care that their stop-gap rescues in areas like corporate bonds don't spare companies which should by all rights go under.
Two of the areas I'm watching closely are banks and insurance companies. Banks were in great shape going into the crisis, and I own JP Morgan (JPM), Bank of America (BAC), and U.S. Bank (USB). All of them would have done very well with even with a high level of defaults - maybe a couple of years of flat to down earnings at worst. The Fed, however, has imposed duties on them which stretch their capacity and in the process has incurred a moral obligation to make good any problems that arise for the banks from this service.
Insurance companies should have been one of the few safe areas of the market, slow growing but more or less immune from risks that they are expert at assessing. Several states, however, have moved to hold them accountable for business risks due to the pandemic which are not in their property and casualty contracts. These actions will probably not survive the courts, but it's impossible to be sure.
Litigation cost was probably one of the things on Buffett's mind in his cautionary views at the recent virtual annual meeting. I'm keeping my large position in Berkshire Hathaway (BRK.A)(BRK.B) but sold positions in both Chubb (CB) and Traveler's (TRV) which had seemed to be, and should have been, rare safe havens. If insurance companies are required to make good business losses they didn't contract for, who will make good the losses absorbed by the insurance companies?
What will happen to business in general if the specific language of contracts ceases to be enforced? The rule of law is one of the underlying principles in ranking a country's suitability for investment.

What Are The Human Implications of The Pandemic

You may have noted that I said nothing about the importance of a vaccine, antibodies, or treatments of any sort. I will be happy when we have one or all of these and especially pleased to find myself still alive and healthy and able to make use of the medical miracles. I do not think, however, that getting vaccines or palliatives is the secret to saving the economy. A second and more deadly wave of the virus could probably make things worse, but it's already too late for a cure to change the basic outcome. The economic problems discussed above are more or less baked into the cake. Cures are for you and me and our children, grandchildren, and great grandchildren and will enable us to rebuild.
And we will.
The immediate human impact, however, matters. Despite the many debates on the lock down, we have chosen this time to put human lives above the economy. Headlines today note that we will soon pass 100,000 deaths. What the headlines do not say is that at the 1918 rate of infection and mortality, and noting that the US population has more than tripled, we might have ended up with more than 2.5 million. It could, in other words, have been much worse.
Writing in 2007, Thomas Garrett of the St. Louis Fed dealt fully with the impact of the 1918 pandemic and efforts to reduce its impact, but included this surprising paragraph:
The influenza of 1918 was short-lived and “had a permanent influence not on the collectivities but on the atoms of human society – individuals.” Society as a whole recovered from the 1918 influenza quickly, but individuals who were affected by the influenza had their lives changed forever."
One of those "atoms" was William Maxwell who lost his mother to the pandemic at the age of 8. Maxwell grew up to be a legendary New Yorker editor and produced the short novel quoted at the top of this article.
Maxwell's novel is a small, perfect masterpiece and has become the classic creative work to come out of the 1918 pandemic which it captures in the way that classic novels like All Quiet On The Western Front captured the essence of the war.
An autobiographical novel written 60 years after the experience, So Long, See You Tomorrow (1980) is about absence and loss as experienced by a child and remembered with adult insight.
It has a plot based upon the narrators's betrayal of a friend and an actual murder case in small town Illinois. The book was suggested to me thirty years ago by a friend, recommended for its direct and unpretentious prose, and I found myself becoming part of a literary cult who believe Maxwell, who died in 1992, was one of our great writers.
If you see the current pandemic in terms of individual human beings and are a person who experiences events through exquisitely crafted literature, you might spend the two or three hours it takes to read it.