In the article, Jim discusses various reasons as to why the US will not be getting the sort of zippy recovery the mainstream media is pushing.
Here’s what Jim has to say about the recovery:
The first reason the economic downturn will persist is the lost income for individuals. Unemployment compensation and PPP loans will only scratch the surface of total lost income from layoffs, pay cuts, reduced hours, business failures and individuals who are not only unemployed but drop out of the workforce entirely.
In addition to lost wages through layoffs and pay cuts, many other workers are losing pay in the form of tips, bonuses and commissions. Even a fully employed waitress or salesperson cannot collect tips or sales commissions if there are no customers. This illustrates how the economy is tightly linked so that problems in one sector quickly spread to other sectors.
In addition to lost individual income, there is a massive loss of business income. Earnings per share of publicly traded companies are not only declining in the second quarter (and likely the third quarter) but many are negative.
Lost business income will be another source of lower stock valuations and a source of dividend cuts. Reduced dividends are also a source of lost income for individual stockholders who rely on dividends to pay for their retirements or medical expenses.
Programs such as PPP and other direct government-to-business loans will not come close to compensating for the losses described above. The loans (which can turn into grants) will help for a month or two but are not a permanent solution to lost customers.
For still other firms, the loans won’t help at all because the firms are short of working capital and will simply close their doors for good and file for bankruptcy. This means the jobs in those enterprises will be permanently lost.
From these straightforward events (lost individual income, lost business income, dividend cuts and bankruptcies) come a host of ripple effects.
Once the government aid is distributed, many recipients will not spend it (as hoped) but will save it. Such savings are called “precautionary.” Even if you are not laid off, you may worry that your job is still in jeopardy. Any income you receive will either go to pay bills or into savings “just in case.”
In either case, the money will not be used for new spending. At a time when the economy needs consumption, we will not get it. The economy will fall into a “liquidity trap” where saving leads to deflation, which increases the value of cash, which leads to more saving. This pattern was last seen in the Great Depression (1929–40) and will soon be prevalent again.
Even if individuals were inclined to spend, there would be reduced spending in any case because there are fewer things to spend money on. Shows and sporting events are called off. Restaurants and movie theaters are closed. Travel is almost nonexistent, and no one wants to hop on a cruise ship or visit a resort until they can be assured that the risk of COVID-19 is greatly reduced.
This will guarantee a continued slow recovery and persistent deflation, which makes the slow recovery worse.
In addition to these constraints on demand, there are serious constraints on supply. Global supply chains have been seriously disrupted due to shutdowns and transportation bottlenecks. Social distancing will slow production even at those facilities that are open and can get needed inputs.
One case of COVID-19 in a factory can cause the entire factory to be shut down for a two-week quarantine period. Companies that depend on the output of that factory to manufacture their own products will also be shut down.
Beyond these direct effects of lost income and lost output, there are significant indirect effects on the willingness of entrepreneurs to invest and of individuals to spend.
First among these is the “wealth effect.” When stock values drop 20–30% as they have recently, investors feel poorer even if they have substantial net worth after the drop. The psychological effect is to cause people to reduce spending even if they can afford not to.
This means that spending cutbacks come not only from the middle class and unemployed but also from wealthier individuals who feel threatened by lost wealth even if they have continued income.
Finally, real estate values will collapse as tenants refuse to pay rent and landlords default on their mortgages, putting properties into foreclosure.
None of these negative economic consequences of the New Depression are amenable to easy fixes by the Congress or the Fed.
Deficit spending will not “stimulate” the economy as the recipients of the spending will pay bills or save money. The Fed can provide liquidity and keep the lights on in the financial system, but it cannot cure insolvency or prevent bankruptcies.
The process will feed on itself expressed as deflation, which will encourage even more savings and discourage consumption. We’re in a deflationary and debt death spiral that has only just begun.
People who regularly read Jim’s work may want to know that a recent Silver Doctors interview took a deep dive into many of these very issues, although we came to a different conclusion on the deflation versus inflation debate.
That interview was recorded last week:
Technically speaking, the US economy is still in the process of crashing, which means the recovery process can’t even begin until we’ve hit the bottom.