It’s Not Your Ordinary Recession, Nor Recovery

The Spellman Report

It’s obvious the economy has taken a large hit. Not just in the US but globally. When demanders and suppliers are told to go home what else should one expect? The question is what lies ahead. An endless recession or spontaneous growth?

The drop in employment and income will no doubt be characterized as a “recession” as that’s how its measured but readers note that this recession is not the same recessionary animal that we’re familiar with. As such, the exit or recovery will be different.

The National Bureau of Economic Research started about 100 years ago and managed to reconstruct macroeconomic data going back to pre-Civil War times. To them what we know today as macroeconomics was the study of the “business cycle.” That is booms followed by busts and the long road to economic recovery.

The getting into a recession and getting out has followed a typical chain of events. The two most recent deep recessions were the “tech” mania that ended in 2000 and the “housing boom and bust” that bottomed out in 2008 that most would be familiar with.

It all starts with strong demand for a particular item which causes suppliers to supply until the expansion of the industry results in over-supply. From there, inventories accumulate, prices fall and the brakes are put on production and employment. The stopping of production and lay-offs is the recessionary phase and will continue until the excess stocks of inventories are discounted and moved out. That’s the usual cause and effect of boom/bust and recovery which could take years.

Remember for example, excess computers in the year 2000 and excess houses in 2008. Then after demand returned it did not immediately revive production until inventories were run off and producers went through “reorganization”. That is, raise additional capital, either debt or equity, and go through firm reorganization. Having just gone through that process with homebuilders and houses a decade ago most readers should understand.

Interestingly enough, one great exception to that boom-bust-recovery sequence occurred with the Farm Crisis in the l920’s, a century ago which is a more relevant comparison to today’s situation. That was because the boom item was agricultural products given that WWI took out agricultural production in Europe. The food scarcity, and high prices incented US farmers to step up production. When the war concluded and Europe went back into production there was a glut that didn’t last long. This is because the glut went into inventory but with ag products, the shelf life is short and the farm belt in the US returned to producing something close to normal the following year.

Given these analogies, I trust the point is made that when the recent air pocket of demand and supply occurred given the virus induced work and shopping restrictions, it did not leave excess inventories on the shelves. Hence it will notrequire months or years to clear out inventory before production and employment picks up again. Demand will return and producers will go back to work. Employment and income generation will resume almost as magically as they both disappeared when someone blew the whistle to go home. If you question that, check out the empty store shelves. With home delivery still working, demand appears to be satisfied, but not supply.

But the other part of recovery is typically firm financial reorganization. That is, to get rid of the excess firm debt that paid for the excess production that set off an oversupply situation. This typically requires firm reorganization with new creditors and stockholders. That adds time to the recovery process.

In this regard today’s virus episode is quite different from the prototype recession because the Fed as the central bank has stepped over a line only crossed once before, which is to provide funding to a private distressed party (AIG as some of you might recall). The Federal Reserve by making loans to distressed small private businesses (via the borrower’s bank) and going into the open market and buying corporate debt is totally beyond what the Fed has ever done before. The Fed was organized to provide cash to banks being run by their depositors so the banks would not need to trash all their saleable assets at deep losses hence preserving bank solvency.

After the AIG event, Congress went back to change the Fed’s enabling authority to match what they actually did. As a result, the Fed in what it deems to be “Unusual and Exigent Circumstances” can now lend to distressed private firms via the borrower’s own bank and it appears they will be doing quite a bit of that to get producers back on their feet. Furthermore, as I understand it, these are forgivable loans being characterized as “grants” with the US government, not the Fed, taking the hit. Basically, the bottom line is these loans are a taxpayer subsidy to small business.

An additional encouraging factor for today’s recovery is the level of interest rates which are so far below what we have ever seen in the US even at the bottom of previous recessions and the Great Depression. Those ultra-low rates both stimulate the economy as houses, for one, are being refinanced at much lower rates and generating cash flow for owners but moreover cheap credit adds to leveraged demand for capital assets and supports asset prices across the board.

So, the Fed is simultaneously supporting production by financially supporting producers, supporting asset prices in general and providing a cheap money environment for borrowers to join in and borrow and spend. And when firm balance sheets again balance (after reorganization, if that’s necessary) and the end-of-the world medical projections being made by necessarily conservative government health projectors, are shown to be worse case, confidence returns likely slowly at first but then off we go again.

In addition, there is the enormous expansion of Federal spending along with fiscal multipliers to total spending and income. Though the multipliers are smaller than they once were but it’s all still positive.

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Source: The Spellman Report

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