73 - Economic Contagion: How COVID-19 could cause a depression

Mental Models discussed in this podcast:

• Second-Order Effects

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode73

How COVID-19 could cause a depression

• The world economy has caught the flu and it is unlikely to go away once COVID-19 is under control
• The problem with the flue is that it hits like a truck and knocks you down for a few days. Then for weeks afterward you're likely to feel tired and exhausted.
• While the coronavirus doesn't cause the flu, it has created a global shutdown of the economy. Global trade is massively impaired due to borders being closed.
• The domestic economy is impaired due to shelter-in-place orders and government-mandated closure of non-essential businesses.
• Right now we're in the phase of economic flu where the economy feels like it has been hit by a truck. This phase will be relatively short. The problem that most aren't anticipating is the second-order effects, the long period of feeling tired and exhausted that our economy is going to go through while we recover. 
• Second-order effects will be set off due to:
  • Large layoffs where people are not quickly hired back after the shutdown.
  • Small business failures due to the limited margin in their operations.
    • Restaurants will close permanently.
    • Hair salons
    • Dentist offices
    • Your local auto repair shop
    • Gas stations may fail
    • Each of these businesses is cumulatively a large part of the employment for individual cities and towns. Yet, we can expect a potential failure of these businesses at an alarming rate if the shutdown continues for too long.
  • Large businesses will layoff employees for longer than the shutdown period.
    • Move Theatres may go bankrupt. (See: AMC)
    • Cruise lines will be restructured. (Carnival already has)
    • Air travel may be impaired for a year.
    • The automotive industry is likely to be impacted by reduced consumer income for a long time. 
• There is a time limit to this shutdown. If it continues past a certain date, a date which we cannot know where the line is in advance, the economy could dive into a depression.
• The line between recession and depression is blurry. The tipping point is the failure of small businesses that cannot simply be restarted after the shutdown is lifted. 

Summary: 

Investors today are likely underestimating the second-order effects of the coronavirus shutdown. Layoffs and bankruptcies will have long-lasting adverse effects on the economy. If the number of layoffs and bankruptcies gets too high, the economy will likely exceed a simple recession and enter a medium-term depression. 

References

• Joshua Kennon's question: What Price Should We Pay to fight COVID-19?