ECONOMICS / IF YOU HAVE NO CLUE WHAT CORONA'S IMPACT IS, READ THIS
Many articles say the world is on the verge of a recession, few agree on the reasons why. Indeed, while it is easy to point at Coronavirus, it is more complicated to precisely dissect and understand the exact factors which are leading us to a global economic downturn — something essential to implement the right governmental policies to stimulate the economy. For those of you who haven't had the time to catch-up, here is everything you need to know on the Coronavirus' economic effects, the few companies benefiting from it, and appropriate solutions to solve this crisis.
SUPPLY AND DEMAND SHOCKS
While it far from being the only economic components of this crisis, it must be acknowledged that, fundamentally, Coronavirus can be summarized as both a supply and demand shock. Long before the health situation got out of hand in Europe and America, transnational corporations headquartered in Western Countries were already being negatively impacted by corona's spread in China. Indeed, the fact that the suppliers of these firms, mostly located in China, had to close their factories when the Chinese government enforced a quarantine led to a drop in their output produced which thus disrupted global supply chains. Therefore, companies which relied on their Chinese counterparts were not able to sell as much as they wanted, leading to workers being fired and shops being closed in order to decrease expenses and thus compensate falling revenues. In countries where unemployment benefits are relatively high, such as France or Spain, this puts pressure on governments and constrains them to borrow more than they already have. This highlights one of the problems of globalization, as countries are getting increasingly interdependent, the fall of one may create a domino effect, or rather a snow ball effect as the economic consequences keep getting worse.
This leads us to the demand shock, whose effects have just become more devastating with the spread of Coronavirus. While initially consumers were spending less money because the companies they were working for were either laying off or paying less (due to the supply shock mentioned above), now they are not going out of their homes as much as before due to the encouraged "social distancing", meaning that they are much less inclined to go out shopping, to a restaurant, or travel. For instance, retail companies which were already suffering from the supply shock now face a decrease in demand, leading to even less revenues, and now have to lay off even more workers. This creates a multiplier effect, an economic term which explains that workers being laid off in an industry, now having a smaller income, spend less money in other industries. Thus this negatively impacts sectors which were, at first, not concerned by the economic downturn. Each year, the airlines, amusement parks, hospitality, and dining industries contribute to 5.5% of the USA's GDP and 11% of its job market— the equivalent of $1.2 trillion and 17 million jobs. As people increasingly stay at home, these industries are at risk, and if they were to fall, the whole country would be headed in the same direction.
The compounded economic effect of the demand and supply shocks can be seen in China, and it is soon, if not already, going to be mimicked in Western countries. Business insider states that:
"- China's industrial production fell by 13.5%, and its service production fell by 13%.
- Manufacturing production was hit especially hard, falling by over 15%.
- Automotive production fell by a whopping 32%.
- New housing starts fell by 44%, and there was a 23% drop in housing completion.
- Retail sales fell by 23% in real terms.
- And finally, because of work disruptions, exports fell by 17%."
Due to this, new global economic forecasts are being done, and they much less brighter than expected:
FORGET ABOUT 2008, 2020 MIGHT BE WORSE FOR THE FINANCIAL SECTOR
The goal of traders is to anticipate future demand for certain stocks, and more generally to predict future economic outlook, in order to know what to buy or sell and when. Therefore, the state of financial markets is usually a good indicator of what is coming for our economy, and it is not looking good.
The chart speaks for itself. Traders are studying consumer confidence numbers, thus the drop in the value of stocks reflects the population's anxiety and decreased spending (demand shock). Ironically, a few companies are doing more than good in this period. Clorox, which sells cleaning products and bleach, is seeing an unprecedented increase in the value of its shares. In addition, companies offering at home services such as Netflix or Peloton are seeing increasing revenues due to social distancing and quarantine, but that might be the only positive prospect for our economy.
If there is one thing that is certain, it is that the policies implemented for the next quarters will be studied in future economic textbooks — either to show what to do during a crisis, or what not to do.
Most governments have already cut the interest rate in response to the coronavirus, the goal of this is to make consumption and borrowing more attractive. However, this technique has been over-used since the last financial crisis, and as interest rates are already close to zero, in most European countries at least, the effect of rate cuts is most probably not going to be very significant. Indeed, not only does it take time to see the effect of this, but for now no-one has cash flows. Currently, the FED's target is between 0.25 per cent and 0.5 per cent, which it aims to obtain through quantitative easing in open market operations. While quantitative easing injects liquidity in the economy by incentivizing banks to give more credit to companies, traders do not seem believe it will help raise inflation, which means that it will not increase consumption. Indeed, investors forecast that inflation will be below 2% (the usual target), which means that they do not believe the government will be able to prevent prices from dropping.
Trump has encouraged cutting payroll taxes to increase consumers' income, but again this seems to be far from enough. Indeed, cutting payroll taxes may add $50 next month to the average household's paycheck, but for workers who have just seen their income halved it is rather $500 which is needed, and immediately. Otherwise, consumption will just keep on decreasing, furthering the demand shock. Nevertheless, as people fear going out of their homes, injecting more money in the economy could actually solely lead to stagflation. Also, do we really want to encourage people going out shopping by giving theme extra money, if our common goal is to avoid social contact ?
This last question reflects a real issue in the way we are dealing with this crisis — should we save the people, or the economy ? While the answer might seem obvious for many, UK PM Boris Johnson has decided not to close any shops, schools, or other public spaces as closing them would, according to him, cost too much to the UK economy.
What should be done then ? One solution for which there seems to be a general consensus is that businesses need to be prevented from bankruptcy because of coronavirus. Indeed, for our economies not to collapse due to a spike in unemployment, governments must step in to ensure that companies can survive even with a null turnover. However, this can only be done through borrowing more, which will have to be paid for by Millennials and Gen Z, the former which has already suffered from job insecurity due to the 2008 crisis. In addition to the fact that there is an increasing number of retirement cost due to our aging population, the coming recession might cause permanent disruption of our spending power.
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