Pandemic of 2020:
Economic and Financial Implications

Recent LinkedIn

• July 8, 2020: Seven Risks to the Economic Path Forward
• June 15, 2020: Risk #4: Policy Fumble
• June 15, 2020: Risk #3: Debt Overhang
• June 11, 2020: Risk #2: Biological Setback
• June 10, 2020: Risk #1: Rose-Colored Glasses

• What will the recovery look like?
• How does this recession compare to other recessions. What can we learn from previous recessions? Will the pandemic induce structural damage to the economy going forward?
• What are the greatest risks to the recovery? How much should we worry about inflation?

• Today, unemployment data was released that suggested the rate was 14.7%. The previous historic high since 1948 was 10.8%. It peaked at 10.6% in the Great Recession.
• However, the rate is understated. The rate is based on survey evidence we know two facts that support the understatement. First 8M have dropped out of the workforce since Feb (they are likely unemployed but are not counted). Second, we have hard data on Initial claims.
• Redoing the calculation suggests that the unemployment rate is likely 23.9%.

• Gold and cryptocurrencies failed as a hedge during the COVID-19 crisis. Note that gold and cryptocurrencies have roared back - and so has the stock market. This is suggestive of positive correlation.
• It is true that some gold supply chains and ease of arbitrage has been disrupted because the transport of gold relies on air travel. However, I don't think this is a big deal and unlikely to lead to short squeezes and other market disruption.
• My research shows that gold is an unreliable hedge looking at centuries of data. Gold has volatility of 15% per annum - about the same as the equity market. Cryptocurrencies have volatilities closer to 90% and there is very little data. They are a very risky safe haven. However, some classes of cryptocurrencies, that are collateralized (for example, with gold) hold considerable promise to disrupt the physical holding of gold as well as ETFs backed by gold.

• Lockdown is destroying the economy. While it might make sense in high density places like NYC, it does not make sense in low density places
• People misunderstand “flattening the curve”. Flattening the curve does not reduce death – it just delays. It was originally advocated because we did not have ICU capacity. We do now. If serious infections increase to the point of challenging the medical response system, we can reevaluate again. Fatality rate has been greatly overstated. Young people, especially, are being disadvantaged.
• Moderate social distancing, testing (accurate), tracing, isolation of infected and quarantine of those exposed. Lockdown needs to be strategically reduced.

• Unlikely the Fed statement
• No new programs announced however there is positive news: a) People realize we are past the inflection point. There is no need for a field hospital in Central Park, b) Serology studies suggest infection rate far higher than thought (25% in NYC) which means the fatality rate has been overstated by an order of magnitude; Promising vaccine research; Promising anti-viral news; Public pressure on policy makers to pivot and end the lockdown.
• Growing expectation that Q4 will have a substantial snapback. My forecast Q1 -6% (after revision); Q2 -30%; Q3 -10%; Q4 +15% which means about -7.8%. The key Q3 and Q4. If we can hold Q3 at 0% that translates into -4.5%. If we can boost Q4 from +15% to +20%, that reduces the pain to -4.3%

• Yield curve (10-yr yield minus 3-mo yield) has inverted before the last seven recessions. My dissertation at the University of Chicago discovered this. Yield curve inverted June 30, 2019 and I forecasted a recession for 2020.
• We will never know if a recession would have occurred in the counterfactual of no COVID-19, however, in 2019, over 50% of US CFOs believed a recession would start in 2020
• The yield curve is upward sloping today signaling an end to recession. QE could mess up the signal but we have had QE before. However, a liquidity trap could even do more damage

• Market tumbled when STAT leaked the preliminary results of Gilead Sciences remdesivir’s trial.
• Other was the serology report that has talked about all week. In a random sample of 3,000 in NY, 13.9% tested positive for anti-bodies and 21% in NYC. This is important for multiple reasons. 1) it means that the infection rate is far higher than reported and these data consistent with 10x which means the mortality rate is greatly overstated. The data are consistent with European data. 2) There is a possibility of going back to work (need more science) and the possibility of plasma donation.
• There are other implications for herd immunity. All good news.

• 4.4M better than last week; total loses is 26.4M adding in the 5.8 that were unemployed in February 2020 (when rate was 3.5%) we get 32.2M.
• This is remarkable because the max rate of unemployment during the great recession was 10.6% with 16M out of work. That didn’t happen until January 2010 (recession started September 2007).
• Stock market went up because this was not unexpected

• There are 30.2M small business and the $349B allocated large for the PPP was not going to be enough (as I said previously). They money is gone as of today.
• Congress is arguing over the scope of a new bill – one version has another $250B for this facility
• Unemployment was very slow to decrease. Did not reach pre-recession levels until May 2016

• We have had 22M jobs lost in four weeks and it is not over. This is why I call this the Great Compression.
• Peak unemployment during the Great Recession was 16.1M (in January 2010)
• he more time wasted on bickering increases the chances that our policy makers induce structural damage to the economy that will prolong the period of recovery. We don’t want to wait 7 years like we did during the Great Recession to get back to normal.

• Declare that worst recession since the Great Depression with -3% 2020 World growth and -5.9% US growth.
• I prefer to call it the Great Compression and the link to the Great Depression is misleading. The Great Depression dragged on for almost a decade. This recession will be short
• Even the IMF’s own forecasts have a +5.8% World growth in 2021 and +4.7% US growth

• 16.8M jobs lost in three weeks; compares to 10M during Great Recession. We are not done yet.
• The last three announcements, each of which is historically unprecedented, was followed by a positive day in the market. That’s because the numbers were expected.
• Unemployment could approach depression level – but this is not a depression. People expect to go back to their jobs.

• Overall $2.3T
• Paycheck Protection Program Liquidity Facility (PPPLF). Term financing backed by PPP loans. (Originally announced Apr 6)
• Expand size of PMCCF and SMCCF as well as TALF to $850B backed by $85B of ESF equity. CCF’s now eligible to buy bonds that became junk after March 22. TALF expanded to AAA CMBS/CLOs.
• Municipal Lending Facility (MLF) with $500B in capacity backed by $35B of ESF equity
• Main Street Lending Program $600B backed by $75B of ESF equity. Can be used for new loans (MSNLF) to small businesses or to expand the size of existing loans (MSELF). Note banks retain 5% share of loans sold. Note 40,000 medium sized businesses in US employing 35M. Originally announced March 23. Term sheet today.

• Yes. MV=PQ
• We had QE in 2008 and the Fed balance sheet grew to $4T.Many warned of the inflation risk. It did not materialize. People extrapolate to today thinking there will be no inflation. I think this is a dangerous extrapolation
• Essentially, we have "unlimited" QE (we did not have that during the Great Recession). The Fed balance sheet could easily go to $8T. An additional $4T could be added to the national debt. Furthermore, there will be massive fiscal deficits.
• I understand why people are hesitant to buy the 10-year or 30-year bond. It is not a matter of default risk, it is a matter of interest rate risk. I will have more to say about this inflation risk in the future.

• Paper by the SF Fed examined experiences after pandemics – going all the way back to the Black Plague. They conclude that growth is very slow after pandemics.
• This time is different. During the Spanish flu, we did not know what it was or when it would end. It began in the spring of 1918 and came back even more deadly in the fall. In 1919, people did not know if it would return again. There was a huge amount of uncertainty.
• Fast forward 101 years, it took two weeks to map the DNA of COVID-19. There are multiple vaccines in trial or near trial (Moderna, Novavax). There numerous pharmacological initiatives to mitigate the symptoms. Once a vaccine is developed and deployed, it is “all clear”. The uncertainty has been resolved. Uncertainty, leads to slow recovery.
• Another example is the global financial crisis. It was a slow moving train wreck. While NBER dated the end of the recession in Sept 2009, in 2010 unemployment was still going up. We had no idea the recession was over. Given the uncertainty, consumers held back on spending and businesses did not invest in capital projects or hire additional people.
• This recession has as biological cause and a biological solution. The key is to minimize the damage to the current economic structure so we can have a sharp recovery.

• This recession is different because it focuses on small firms. There are 30.2M small businesses in the US. Last recession, policy makers could focus on the 25 largest banks.
• In addition, many of these banks were the cause of the GFC. No one can point their finger at small business for being the cause of this crisis because it is biological. It is more akin to a natural disaster.
• It is not sufficient to simply pass a bill with $350B for small business bridge financing. The money needs to be deployed quickly. This is what I worry about.
• (1) “Application information is not uniform across banks – for example, various banks count employees differently”; (2) “There is no notice that your application has been received”; (3) “There is no way to update application once submitted”; (4) “You must do the whole application in one sitting – you can’t save your work”; (5) “The level of detail that they are asking for is ridiculous and doesn’t seem to make any sense”; (6) “Since they are inundated, they have indicated that it will be a while to process. Who knows what that means”; and (7) “I tried to submit on Friday and the system crashed on me”.
• In 2008, when you lost your job at Lehman Bros, there was no going back and, indeed, it was very hard to be placed at another firm. In 2020, the word is “furlough”. Many have lost their jobs at high quality firms – and assume they will go back to work. That is different and this is another reason that the recovery will be swift.

• $350B was not enough money.
• McConnell said he would introduce legislation this week to recharge the funding; this is administered by banks and overseen by Treasury and the SBA.
• I worry the damage has already been done. There are 30.2M small businesses according to the SBA. Losing 10% of the high-quality small firms would delay the recovery.

• The Fed has lots of special purpose vehicle (SPV) initiatives: Commercial paper, corporate debt (primary market), corporate debt (secondary market), primary dealers, money market funds, student debt, and credit cards, as well as the Main Street Business Lending Program (no term sheet).
• The latest announcement would allow the Fed to buy some of the Paycheck Protection Program (PPP) debt from banks, thereby freeing up lending capacity (no term sheet).

• Yes, this was a paper from the San Francisco Fed that looked at pandemics back to the Black Plague. I think this time is different. In 1918, no one knew what was killing millions of people. There was a terrible second wave in the fall of 1918 when most of the deaths occurred. At the end of 1918, people had no idea if this would drag on forever.
• Similarly, in the GFC, no one knew if it had ended. Unemployment continued to increase. People were talking about a depression.
• This time around we know the cause and it is biological. It took two weeks to map the DNA. We have vaccines in trial. We have pharmacological candidates to lessen symptoms. Once the vaccine is available and deployed, the uncertainty is resolved like no other economic episode in the past.

• 15M at high risk in restaurants, bars and retail (half the employees). Another 17M in next layer of risk. Hence, +10M unemployment in past few weeks is not surprise and it will get worse
• Employment report tomorrow will not be that informative. It is based on a survey of 60,000 households and the data is not as timely as claims
• Great Compression. During the great recession we had +9.6M incremental unemployed. We got that in the past few weeks?

• We have seen record increases in unemployment and we can see record decreases
• In the GFC, there were structural problems in the financial sector. Many firms disappeared or were acquired and jobs were permanently lost. This crisis is biological. When the biological cause is mitigated and assuming companies are still around, there is a place for employees to return to work.
• Assuming our policy makers provide bridge financing, this could look like a skinny U. Q2 and Q3 will be ugly but there will be an improvement in Q4. Assuming a biological solution (vaccine) begins to be deployed in Q1 2021 we can have a rapid recovery.

• Two forces are important for recovery: biological and financial. Let’s assume the biological is taken care of
• To me, the weak link in the chain is the potential difficulty the SBA will have in deploying loans. Congress allocating funding is necessary but not sufficient. The funds need to be deployed. Banks should be apply to rely on borrower’s information – they should not be required to verify. If that happens, it will take far too long.
• There could be unnecessary damage if potentially 100,000 small companies go out of business. There would be nowhere for employee to return to.

• Initial claims on Thursday will be very meaningful.
• Unemployment on Friday less meaningful because it is based on a survey in March of 60,000 and things really got bad in the last two weeks of March
• Rate could go to 25% greater than the Great Depression. However, the Great Depression lasted for a very long time. This will be the great compression – years’ worth of bad news in one year.

• Yes, they finally talked about the models. They seemed unaware of the IHME model but talked about it being similar to their model
• I looked at the IHME model and it is similar to mine (though it calibrates some parameters from the Wuhan experience – which I am not sure is applicable)
• Mory Elsaify and I have added many new options for our model see here.

• I would replace “market” with another word.
• There is so much uncertainty. The market was prepared for the 3.28M initial claims but are they prepared for 4 million next week and potentially the same the week after?
• In addition, it is not clear we are past the inflection point (rate of new cases decreases). However, the good news is that we are likely close (according to my model)

• I had read the initial version of March 19 which was 247 pages. The version passed unanimously by the Senate is 880 pages!
• The items are: $349B in small business loans and $454B for the Treasury’s Exchange Stabilization Fund which allows the Treasury to backstop other Fed initiatives
• Interestingly, the bill explicitly mentions the Fed’s announced (but not formalized) Main Street Business Lending facility

• We expected it to be bad. BofA forecast 3M and they were close. It is a historically unprecedented jump. But it was not hard to forecast. There are 30M working in restaurants, bars, and retail. The math was simple.
• The way to look at it as this week’s announcement was equivalent to the incremental claims in the first 52 weeks of the global financial crisis. If we get 4 million next week, that will be equivalent to the next 16 weeks of the last recession.
• Think of this as a compressed recession. The good thing is that the health issues will not last for more than one year (assuming a vaccine is ready). In global financial crisis recession, we didn’t know when it ended. The recession was over in June 2009 but it wasn’t announced until September 2010.

• When there is extreme volatility, it is hard to read much. For example, there is now 95% confidence that the Dow moves between +1,700 and -1,700 points.
• There is still plenty of uncertainty but markets receptive to a bipartisan effort in the US for an aid bill.

• I do like calling it “aid” rather than a bailout. Notice US GDP in 2007 was $14.7T and today $21.7. Also, 2008 was different because it was a bailout of the banks. In this crisis, everyone is impacted.
• I doubt it is enough. You want to see a bazooka, look to Germany. Their package is $820B and on a GDP adjusted basis, $4.3T. In addition, their state development bank has a war chest of another $2.9T
• The crucial factor is when we get over the biological hump.

• Mory Elsaify and I will update after 9pm every day. This is the time the Johns Hopkins data are released.
• There was a slowing in new cases reported which is good news (though the data could be noisy)
• These model are very sensitive to new observations.

• Fit classic Richards model to daily dataset from European CDC
• Obvious, US has not flattened the curve
• While hard to estimate, new cases should start to decrease in 7-10 days. The peak total cases is in the second week of April. Plenty of caveats. Models do not take account of interventions like mandatory quarantines.

• This is not the end to volatility
• The macroeconomic data will be shocking and add to additional uncertainty because our economy has suddenly stopped.
• Main good news was some progress on legislation

• We don’t know what the bill includes but has been talk o9f $350B for small business lending which is much better than the $50B initially offered
• There were also reports that $425B has been allocated to the Treasury’s Exchange Stabilization Fund. The ESF is important because it provides backstops to a number of Treasury initiatives that either indirectly or directly benefit small businesses. Currently, the ESF has less than $100B and is not a credible backstop.

• Policy makers need to share their forecasts to reduce uncertainty
• Why do I have to model this? Turning point is expected in seven days
• Thursday will be particularly painful given the initial claims

• Restarants/bars 12.3 million; Hotels 2.1 million, Retail trade 15.7M, that’s just the beginning
• Assume half have lost their jobs. That’s surge of 15m just from these industries
• Global financial crisis unemployment rose by "only" 9 million

• As usual, the market was down – but the market might have been down more if the initiatives were not launched
• First, unlimited QE (which now also includes CMBS)
• Second, Secondary Market Corporate Credit facility (SPV to purchase corporate bonds backstopped by Treasury)
• Third, Term Asset-Backed Securities Loan Facility (TALF) which was used in the financial crisis lend to AAA asset-backed securities composed of newly issued consumer and small business loans (SPV also backstopped by the Treasury).

• The Fed intends to launch a Main Street Business Lending Program
• There are no details yet but this is the most promising initiative.
• It would complement the actions of the SBA

• All of these initiatives are backstopped by the Treasury’s Exchange Stabilization Fund (a fund created in 1934).
• However, the ESF does not have enough money (they have less than $100B in assets)
• Draft bill in Congress sets $425B to the ESF

• Yes, claims next week will skyrocket and investors might overreact to this
• 1.5 million represents a 60 standard deviation move
• Better to think of this as 5 weeks of GFC. There 39.5m initial claims filed during the crisis and 10m above normal

• Money Market Mutual Fund Liquidity Facility, or MMLF, was augmented to receive high quality municipal bonds (which will help the municipal lending market).
• Five key central banks, ECB, BoC, BoJ, BoE, and SNB will increase the frequency of the dollar swap arrangements from weekly to daily
• While I was critical of the Fed for slashing the Fed Funds rate to zero, the Fed has been very helpful on the liquidity side of the market.

• WSJ reported that the draft proposal by Republicans includes $300B for small business lending
• This is much better than the $50B the President initially proposed
• It is probably not enough. We want to avoid small business laying off their employees because they fear there will not be any bridge funding to get them through this crisis.

• Liquidity trap
• Fed stabilizing the long-term with $150B of shopping
• Welcome to European style interest rates

• Appears to be US cash and other countries joining in
• Euro, pound, yen, franc, CAD, CNY, MXN all getting crushed
• Fed announced new swap facilities with 8 central banks

• Department of Labor released claims and they were up 70,000 to 281,000 (reflecting last week)
• Preliminary state data is far scarier according to NYT with claims this week in California possibly exceeding all of the national claims last week

• Rates so low, no one wants to invest in bonds, prefer cash
• Evidence today that stock bond correlations have changed (consistent with trap)
• Fed becomes buyer of bonds (they have already committed $500B)
• Are we headed to a Japan scenario?

• This does not benefit small and medium sized businesses directly (they have no access)
• There is an indirect benefit because large corporations can use this rather than draining lending facilities at large banks (leaving some room for small and medium sized businesses borrowing)

• Perceived safe havens gold have failed (consistent with my research on gold)
• At the beginning of this crisis, US Treasury bonds were effective, however, given rates are so low people prefer holding cash

• Remember stock market dropping from historic high which makes things look very bad
• There is plenty of encouraging news on health front: 1) Both China and Korea have past the hump with very few new cases; 2) Vaccine trial has begun (Moderna); 3) There are plenty of other vaccine initiatives including Arcturus Therapeutics-NUS-Duke; 4) Evidence that some common retroviral drugs can be effective in treating the symptoms.
• Importance of having a forecast to reduce uncertainty.

• Actually markets were volatile there is still a lot of uncertainty
• Treasury is getting involved and there will be some type of bipartisan package

• Historical background, established in October 2008
• No, but it is helpful for larger corporations
• Only those with a recent record of issuing CP are eligible - so this is irrelevant for small businesses

• According to a Fed study, 40% of Americans would have trouble coming up with $400 for unexpected expense – so some type of relief is necessary because we are facing that situation
• However, we are not addressing the small businesses who are critical

• This was an important question in 2008 when there were good banks and bad banks
• It is less important today because this crisis is not a result of any bad behavior of individual companies – it is more akin to a natural disaster

• Rates already low
• Aggressive action seems like panic
• Heading to a Europe/Japan equilibrium
• Long-term damage due to distortions

• Biological crisis causing financial crisis
• Banks stronger (liquid assets + equity)
• $1.5T of excess reserves
• Different leadership

• New playbook (do not want to repeat GFC mistakes)
• Bridge financing
• Transparency in projections

• Half of employment
• 60% of growth in employment
• Crucial in the supply chain

• I called a recession due to the yield curve inverting June 30, 2019.
• The major reason for the steep drops is where we started from (an all-time high)
• In 2003 (SARS), the market had already shed 40% of its value (tech bubble)

• We can learn too much
• 1918 pandemic killed 6x the number of Americans as WWI, yet the market shrugged it offbecause there was a peace dividend (so we can really use that one)
• 9/11 is a comparable given the degree of uncertainty was large and people retreated
• COVID-19 should be short (new cases should peak in a few weeks) but the sharp contraction will play out for many quarters. COVID-19 hit quickly were as global financial crisis was a slow moving train wreck. That’s why I think 9/11 is a better comparison.

• Initially the market rose but then plummeted
• People worry that the Fed thinks this crisis is the global financial crisis - It is not

• President’s speech promised $50B in the form of loans to be administered via the Small Business Administration
• $50B is not enough
• Small businesses hit with a natural disaster – it is not their fault (unless financial crisis where banks were at fault)

• Good news on the health front with China and Korea passing the peak
• Worried that many cannot WFH and those people will be laid off prolonging the recession

• US was already slowing and yield curve had inverted
• More than 50% of CFOs thought recession going to happen in 2020 before the COVID-19because there was a peace dividend (so we can really use that one)
• Obvious that recession started in February 2020

• Fed cut rate from 1.5% to 1% which I thought was a mistake. In September 2007, they also cut 50bp but from a starting point of 5.25%
• Key is the supply chains and this means Treasury must focus on small and medium sized businessesbecause there was a peace dividend (so we can really use that one)

• Global financial crisis caused by financial event and banks were the target whereas this crisis is a biological event causing a financial and health crisis
• Comparison to SARS in 2003 is difficult because we were in bear marketbecause there was a peace dividend (so we can really use that one)
• Comparison to Spanish flu in 1918 is difficult because of the end of WWIbecause there was a peace dividend (so we can really use that one)

• When equity market at all-time high, expected returns are low
• During a recession when market prices decrease, expected returns increasebecause there was a peace dividend (so we can really use that one)
• Opposite for the bond marketbecause there was a peace dividend (so we can really use that one)

About Professor Harvey:
Campbell R. Harvey is a Distinguished Professor of Finance at Duke University and a former President of the American Finance Association. An important part of his research focuses on risk management. He also serves as a Partner and Senior Advisor to Research Affiliates LLC and as an advisor to Man Group, PLC. Follow him on LinkedIn and on Twitter @camharvey.