Category: Uncategorized

by Mark Schniepp
September 15, 2020

So now we know that the answer to restoring the economy is to end the pandemic. That may seem obvious but here’s why it’s not. Containment has proven fragile, with notable spikes in parts of the country. Moreover, premature reopening may mean that the curtailment of pandemic hot spots will take longer.

The pandemic must be eradicated rather than controlled, because new outbreaks are possible and/or a 2^nd wave might occur, resulting in the possible reinstatement of business closures and economic carnage. In other words, we can’t predict which way the virus will go and who it will affect. We have already witnessed this with the reopenings and subsequent closures of regional and state economies and with public protests and non-distanced civil unrest in late May and June.

These events caused another surge in cases. They also caused an increase in hospitalizations and deaths, among more than just the elderly age group.

Eradicating the coronavirus means a therapeutic cure or a vaccine to inoculate the population from contracting the virus, now, or in the near future.

To forecast how the economy will evolve, we have to devise a plausible story with particular milestones and conditions, mostly about when business restrictions are entirely lifted.

We have assumed that the vaccine becomes ready after the beginning of the year, or in January/February of 2021. Dissemination occurs over the subsequent 3-4 months when most of the U.S. population receives it. Consumers will gain new confidence that they won’t contract the virus and most will resume public interaction and gatherings as before. Businesses prepare for normal operation during the spring months of 2021.

The economy effectively opens up more fully next summer. Travel resumes with more exuberance and spending on goods and services, and recreation surges. The 2nd half of 2021 results in stronger growth and major gains in employment and income.

The economy however is not back to the pre-crisis status. During most of calendar 2020 and in much of the first half of 2021, ongoing economic restrictions will have resulted in millions of permanent business closures and jobless workers. These closures cannot be reopened quickly by replacement businesses. There may also be some lingering fears that a mutated strain of the virus could be present, unaffected by the vaccine, and this would prevent some consumers from spending freely at stores, shops, or other public venues. Furthermore, many people may opt to forego the vaccine. It will also take some time for the demand for travel to be reestablished. It took more than 2 years after 9/11 for air travel to return to its prior peak.

We believe that even with the availability of a vaccine it will take time for consumers to return to normal.

With businesses taking on a huge amount of debt, repayment of that debt will take a priority over new capital spending. This will produce a drag on growth. And do not forget that state and local budgets suffered a revenue collapse that even with federal assistance it will take years to recover from.

Consequently, because the economy needs time to fully recover, don’t expect a rapid return to normal once the pandemic is declared over. During 2022 and 2023 new businesses will open, workers become rehired, income is generated, and spending will rise as a result of the wider income growth.

California Will Lag

This state has been subject to the harshest restrictions on business in the nation. Most of the largest counties were shut down for a 9 to 10 week period, or longer. The easing of restrictions for all counties by June 1 was effectively removed 4 weeks later when reversals in re-openings were put into place just ahead of the July 4 holiday and on July 13. Limitations principally designed to keep people outside remained in place through August.

Unemployment surged in April, May and June, appearing slightly better in July. However, the effective unemployment rate that we track weekly still reports a 15.8 percent rate in the first week of September.

And compared to other states, California’s official unemployment rate ranks 6^th highest for the month of July:

Through August 21, spending at restaurants is down 39 percent from spending levels that prevailed in January of this year. For transportation, spending is off 52 percent. Few people are flying anywhere, and gasoline prices are very low.

Consumer spending is down nearly 12 percent from January. In other states, the spending decline is significantly lower or has largely recovered:

There are 25 percent fewer small businesses open today in California than there were in January. The carnage has been significant, especially for businesses in the leisure, hospitality and recreation sector which have suffered a 35 percent closure rate. In retail trade and transportation, the small business rate of closure is at 30 percent.

Many of these businesses will not reopen. A surge in bankruptcies has not emerged yet but more bankruptcies are coming over the next 5 months.

To date, the national economy has recovered 52 percent of all jobs lost in March and April. The California economy has recovered just 30 percent.

The New “Blueprint” for a Safer Economy

As of today, 33 counties representing 71 percent of the population remain in the most restrictive tier of counties based on daily case rates and the test positivity rate. The criteria for meeting the thresholds that reduce the restrictions on business are very strict. The restrictions on establishments prohibit indoor operations of nonessential business. Retailers can only allow customer capacities in their stores of 25 percent. Ditto personal care shops. No entertainment venues can open. Bars and restaurants can’t open unless they are outside.

If a County moves from the most restrictive (tier 1 or purple) to the next less restrictive (tier 2 or red), capacities are allowed to increase from 25 to 50 percent, and gyms can move indoors but only with 10 percent or normal capacity.

This is likely going to be the California economy for the next few months or the remainder of the year. Moving to the less restrictive tier 3 or tier 4 appears to be near impossible for most counties unless the virus burns itself out, an unlikely condition in view of the daily new case counts in the state. Right now there are only 11 counties classified in tier 3 or tier 4 and they represent less than 5 percent of the population of California.

Schools are not going to open for the remainder of the year. Given the opportunity to open with a waiver, few public schools applied for that waiver, choosing to remain closed to in-person instruction. However, more private schools are choosing to apply, and many have already opened up.

Even if the pandemic were to suddenly end tomorrow, the economic carnage to date would be both irreversible and not yet over.

Therefore, with new protocols for California that are more restrictive on business than before, and with public schools remaining closed for the remainder of this year, the outlook for the economy predicts little improvement.

Expect a challenging fourth quarter for small businesses in California. Expect no change from the way your kids are currently receiving their education, unless you move them to a private school. And expect the travel industry to struggle for an indefinite time period because that industry is not really evolving with all distance business conducted via zoom.

by Mark Schniepp
August 4, 2020

The strong recovery we observed in May and were optimistic about going into the summer has clearly weakened. The economy is now moving sideways, at best.

The western world has now suffered through 20 weeks of the pandemic. During the 20 weeks, May 16 to August 4, 4.9 million people have tested positive for coronavirus in the U.S. Reported deaths from the disease now stand at 160,000.

Most of the U.S. economy was locked down for half of March, all of April, and about half of May. Consequently, economic activity was dramatically impacted in the second quarter.

The growth of total output in the United States from the peak quarter (2019 Q4) to the second quarter of this year was negative 11 percent. On an annualized bases, the economy was down 33 percent in Q2. To put this into context, our annual average growth rate over the last 10 years has been +2.3 percent.

There has been very little travel, no large public gatherings, no audiences at sporting events, no in person concerts, conventions, or conferences since mid-March. There is now a pause in re-opening plans in most large states, or reversals of openings with re-closings of restaurants, bars, personal care stores, shops, gyms, and museums.

European countries are now open and travel within the EU is rising but occupancy at most hotels remains low because tourism is crippled by the travel ban on U.S. visitors. We represent 15 million travelers per year to Europe, mostly in the summer months. None are there now.

Consumer confidence dipped in July. And consumer sentiment is unlikely to make a comeback until the labor market improves, states reopen non-essential businesses, and the number of reported corona cases falls significantly, and for long enough, to extinguish fears of another wave of infections.

While the second quarter GDP report was ugly, it was no surprise. Despite the reversals, economic growth will rebound in the third quarter because so much more of the national economy is open and operating than in the April-May period.

However, the labor market will be slow to follow. Because of the ongoing restrictions, the unemployment rate will remain elevated and may not improve in the third quarter. It is already increasing again in California. Moreover, most businesses are no longer investing or hiring, meaning those permanently laid off will find it difficult to return to work immediately.

Continuing unemployment claims rose again at the end of July (the latest report), and surveys indicate that fewer people are currently working. This is all because of the reversals in the economy and the depletion of the Paycheck Protection Program loans that rescued many workers from layoffs between April and June.

Those loans were largely used up on worker payrolls. Also now completed is the federal program to supplement unemployment insurance benefits to laid off workers. The bonus payments ended on July 31st.

The first round of Federal stimulus is therefore wearing off. Federal Reserve chairman Jerome Powell said that additional direct fiscal stimulus is needed as the economy has begun to weaken because of the surge in COVID-19 cases and states either pausing or rolling back their re-openings. There is no replacement rescue program, yet.

There is now a divergence emerging between the U.S. and California, and this is because California is still the most locked down state.

The number of small businesses open in California has turned down again and is now off 22 percent from the number of small businesses that were open in January 2020.

Small businesses are suffering in most states, so the decline of establishments is not unique to California. It is estimated that states accounting for 70 percent of the nation’s GDP have paused or reversed their re-openings. Furthermore, more people are putting themselves in self-quarantine and this along with the massive number of layoffs is curtailing overall spending.

Because schools are not starting in-person education in the fall, the economy will be absent a significant boost in economic activity from student transportation services, food services, school and campus events and sports activities, social group spending, and dormitory services at universities.

How will schools raise money for special education services? Will there still be bake sales or Christmas wrapping paper drives? What about high school football? 27 states will start the fall season as scheduled. Seven have yet to decide. The rest including California, Nevada, Arizona, Oregon, and Washington will delay or cancel the season. California will move football to the winter season, starting in January.

College football will proceed, but the number of games will be reduced and often limited to intra-league play. Will games be played in empty stadiums? In many states this will be the case, eliminating all of the economic activity generated by spectator spending.

The haze over the outlook for the economy is clearing some. We can now see that what is needed to rebound out of this mess is restoring confidence so consumers will leave their proverbial bunkers and go out and spend. We need state and local governments to withdraw all the restrictions and allow small business (and all business) to expand production and sales and hire again. Neither of these actions will occur until the pandemic is under control, and the concern about infection has passed.

Ending that concern may be near impossible without a cure or some clear evidence that the virus is burning out.

by Mark Schniepp
July 3, 2020

We are assuming that the recession is now technically over, because growth in employment, payrolls, and spending has resumed. Therefore, the recession that began in March and likely ended in May could be both the deepest and shortest recession on record.The average length of a recession is 11 months and none has lasted less than six months. However, this isn’t, or wasn’t, a normal recession or business cycle. This recession wasn’t caused by the traditional catalysts, and the recovery is likely to differ from those in the past.

The monthly estimate of GDP declined 5.2 percent in March and 11.4 percent in April.

As of 7/2/20, we were 15 weeks into the Coronavirus crisis. The reopening of many U.S. state economies has led to a gradual economic pickup. Mobility has risen, and although initial claims for unemployment insurance benefits have been steadily declining, they still remain at massive levels. GDP estimates for the month of May should be positive because the economy was allowed to slowly wake up.

But because the reopening is limited to specific business sectors and with capacity limitations it will produce a limited and temporary boost in demand. People still find their movements and options to spend severely restricted.

Consequently, retail sales and services still suffer today from unprecedented reductions.

This is the contributing factor as to why a V shaped recovery cannot occur, because of the manner in which the economy is being allowed to recover.

If regional economies could phase out restrictions, economic growth would bounce back more sharply. In sectors or states in which restrictions were eased earlier or more than others, there is a higher level of production and a faster restoration of spending.

The PPP Flexibility Act, which became law on June 5, creates a downside for the number of workers rehired in June. Businesses that received PPP loans in late May and June are now in no rush to rehire, and can delay until local lockdown orders easy enough to make it worthwhile to restore workers. Hiring foregone in June should show up in later months providing there is continued progress on reopening up the economy.

Economy Reversals

Troubling signs of coronavirus re-emergence are coming from some of the nation’s largest economies. And with this resurgence, the progress of the economic recovery has now been interrupted.

Bar and restaurant and some gym closures in Colorado, Texas, Florida, Arizona, and Michigan occurred in June. On July 1, dining inside restaurants and drinking inside bars, breweries, lounges and wineries was closed down again in 19 Counties in California. Also closed were movie theaters, zoos and museums, all for at least the next 3 weeks. This is a major setback to California’s economic recovery.

The reclosure of business activity will slow rehires and reduce hours for many restaurant and food services employees. It will also reduce business revenue potential leading to a greater likelihood of more business failures and permanent layoffs.

Consequently, if no new progress is made on reopening the economy further, the gains in employment and revenues are unlikely to continue in the month of July, and may even reverse for the food and beverage services sector.

Uncertainty

There is no shortage of the unknown still, and this is frustrating for us who forecast the economy. Sudden brute-force lockdowns of economic activity, or the delays in deciding to move to Phase 3 or Phase 4 of re-opening, make predicting the growth of new production, jobs and income impossible.

Consequently, the status of the recovery can change weekly based on the public health determinations of what and how much we can and cannot do.

The European Union opened up their economy to international visitors on July 1. However, the U.S. is still precluded from all but essential travel there. This will slow the recovery of airlines and the airports this summer. The EU could still reverse this decision and if they do it could bring major upside impacts to the airlines. But clearly, this is a huge unknown.

Our baseline forecast anticipates that the economy will continue to grow throughout the year and into 2021. We assume a steady path of reopening without start-and-stop reversals of economic activity due to forced shutterings.

But these assumptions are clearly becoming precarious. Backpedaling on the gradual enabling of businesses to operate more normally will have significant economic costs and will lengthen the period of time needed to restore fuller employment. The economic recovery was going to be hard enough without the re-emergence of COVID-19. In the case of much of the country once again subject to reinstatement of some form of shutdown, the U.S. economy could experience a double-dip recession.

The good news is that home buying is rebounding along with automobile purchases. Housing inventory is way down, but that should pick up this summer because home values have not been impacted. Car purchases continue to improve though car production may lag due to factory work stoppages as plants contend with new protocols and COVID-19 concerns.

Neither of these sectors will produce a drag on the recovery providing demand holds up. But here again, demand is dependent on the progress of the recovery which is clouded by the potential erosion in consumer confidence to spend, as a result of the start and stop economy.

From an economic perspective, it’s imperative that this state and all states work cooperatively with the business sector to provide the most effective way to address public health concerns without subordinating business concerns. To date, that has not appeared to be the approach taken, at least not in California.

by Mark Schniepp
June 5, 2020

The labor market report for May was presented today from the Bureau of Labor Statistics. The U.S. unemployment rate is 13.3 percent.

However, more important, it showed that the economy created (yes created) 2.5 million jobs during the month. Leisure/hospitality, which had suffered the largest declines in April, led the way back. Payment of workers through the Paycheck Protection Program may explain some of the increase, even if they did not actually work.

Now, many people who were employed but were “absent from work” again misclassified themselves because they should have been counted as “unemployed but on temporary layoff.” This understated the unemployment rate in May, just as it did in April.

We routinely estimate the U.S. unemployment rate from the unemployment insurance claims data that is reported weekly.

During the particular survey week in May that would have produced the official unemployment rate of 13.3 percent, our estimates of the actual unemployment rate were 16.1 percent, or nearly 3 percentage points higher. For California, the rate was 16.2 percent, or nearly the same.

The number of unemployed workers declined by 2 million in May. This is an encouraging sign that the economy is taking the first steps that clearly define the economic recovery. And the recovery of jobs and income is the most critical step.

How does this report change our expectations for the labor markets over the summer months?

Restarts

We clearly expect the restart of the economy to bring more improvement in June and July. By June 1, all 50 states had some parts of their economies re-open and more sectors in all states will be opening further this month.

With Europe opening up to tourism once again in the mid-June to July period, there will be more jobs in travel restored, more airline flights, and more hotels opening back up.

Universal Studios in Orlando Florida opened on Friday, June 5. Visitors take temperature screenings, are required to wear face masks and are encouraged to social distance. Capacity at the park is being limited to 35 percent of normal. Disney World in Orlando will start opening up on July 11.

Because amusement parks are labor intensive, these initial re-openings will re-employ thousands of furloughed workers this summer.

Church services are opening in California along with barber shops and salons.

Destruction and Vandalism

Some businesses in the larger American cities are now under added stress due to losses from store destruction and the looting of inventory. Until the social unrest subsides and police protection is restored, consumers may not feel confident to participate in large city downtown areas in tandem with re-openings of restaurants, retail stores, and personal care shops and services. Store repair is going to delay job creation in June and July in big cities including New York, Los Angeles, Minneapolis, Washington D.C., Seattle, Philadelphia, and Chicago.

Insurance industry groups say common business insurance policies will cover most of the damage caused by looting or vandalism. Business insurance does cover civil commotion, and most commercial buildings, homes, and cars will be replaced with insurance proceeds.

While some stores may choose to close permanently, most will elect repair and restoration.

PPP Funding

As of May 30th, 4.4 million loans have been extended to small business in both rounds of the Paycheck Protection Program for a total loan value of $510 billion. The PPP loans require that employers use no less than 75 percent of the funds to pay their workers so that they maintain their incomes and their ability to spend.

The program potentially kept millions of workers on business payrolls in April, May and now June. Proceeds from the loans will generally run out this month or in July. Consequently, we will be watching to see if some or many of these workers lose their jobs when the program’s funds are depleted. This critically depends on whether businesses can restart and keep the number of employees they were paying through the program.

If businesses are generally up and running, many of these workers could be seamlessly reabsorbed into their previously productive roles with little impact on the summer employment reports. Stay tuned for future reports on this development.

Upside Risks this Summer

The downside risks dominate the scenarios of how the economy will grow over the next 6 months because there are too many unknowns associated with how COVID-19 will evolve or devolve. Furthermore, the unknowns extend to how state and local governments will respond and how people will tolerate their response if they perceive the shutdowns as an impediment to their civil liberties.

Nevertheless, the upside alternatives to muted demand for goods and services and hesitation by consumers to participate in the restart of the economy is an encouraging display of pent-up demand behavior.

If we observe stronger than expected demand for cars, appliances, homes, personal care, food away from home, and entertainment with minimal hesitation by consumers, labor markets would generate impressive job creation in June, July and August. This kind of response would jump start a robust economic recovery this year.

We look for the third quarter to show positive economic growth with more upside potential if the confidence of consumers is more rapidly restored and people will believe it’s safe to resume increasing levels of pre-crisis movement and participation in commerce.

by Mark Schniepp
May 1, 2020

Annualized GDP growth in the first quarter came in at -4.8 percent. The report doesn’t really provide information on the extent of the actual GDP decline that has occurred over the last 6 weeks or since mid-March.

GDP was tracking at about a 2 percent rate of growth in January and February (and likely the first 2 weeks in March). Consequently, over a two week period in which there was an abrupt and severe closure of the economy, the impact on GDP was crushing. And this has continued through April and likely will through much of May.

The rate of real GDP growth is likely in the vicinity of negative 35 to 40 percent.

The immediate loss of sales and then jobs and income is the first blow to the economy. Stay-at-home orders substantially limit spending even by consumers who are not losing income. The first quarter GDP numbers show that the principal pullbacks on spending were restaurants and bars, airlines, and healthcare.

Stimulus checks and unemployment insurance are offsetting some of the impact but it’s tiny in comparison to the losses being suffered. Only half of small businesses that applied for PPP funding received it in the first round.

A second blow to the economy affecting households is diminished wealth. Losses in the U.S. stock market are 25 percent, even with its recent recovery. The negative wealth effects—the change in consumer spending in response to a loss of wealth—are and will continue to be substantial. The baby boom cohort, now in its late 50s to early 70s and owning 60 percent of all stock value, has become particularly reticent about spending.

Stay-at-home mandates are wrecking the economy, not only in the present but for the future. The longer the present carnage persists, the longer the recovery period and the higher the chance for subsequent business failures and persistent unemployment.

In a recent Goldman Sachs survey, 23 percent of small businesses are not confident they will survive. This number will grow if these firms are not allowed to resume business.

The Bay area shutdown has now been extended through May. This was a characteristic of the pessimistic scenario we described in the April newsletter which we hoped to avoid.

While the Governor has formulated a plan, no date has been scheduled for easing shelter-in-place in California. Meanwhile 15 other states have already or will open partially by May 4. This puts California behind the rest of the nation and many European Countries that have recently opened or never closed.

The rock bottom of the crisis on the economy has probably been reached. The unemployment rate in the nation was 20.1 percent this past week. For California, it was 23.8 percent. 3.9 million California workers are receiving unemployment insurance due to layoffs. We estimate an additional 1 million workers that are laid off or have substantially reduced hours.

Federal rescue money will now start circulating through the economy in earnest. The injection of stimulus to small businesses will help to prevent further layoffs and generate some “rehires.” Disaster relief funding will do the same as will the Federal Reserve Banks’s new loan program to larger businesses.

So from right here and now, and as other States start to come back, we believe we have moved to the recovery phase of the recession.

And the speed and length of the recovery is entirely dependent on the guidelines and protocols enacted by States on businesses when shelter-in-place orders are eased.

Capacity limitations of people in places of public gathering hinder spending and therefore revenue earned by business. Reticence to enter public places by consumers will be another limiting factor on demand. Consequently, businesses face a tough uphill challenge on the road to recovery unless or until restrictive distancing rules are removed.

But what’s the chance of that? This is not my area of expertise, but health officials are telling us “not likely until a vaccine or a cure for COVID-19 is developed and disseminated.” Consequently, we are in this for a longer period than people, including those making key decisions, generally realize.

by Mark Schniepp
April 3, 2020

In February while we were assessing the early economic indicators for the U.S. and California it became clear that the momentum from 2019 was pushing into 2020. Moreover, momentum was actually accelerating.

We thought the forecast for 2020 would be another year similar to 2019 when employment reached record highs, unemployment fell to record lows, trade was improving, manufacturing output was growing, and general economic sentiment by Americans was near historic levels of optimism.

Well, that condition rapidly turned on a dime.

A National Emergency was declared by the Trump Administration on March 13. By March 15, Governor Newsom ordered shelter-in-place for the Bay Area, and 4 days later, for the remainder of the state. Everything closed and events were called off. Not just a few events, all of them. Only grocery stores and stores selling critical products to households and to workers who work from home remain open. Little else.

Many grocery items are intermittently scarce, except toilet paper which is always scarce. There is plenty of booze and oddly I can always get tomatoes but not garlic. Why is that? Pasta and rice and flour sell out quickly. More delivery trucks and larger loads are needed to supply grocery stores now that everyone is buying nearly all of their food there.

The unemployment rate (that we estimate for the latter part of March) surged and is now higher than during the Great Recession of 2008-2009. Five million jobs in California are at risk of being lost. Many of these jobs will remain on company payrolls and/or workers will be furloughed without pay, but an unknown number will be terminated.

So far, over one million workers have filed for unemployment benefits. These will remain elevated for the next week or two because there is likely a backlog of filings.

The rescue program passed by Congress last week will prevent many potential layoffs because it provides businesses with payroll relief loans for the next 2 ½ months. And down the road, the loans may be forgiven.

Airline travel has declined 74 percent. Flights through LAX have been reduced from 1,675 a week in mid-January to 431 this week.

Sales of new vehicles plunged in March, off 40 percent from sales in February. With most car dealers closed, sales of new automobiles can principally occur online, with little chance of kicking the tires before hand.

The Great Coronavirus Shutdown

The amount of economic activity that has been concurrently shut down is both shocking and unheard of.

• Other than take-out, all restaurants and bars
• All recreation and personal care: Gyms and salons
• Retail stores except for groceries, household necessities and drugstores
• The NBA Season suspended
• The Major League Baseball Season postponed
• March Madness cancelled
• All schools closed
• All high school sporting events suspended
• Colleges and Universities closed, offering online classes only
• All amusements closed, Disneyland, Universal Studios, Magic Mountain, etc.
• All movie and live performing theatres closed
• State Parkes, campgrounds, and state beaches closed
• Concerts cancelled
• Conventions cancelled
• Conferences cancelled or postponed
• Non-essential government offices closed
• All flights from Europe and China banned and other areas as needed
• Shelter-in-place ordered in most states; 250 million people nationwide at home
• The 2020 summer Olympics postponed for a year

These activities will result in a massive loss of revenue, due to the lack of expenditure, and subsequent earnings by workers. All jobs associated with these activities are idled.

The vulnerable sectors of the economy in which the most jobs are at risk include recreation, leisure, and hospitality including food services, retail trade, manufacturing, and administrative business support.

Over 737,000 California workers were laid off in March, excluding self employed workers and independent contractors.

The Outlook for 2020 / An Early Assessment

The economic outlook changes because information underlying the principal assumptions seems to be changing rapidly, largely due to the policy response. Critical to the forecast is the length of time economic activity remains shut down in California and the rest of the nation. Tell me when we are allowed to go back to work and I’ll tell you what the forecast for 2020 looks like.

Our assumptions today reflect the following scenarios:

California and the nation remain in shelter-in-place through the month of April. Activity begins to return during the month of May. Events and travel begin to ramp up in June. That’s the optimistic scenario.

1. For the entire nation, GDP falls sharply in the April to June period, with some recovery occurring in late June and then during the third quarter of 2020 (the July to September period).
2. The unemployment rate rises sharply in April and remains very high in May, with noticeable improvement coming in June and July. The July to September period of 2020 has jobs returning and the army of unemployed sharply declines.
3. Under a pessimistic scenario in which the current effective “lock-down” persists another 31 days through May, the slow return of the economy in June and during the summer months will effectively render it still in a negative growth state.
4. By the fourth quarter (October through December), the economy rallies sharply as supply chains are more fully restored and events and travel occur near normal. There will be persistence however, in that a number of businesses will not return to operation and workers will remain unemployed as a result. Consequently, the unemployment rate remains elevated for much of 2020.

The pessimistic forecast is the result of a lengthier period of economic stagnation in which businesses can’t operate, people can’t go out, and travel and events don’t occur. Businesses can’t hold on and they fail. Supply chains move to alternative uses where revenue can be generated. Workers find alternative employment opportunities and don’t return to their previous jobs.

All of these unintended outcomes lead to a more lengthy economic recovery that further reduces household income, spending, and delays the return of the pre-COVID-19 world.

Watch for our regular updates of how the U.S. and California economies are responding to the tight restrictions put in place under the pandemic.

Go to COVID-19 Update Page

Follow our COVOD-19 page and you will be the first to understand the extent of the fallout and the first to see the beginning stages of the recovery.

by Mark Schniepp
March, 2020

Up until mid February, there was little worry about the 6 month outlook for the U.S. economy. We were relatively certain that the expansion would continue at least that long because the seeds of a general slowdown were simply absent. Even today, job creation through February continues to impress, manufacturing is clawing back from the effects of the trade war, spending by consumers has continued and the stock market was making record high after record high going into the last week of February.

COVID-19

The emergence of the corona virus has been swift and substantial. Between January 22 and March 6, the number of cases globally has exploded, from less than 500 to just over 100,000. New case growth in China appears to be contained. That’s not yet the case in Italy, Iran or South Korea.

On January 30, 2020, the International Health Regulations Emergency Committee of the World Health Organization declared the outbreak a public health emergency of international concern. So it was at that time that we entered into the world of pandemic.¹

Two weeks ago, the CDC reported that “the virus is NOT currently spreading in the community of the United States.² ” However, more new cases emerging in the State of Washington and elsewhere suggest that the virus has been spreading for weeks.

The high profile reporting of the circumstances of the virus spreading globally into a pandemic has motivated rapid behavior on the part of many countries to contain it. But at the same time, the daily media reports on new case and death counts have created a hysteria in the world’s population.

This is a perfect prescription for a recession: a sudden and unexpected chaotic event that produces a massive crisis of confidence. In our year long search for the ultimate cause of the long awaited recession, could this be the catalyst for the event?

Perhaps, but in this case, the virus represents an “external shock” that is unrelated to an economy that may be evolving over time with imbalances. The impact of the virus on the economy has so far been to reduce supply and not demand. And that reduction in supply (of people and the goods they produce) is temporary and will seemingly be fully restored once the virus is contained.

Financial markets crashed the week of February 24 as the virus spread and the uncertainty of containment gripped investors. Even today, there is uncertainty and panic regarding the extent and direction of the virus. And that panic continues to impact the stock market.

If the market continues to sell off, households will perceive their wealth positions to have eroded. Along with the fear of contracting the virus, consumers will reign in their spending. They will stay home and avoid restaurants, bars, the movies and other venues of entertainment. Then the “external shock” evolves into a demand issue.

We are already suffering from lower demand by foreign visitors for travel to California and the U.S. Events are being cancelled and schools are temporarily closing. Supply chain problems for some U.S. companies are hampering production, and some layoffs are occurring. Both production and spending may therefore be meaningfully impacted unless COVID-19 is contained soon or the hysteria subsides.

U.S. Containment

The U.S. has so few cases at this time with nearly all having origins of contact traced to Asia. Containment efforts have been swift and ongoing. Cruise ships to and from China were suspended. Airline flights in and out of China were cancelled. Anyone having had contact with China was barred from entry or immediately quarantined. Hong Kong has also been removed from the flight schedule by the airline companies. The U.S. added South Korea and Italy to the screening list for all U.S. bound passengers from those countries. All Travel from Iran is banned.

Hypothetical Scenarios for COVID-19 and the Effect on the Economy

Many provinces (24) of China were shut down by February 1. Factories closed and workers were told to remain at home. These provinces accounted for more than 80 percent of national GDP and 90 percent of exports.³ An estimated 56 million people in Hubei province (the epicenter of the virus) were under lockdown for nearly a month. By February 5, millions more workers were ordered to stay indoors as a measure of China’s draconian containment effort. This produced a major supply disruption for the international economy because China is the world’s second largest economy. Google, Apple, and Tesla have shut down all operations in China.

A survey by the American Chamber of Commerce in China, released on February 27, provided the first initial response of how Chamber members have been impacted. Nearly one-third of respondents indicated they have faced increased costs and significant revenue reductions already. Their outlook in general has been negatively impacted regarding the U.S.-China relationship.⁴

Disruptions to world tourism have resulted from the spread of the virus. With flights and ships suspended from entering China, visitors to Shanghai, Beijing, and the Great Wall are currently non-existent. Chinese visitors to California are also non-existent. And Chinese tourism is responsible for an estimated $4 billion in annual expenditures in California.

In late February, China started to restore work. While the government is advising local decision makers in the affected provinces to take all measures possible to limit the spread of the virus, there are also instructions to gradually resume work schedules to meet economic growth targets for the year. The Country has effectively been closed down for the last 3 weeks. However, the biggest bottleneck is a “labor shortage” since many workers are quarantined for 2 weeks before being allowed to enter factories and offices.

It is still too early to determine how significant the long-term impact of the virus will be. Here are a few scenarios: best to worst case:

1. By late March, the virus appears contained with no meaningful increases in infections globally. More people recover from the virus than contract it. Most of China’s factories reopen and supply chains are largely restored to businesses in China, the U.S. and elsewhere worldwide. There is a 45 to 60 day impact.
2. COVID-19 remains active throughout March and into April, peaking by mid-month. Containment is achieved in late April. Economic production is mostly restored by mid-May. June is a more normal month. Economic growth in the U.S. is impacted for the February 15 to May 15 time period, or about 3 months.
3. Containment is not achieved until August 1, 2020. There are 500,000 to 1 million cases of the virus. Factories in China have all reopened by July after 5 months of either complete or partial shutdowns. Quarters 1 and 2 produce negative growth for China. In the U.S. GDP growth is impacted by up to 200 basis points. Production slowdowns or suspensions due to supply and demand issues force companies to lay off workers. Depending on intrinsic slowdowns in other sectors, this likely produces overall negative growth in Quarter 2 of 2020.

At this writing, I’d opt for scenario 2, but scenario 1 can’t yet be dismissed. We will know next week if financial markets globally will break their fall. Factories in China started opening again late last week and many people that tested positive for COVID-19 over the last month have now recovered.

Recession is a possibility for the U.S. due to COVID-19 but not a foregone conclusion. It all depends on the speed at which the virus can be contained and the current hysteria defused.

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¹ Coronaviruses are a large family of viruses that are common in many different species of animals, including camels, cattle, cats, and bats. The SARS-CoV-2 virus is a betacoronavirus, like MERS-CoV and SARS-CoV. All three of these viruses have their origins in bats.

² https://www.cdc.gov/coronavirus/2019-ncov/summary.html

³ https://www.cnbc.com/2020/02/01/coronavirus-more-of-china-extend-shutdown-accounting-for-80percent-of-gdp.html

⁴ https://www.amchamchina.org/uploads/media/default/0001/12/2d4eedc6090762958f083af0865a94d68422f189.pdf

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by Mark Schniepp
February 2020

Economic Issues Today and How We Think About Them

• Last month in the January Newsletter I discussed the National Debt which is a long term pressing issue for the U.S. It’s not something that needs addressing immediately but the condition of growing debt and its effects will prove burdensome on American businesses and all taxpayers longer term.

Today, few people are thinking about the national debt. It tends to be a more esoteric concept and its ultimate consequences are not affecting anyone yet.

• Education and training (or retraining) our labor force to prepare for a different world is another long standing issue that we have to remain vigilant with. The Millennials did not prepare well, but Generation Z appears to be focusing on this with the kinds of choices they are making for majors at colleges and universities today.

With everyone anticipating the coming of the robots, we are threatened with a large reduction in job opportunities because many will be eliminated by automation. Students today appear to be planning accordingly.

But again, unemployment today is at record lows, everyone that wants a job has one, and no one is immediately worried about the impending mechanical replacement for their position.

• Inflation is always a long standing issue for economic policy to grapple with. Higher rates of inflation lead to unintended distortions, like discouraging saving. It also increases the cost of borrowing because interest rates rise with higher inflation.

But right now, inflation remains unusually low, around 2 percent. No one cares about inflation because they are not experiencing any and haven’t for the length of the current economic expansion.

• The stock market will perpetually remain a concern of American Investors, simply because it can melt down (or melt up) in a heartbeat. Since 52 percent of families have an interest in the stock market either directly or through their IRAs, market movements can have predictable effects on household behavior. A decline in the market can impact consumer sentiment and/or confidence and cause worry or even panic.

The stock market is currently at all time record highs—all three major indexes. However, because this situation can turn on a dime, these markets will always remain issues of potential concern. Investors certainly care about the market, but they don’t seem very worried about it today. Over the last 6 years, the returns have been unprecedented for the markets, especially last year.

Given the current course of the economy, there are few issues that Americans are concerned about. In fact, economic concerns in general are less relevant today than they’ve been in the last 20 years. The most recent Gallop Poll (January 2020) of the percentage of Americans “mentioning” economic issues as the Nation’s most important problem has just declined to 10 percent. It’s never been this low since the survey has been conducted.

Gallup’s poll of American’s confidence in the U.S. economy is currently at its highest level since 2000.^[1] Gallup summarized the results of their economic surveys with this statement on January 23, 2020:

Rarely in the years that Gallup has tracked public ratings of the economy, since the early 1990s, have Americans had higher confidence in the economy than they do now. Nearly six in 10 describe the economy’s current state positively, and a similar percentage say it’s only getting better.^[2]

The International Monetary Fund forecasts global economic growth to rebound in 2020 to 3.4 percent. The World Bank says 2.7 percent. The downside risks to this forecast have actually moderated this year. One diminishing risk is the Trade War, with Phase 1 of the U.S. China deal now complete, and with USMCA also completed.

Furthermore, Brexit is completed, and the U.S. and the U.K. will negotiate their own free trade deal this year, probably pulling Britain closer to the U.S. in terms of relaxed economic regulations and a boost to GDP growth in the United Kingdom.

Therefore, most people are much less concerned about trade policy today than they were a year ago (if they were then).

Then what are Our Concerns?

If there is no current worry about the national debt, inflation, training for future jobs, the stock market, or international trade, then what are we concerned about?

Recent Gallup polls indicate that “The Government” and “Immigration” are higher concerns than the economy. There are others, but these are the ones that are way ahead of the economy.

If you are concerned about some worldly issue, what do you immediately do to find out more information about it? Everybody knows the answer to this. You “google” it.

What are the most pressing concerns (from a googling standpoint) of Californians today?

Well, “the economy” is not one of them, not compared to other issues. Take a look at the chart here extracted from Google Trends. Compared to “weather,” “movies,” “Facebook,” “Instagram,” or “football” (or the 49ers), the search term “economy” ranks dead last, and not just now, but every day over the last seven months. Ditto for the search term “recession.”

In the past, Americans have been generally concerned about the economy, but not today. Other issues are more pressing. And the principal economic problems that have generated substantial worry in the past are mostly unimportant today.

Conclusion

Concerns about the economy today are practically non-existent. The consumer sentiment and confidence indices have been recording the highest levels of positive attitudes towards the economy in the last 20 years. Ditto the Gallup poll. As we head into the 2^nd and 3^rd months of 2020, few things have changed from the last 6 months of 2019, and economic risks have actually lessened. At the present moment, the economy is not something to be worried about.

But stay tuned because conditions can turn on a dime.

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^[1] https://news.gallup.com/poll/283940/economic-confidence-highest-point-2000.aspx

^[2] Ibid.

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by Mark Schniepp
January 2020

The National Debt has continued to be a significant subject of domestic controversy, especially in view of the magnitude of fiscal stimulus undertaken by Presidents Bush, Obama and Trump.

Generally, economists agree that:

• Rent control is bad
• Tariffs are bad
• High minimum wages are bad
• Wealth taxes are bad, and
• Too much debt is bad

Actually, everybody knows that too much debt is bad, but does the United States have too much debt now? Many believe that the U.S. debt is growing at an unsustainable rate, and that if debt holders grow pessimistic and stop buying U.S. securities, a debt crisis would ensure, shackling many Americans to a poorer quality of life in the years to come.

The national debt currently stands at $23.2 trillion (December 31, 2019), and this is the highest level ever. Federal debt held by the public accounts for $17 trillion and this is the more useful debt number because the government has to pay this back to people and corporations and countries that own U.S. treasury bills, notes, and bonds. That’s how it got into debt in the first place, by selling securities to the public.

The other $6 trillion of the national debt are loans between government departments. One of these is social security which is owed billions by the federal budget for monies received over time to finance government spending. The federal budget has to pay this back as well, especially as the demands on social security rise and the department must deliver retirement benefits.

Since 2017 when Trump entered the White House, the debt has increased by $2.7 trillion.

During the Obama administration, debt rose $8.2 trillion. During Bush, debt jumped $6.4 trillion, and Clinton: $1.4 trillion.

What is the Problem With Debt?

When the federal government borrows money to finance economic expansion, it’s normally accepted by the public because both current and future generations will reap the rewards of this expenditure. In the short run, the economy benefits from deficit spending when it is directed at economic growth and stability. The federal government pays for major infrastructure projects or defense equipment, and contracts with private firms who then hire new employees. Healthcare expenditures do this as well. These new employees then spend their government-subsidized wages on gasoline, groceries, new clothes, and more, and that boosts the economy over time.

When the federal government incurs debt to increase current consumption such as Medicare, Medicaid, Veteran’s benefits, or social security payments, only the beneficiaries of these programs will receive direct payments, and often these programs are without widespread support from the public. We often question these expenditures.

It’s the same issue for households. If you go into debt to make investments that will benefit you and your family in the long run, you feel the increase in household debt is worthwhile. However, if you deficit finance your new boat or a Hummer SUV, some measure of guilt is going to haunt you, along with perhaps your spouse.

When interest rates rise, there are higher debt payments which can overwhelm the annual federal budget, just as higher mortgage, boat and car loan rates increase your monthly payments and wreck havoc on your household budget. Had you stuck with the 2011 Camry, you’d probably have much lower car payments and less overall stress.

Higher Interest Rates

In the long run, debt holders could demand larger interest rate payments to continue carrying U.S. debt, because the risk of being repaid rises with expanding debt, especially as a percentage of Gross Domestic Product. A decline in the demand for U.S. Treasuries would increase interest rates, raising debt payments for the government (and households too), and at the same time, slowing the economy.

If the demand for U.S. Treasuries was to decline, the value of the dollar would also decline relative to other currencies, and foreign governments like China would be less willing to buy U.S. debt (i.e., bonds).

The Treasury Department would then have to offer higher yields (interest rates) on newly issued Treasury bills and bonds to attract new investors and maintain the debt levels. This would create more debt due to the higher payback obligation.

Debt Crisis

Is a debt crisis coming? Well, is the demand for treasuries declining and yields (interest rates) rising? The answer so far is no. There is sufficient demand for U.S. Treasuries largely because the yield on the 10 and 30 year bonds is so much higher than for government bonds in Japan or Canada, or anywhere in Europe or Australia. In other words, it’s still one of the safest investment instruments in the world and it pays a higher return.

A crisis is unlikely any time soon. But there is a general notion that the tin can of debt cannot be continually kicked down the road forever. This is especially true when the Social Security Trust fund won’t have sufficient funds to finance the retirement benefits of the baby boom generation that is retiring now at an accelerated rate.

Congress will ultimately have to raise taxes to generate the revenues needed to finance the budget and pay the Social Security Trust fund back. Either that, or benefits will have to be curtailed, impacting younger boomers who will retire last, and the older Gen Xers who will retire first.

Do we need to pay closer attention to this now or can we continue to defer serious action towards addressing the national debt? Right now, the net interest expense represents 8.7 percent of total federal expenditures and is less than outlays on Medicare, Medicaid, Defense, and Transportation & Education. It’s rising again but it’s low compared to the 1980s and 1990s.

Clearly, debt needs to be paid back, and with tax dollars. Ever rising debt will ultimately push interest rates higher along with debt service payments, diverting the amount of direct tax revenues that could be used on other government services. The public’s quality of life is therefore diminished. The federal government would have to raise taxes to maintain existing service ratios for the public, and higher tax rates would reduce disposable income for households.

So at some point in time, we or future generations are facing higher taxes or diminished government services or both.

Conclusion

The national debt, when managed correctly, can be used to stimulate economic growth and future prosperity. However, rapidly increasing debt would ultimately raise the interest expense on the debt. And taxes will need to be raised to finance the debt service or government services will have to be meaningfully reduced. Both results are likely.

by Mark Schniepp
December 2019

2019

It’s time to review 2019 briefly just before we move into next year. A quick evaluation of the year might provide some insights about 2020 and what we can expect.

We leave 2019 having observed the record long expansion extended for 126 consecutive months (and no material signs of recession). This means generally favorable conditions for workers and for corporations that are not facing trade war tariffs for their inputs or their outputs.

11 months are in the books for 2019. And the twelfth looks reliably predictable to me. So much that I can provide a pretty definitive summary of how the economy did and whether there is any momentum to lead us into 2020 with continued positive news.

The decade of the 2000s was the lost decade of the American economy where by 2010 there were fewer people employed than in 2000. Unemployment was 10%. Housing bubble splatter was a mess; foreclosures everywhere. Dodd-Frank Wall Street reform was signed.

The decade of the 2010s was just the opposite. There was more steady and continuous job creation during the decade than any other on record. Unemployment plunged to a 50 year low. Average salaries per worker, adjusted for inflation, reached new highs. Household debt reached new lows.

During 2019, the long anticipated recession did not come. But there were early indications that it could have. The stock market sold off sharply at the end of 2018 (down 19 percent) ending the long 3,494 day bull market, but then rebounded sharply early in the year.

The fiscal stimulus has faded—the boost provided by last year’s tax cuts has played out. Interest rate increases by the Fed tightened monetary policy, slowing growth. Since then however, the fed has cut rates three times.

The yield curve first inverted in March, and then remained inverted between May and August. The trade war intensified and many politically oriented analysts predicted impending doom as a result. Uncertainty created by the tariffs has undermined business sentiment and made businesses more cautious. Investment spending has flatlined.

But no recession. In fact, NOT EVEN CLOSE. Overall growth remains above 2 percent. Employment is full and the unemployment rate has remarkably moved lower all year. Surveys of positive confidence in the economy by American households remain near record highs. 2019 has been a huge market for investors as the stock market made several records highs and is currently at another.

And as a result, households keep spending, extending the consumption engine of growth that is largely responsible for the long expansion. Inflation adjusted spending has maintained a sturdy 2.5 percent pace this year.

2020

I don’t see any financial crisis in the offing heading into 2020. There are no asset bubbles. Earnings appear to be holding up well, providing some foundation for the high stock valuations. Weaker trade and tepid business investment, which will likely continue into next year, are not enough to trigger a recession.

What is then? Something that causes us to pull back on our spending behavior. And with wages rising, unemployment at near record lows, and help wanted signs littering the American landscape, those are compelling reasons to expect continued spending and continued expansion into next year.

The U.S.-China trade war is expected to subside in 2020, causing growth to actually accelerate.

Finally, there’s the general notion among economists that if the impending downturn were to occur, it would be short and shallow, perhaps so short and shallow as to avoid official classification as a recession. Recession is generally defined as a period of unwanted idleness of labor and capital. We don’t have that now and it could be avoided during 2020. Currently, all labor resources are fully utilized, industrial production remains high, and capacity utilization of the nation’s factories is rebounding after the UAW strike.

We are on the watch for trouble but haven’t found it yet. So stay tuned because you’ll want to be the first to know. And happy new year.