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