Saturday, November 04, 2006

Baby it’s Cold Outside


Dr. Michael Osterholm has likened a pandemic to an 18-month global blizzard, where nearly everything is shut down. Many folks will be without a paycheck, either due to their refusal to work and risk exposure, or because their jobs are simply no longer available. Most debt payments; from mortgage, to rent, to credit cards will likely cease.

The cascade effects are all but unimaginable.

While most of us think of a pandemic as a public health crisis, you can be assured our government, and the governments around the world, are also looking at this as an economic disaster of the highest magnitude.

Occasionally, I hear people ask if their employers will have to continue to pay them if they are put out of work by a pandemic. Some have even asked if they would be eligible for unemployment benefits. I have a hard time seeing either of those happening.

Where would the money come from?

The concept that employers are rich, and can afford it, or that the government has the resources, and would bail them out is specious. Very few companies could last 18 weeks without accounts receivable coming in, much less 18 months. And the government would quickly find that their only source of income, taxes, have dried up.

As an example, lets take a typical medium sized business and see what might happen during a pandemic. We’ll use a car dealership, but we could just as easily use a restaurant, or an insurance company, a homebuilder, or any other enterprise. The law of economics applies pretty much wherever you go.

The Anytown XYZ car dealership employs 7 sales people, 10 mechanics, 5 office staff, 4 misc. employees, and 4 upper management types, and has a total payroll of nearly 2 million dollars a year. They sell, in an average year, 800 new cars, and have on their lot 200 new cars at any given time. They make money not only from the sale of their inventory, but also from the service department. It’s a pretty good business, and it generates more than 2 million dollars a year in tax revenue for the state and federal government.

The XYZ dealership’s inventory of 250 cars is worth about 4 million dollars. It costs the owners interest for every day a car sits unsold. As long as cars are selling, the interest gets paid, the employees get paid, the taxes are collected, the overhead is met, and the owners make money.

Now lets interject a severe pandemic, one with an attack rate of 40% and a CFR (Case fatality rate) of over 20%, and see what happens.

With millions sick and dieing, fear grips the world and draconian measures are enacted to reduce the spread of the disease. Social distancing is promoted, many businesses are closed, and international trade, and travel are sharply curtailed.

Overnight, car sales plummet. In fact, they virtually cease. No one is interested in taking on new debt when their own jobs are either gone or at risk, gasoline is in short supply, and besides, who wants to go kick tires when the salesperson, or the secretary, or the guy who details the car might be infected? A new car is the last thing on anyone’s mind.

But what doesn’t cease are the interest payments on the floor planned inventory. The cars sit there, unsold, draining the lifeblood of the company away a little more with each passing day.

With no sales, the sales staff gets laid off. Most of the mechanics are laid off too. For a while, the doors remain open in the hopes that the service department can generate some revenue, but that doesn’t last long. Soon, the entire dealership closes.

Thirty people are no longer drawing a paycheck. The bank, or the manufacturer who extended the credit for the inventory, are no longer getting the interest on the 250 cars sitting unsold on the lot. And the State and Federal government are no longer collecting sales and payroll taxes.

Without an income, the employees can’t pay their mortgages, credit card debt, or even their taxes. And this scenario is repeated in every business, in every town, and in every country around the world.

This produces not a ripple effect, but an economic Tsunami.

Banks, who lend out 90% of their deposits and rely on the repayment of interest to stay afloat, close their doors, and most depositors are left without access to their funds. The FDIC, which insures bank accounts, has only 1.35% of the funds needed to cover the loss, and issues open ended I.O.U’s. Credit card companies are left holding a trillion dollar bag, and quickly shut off the credit spigot. Stock markets around the world plummet, and gold soars, as investors try to find safe havens.

And as far as a bailout by the government is concerned, their only source of income, taxes, has dried up, while their expenditures continue. In the United States alone, the hemorrhaging of red ink runs in excess of 200 billion dollars a month.

The global economic engine, which is lubricated by credit and cash flow, seizes up and throws a rod.

How we pull out of such a scenario is unknowable. It could make the Great Depression of the 1930’s look like a picnic. Restarting an economy, when the entire world has been shut down for months, perhaps years, is something we’ve never tried before. This is Terra incognita: uncharted territory. Where does one even begin?

How does our fictional car dealership (or any other enterprise) resume business after the pandemic passes?

Assuming the cars are still on the lot (a big `if’), who would be able to afford one? How does any business rehire employees, and resume business, when no one is working? You have to collect accounts receivable in order to make your accounts payable and payroll. It becomes a nightmarish version of the classic chicken or the egg conundrum.

There is no magic switch that you can turn on, that restarts the economy.

It would be naive to expect the Federal Government to somehow `fix’ this problem. In the 1970’s, when we were mired in a mere recession, they tried wage and price controls, and that only made matters worse. After a year or more of virtually no tax income, and with no lender countries in any better shape than we are, where do they get the resources to repair the economy?

Do we, along with every other nation, simply open up the printing presses at the mint and start flooding the economy with trillions of dollars of worthless paper? Will the U.S. dollar, and the Euro, and the Yen fall to the same fate as the German mark in the 1920’s or the confederate money?

With hyperinflation, governments could fall. Those with substantial savings (assuming they had access to it) could find their holdings rendered all but worthless. In 1923, the Weimar Republic of Germany was issuing fifty-million-mark banknotes. Useful if you wanted to buy a loaf of bread.

It has taken hundreds of years to progress from a local, largely bartering economy, to a global economy based on credit and cash flow. It could easily take generations to recover from a global economic collapse.

While it may seem crass and insensitive to worry about economic issues in the face of millions, or perhaps hundreds of millions of human lives lost to a pandemic, the long-term effect of such a collapse could have even greater ramifications.

This is the elephant in the living room that no one wants to talk about.

While I can see how we can get there, to a global economic collapse, I have no idea how to reverse it, or even how to prevent it.

It would probably take a severe pandemic, one equal to, or greater than the one in 1918 to produce such a dire result. Maybe we get lucky. Maybe the pandemic doesn’t happen. Or if it does, maybe it won’t be that bad.

The question is; do you feel lucky?

Well, do you?