In the decade after the turn of the century, the United States economy experienced a severe financial crisis, which was the result of speculating in financial and commodity markets. The crisis caused GDP to fall about 8 percent that year and led to a recession. Just over 10 years later, a global pandemic hit the world economy. Initially, countries censored information regarding the disease, but facts about a rapidly spreading illness can only be contained for so long. Eventually policies such as social distancing, masks, and isolation helped end the pandemic.
Of course, I’m discussing the Financial Panic of 1907 and the 1918 Spanish influenza pandemic that ultimately led to millions dying. The parallels are eerie.
In the aftermath of the Panic of 1907, the U.S. established the Federal Reserve System (the Fed), which was later charged with the explicit goal of to help foster a stable economy. The Panic of 1907 would have also been in the recesses of JM Keynes mind when he wrote the influential text The General Theory of Employment, Interest and Money, which was the birth of macroeconomics and economic stimulus.
The flu pandemic helped change countries' health care systems. Because you cannot blame someone for getting sick, the concept that any given individual’s health being the outcome the environment began to germinate into the idea of “public health.” This was the catalyst for the adoption of public health systems and state run health insurance, the first in Russia. While many European countries followed suit, the U.S. went with an employer based plan.
Fast forward to today. In the U.S., the first COVID-19 (C19) case was confirmed on January 19 in Seattle. Now, six weeks later, as of this writing, there are 432,000 confirmed cases in the U.S., growing an average of 18 percent per day, and the global total is over 1.5 million. In Montana, there are 415 confirmed cases, with Gallatin County accounting for roughly one third of the total. Numbers are likely to rise as testing becomes more frequent, reliable and results revised.
In response to the C19 pandemic, countries and states have taken pages from the Spanish flu playbook to help slow the speed of transmission and effectively buy time for a vaccine and obtain more information about the nature of this virus.
And information, or lack thereof, is at the crux of this crisis. During the 2007 financial crisis, a “once in a lifetime event” I thought until a month ago, uncertainty was also at the heart off the issue. A multitude of complex equations, obscure financial instruments, and algorithmic trading created a many-headed Medusa that few, if any, people truly understood. But no one died from an obscure and fickle financial instrument — at least not directly.
The C19 pandemic changed the game, and we’re playing with ever shifting rules.
Fundamentally, the ongoing health vs. economy debate is centered on the extent of the trade-off we are willing to make with imperfect information. In economics we discuss this in terms of the expected costs and benefits that occur over the short and long run. A multitude of economic research has shown that one of the primary engines of long run economic prosperity is the accumulation of human capital — which is loosely defined as “ideas/education and health.” Not machines, not technology. But, concentrating on preserving health, which is the current tactic, is a cost to short run economic vitality.
Gov. Steve Bullock initiated closure of dine-in establishments such as restaurants and bars on March 20. Earlier this week the governor extended the stay-at-home orders implemented on March 27 until April 24. The economic cost of this in the short run is steep, and we are already seeing it in the data.
The canary in the coalmine was financial markets. Drops in stock market indices were the most obvious, but other markers waved a red flag. Between February 19 and March 9, the benchmark 10-year U.S. bond yield fell 100 basis points to 0.54%. Over roughly the same period the ViX, the so-called “fear,” index increased from 14 to 75 — the normal range is 10-15. It reached a maximum of 83 the following week.
To put things in perspective, the highest the ViX index got during the financial crisis was 81 and the lowest yield on the 10 year bond was 2.9%.
Another indicator of global financial nervousness is the dollar exchange rate. It appreciated almost 9 percent during the first three weeks of March as global capital sought a safe haven. Developing countries have suffered $83 billion in capital outflows.
In early March, I estimated the probability of a third quarter recession to be just under 90%. Those were halcyon days. As you might expect, the probability now is almost 100 percent.
In the past three weeks 16.8 million workers have applied for unemployment insurance in the U.S. In Montana that number is 63,929 which represents about 14% of Montana employees covered by unemployment insurance.
Numbers for sector employment at the state level have not come out yet, but the national level the most recent data shows that of the 700,000 who lost their jobs at the end of the March, about 66 percent are from the leisure and hospitality sector. This is a concern for the Montana economy as a relatively large percentage of jobs here are in the leisure and hospitality sector, almost 14%. If we add another largely effected sector, retail sales, the total rises to 25% of state employment.
This translates into economic growth numbers I never thought I’d see in my lifetime. The broadest measure of economic output is gross domestic product, or GDP. GDP shrank 23 percent during the Great Depression. The Conference Board and the Congressional Budget Office are calling for an decline of almost 30 percent in the second quarter of this year.
On a positive note, the grim forecasts only last one quarter. By the fourth quarter, the Conference Board is projecting 18.5 percent positive growth, for an annual growth forecast of negative 6 percent.
Ultimately, short term costs are the long term’s gain. By preserving an economy’s most precious asset, human capital, long term growth will thrive. Recent research by economists from the Massachusetts Institute of Technology and the Fed demonstrate that cities in the U.S. that used, among others, social distancing strategies were more successful after the Spanish flu pandemic than those that did not. Philadelphia was the exemplar of what not to do, whereas other cities, such as Portland, Oregon, which had stay-at-home directives for 120 days or more, recovered relatively quickly.
There are some key differences between 1918 and 2020. First, the American economy is fundamentally different than one hundred years ago. Then, almost no jobs could be done at home. Secondly, the idea that Federal government expenditures could be used to counteract the declines in other spending, either directly or through household income support, did not exist. And third, health care is no longer in its infancy. Hospitals were less of a place of healing than a final resting place. Now, the opposite is true, and more people have access to care.
Today, we have tools to combat this short run downturn. The Federal government passed a $2.2 trillion rescue package, and Montana sold $33 million in AA+ infrastructure bonds, at a rate of 1.56%, largely for state infrastructure projects.
The Fed, which was an untested institution in 1918, has learned from mistakes made during the Great Depression and 2007 financial crisis, is flooding the economy with up to $2.2 trillion to prevent a liquidity crisis. The Fed has earmarked $300 billion to be used for loans to small businesses to help keep them afloat.
Robert Sonora is the Associate Director and Director of Health Research at the Bureau of Business and Economic Research at the University of Montana.