A LONG, VALUABLE MESSAGE FROM MY SON, PATRICK

Friends,

It’s been really wonderful to connect and reconnect with many of you over the last several days. I hope you are well and you are able to relax at least a little this weekend.

In this email, I would like to consider the wisdom of the current response in light of the terrible economic damage it will cause, characterize the nature and scope of that damage, and speculate on how things may proceed from here. There are three sections to this email:

1. Why must we do this?
2. What is happening economically and financially?
3. How might the economic and financial consequences proceed from here?

Why must we do this?

The dramatic social distancing response of governments around the world will take a terrible toll on the economy, and the damage to the economy will take a terrible toll on people’s lives. We should therefore ask whether the medicine is worse than the cure. Why are we choosing to do this?

I think there are two reasons.

The first reason is that, politically, there is in reality no choice. China initially neglected the epidemic, and when it started to rage wildly the government responded with an even more aggressive social distancing campaign than we are doing. When Northern Italy saw the disease get out of control, it shut down the entire country. The example of Italy frightened most of the West into the posture of social distancing, but England initially thought it could go a different way, to “keep calm and carry on” and maintain a more normal economy. Yet within days the political will for that approach crumbled. What we have seen across cultures and political systems is that as the public realizes the danger, the government is compelled to respond as aggressively as possible. Had all the governments of the world developed better approaches in advance (like South Korea did, for example), there would have been more sophisticated tools available to choose from. But since social distancing is the only weapon of consequence available to us, it is the one we are forced to use.

This is not a satisfying answer, since it means we are taking extraordinarily radical action without a careful analysis of the consequences – it substitutes “must” for “ought”. But I also think it is simply true that from a realpolitik perspective, the choice is not “act or do not act,” but rather “act now or act later.” Given that reality, against an enemy that operates on exponential time, the only possible choice is to act now.

But I do think there is a second reason as well, and this reason – while it is not the real reason we are tumbling down this rabbit hole – is very plausibly the right reason. I had been forming these thoughts over the last day, and then I received an email from a good friend who is both generally wise and specifically knowledgeable in this area. He said it better than I could, so let me quote him:

COVID-19 will prove to be a positive shock for society because it is forcing us to learn how to adapt and respond to future pandemics.  COVID-19 is priming society's immune response so that we are better prepared and equipped for the next pandemic.  We have learned the importance of masks, respirators, social distancing, fast response, decisive quarantines -- and as a society, we have a mental map of how to respond. A pandemic was inevitable. It was only a matter of time. So thankfully, this pandemic is a good "first" pandemic in the modern era. COVID-19 is dangerous enough to warrant a mass response -- a full scale war, as you described it.  But this particular virus is, in the scheme of things, relatively benign.  Even if the impact is 10x the flu, one can easily image a much more dangerous pandemic -- higher death rates, more dangerous to children, harder to test.  COVID-19 is the best case in the terrible bucket of a terrible, global virus disaster.

The key idea is not just that COVID-19 is lethal enough to warrant an aggressive response, but also that only by responding aggressively can we adapt and learn to deal with future pandemics. It is of course impossible to prove the counterfactual: one could claim that if we kept the economy going and allowed this virus to rage, we would nevertheless still learn how to anticipate future pandemics. But I doubt that is true. I believe a posture of avoidance would reinforce avoidance in the future. Only by engaging fully with this menace will we truly learn. And we are going to learn some terrible lessons: not just about viruses, but also about the economic damage that social distancing can inflict and how to minimize and recover from that damage. Let’s hope we learn those lessons well.

What is happening economically and financially?

Those of you who work in finance and markets may find this next section blindingly obvious, so I hope you will bear with me. I think many people who are not similarly trained do not appreciate the full gravity of the situation.

We are in the process of a worldwide, dramatic deleveraging that may be even greater and more rapid than what happened in 2008 and 2009. It is this deleveraging that most threatens our economy.

Ask yourself this question: Who in their right mind right now would borrow money to buy a house, fund a business, finance capital expenditures, or do anything else in the current environment? Nobody but a very few exceptions, of course. So it is not just the laid off waitress or bartender who will be spending less money: it is just about everyone in the world. With less spending, there will be less income; with less income, there will be less spending, and so on.

One of the most important components of our modern economy is confidence in the future. You borrow money to buy a house because you are confident you will have enough income to pay the mortgage, and because you are confident the surrounding economy will be good enough to validate the price you are paying. A business borrows money to buy durable equipment because it is confident there will be enough demand in the future to justify the investment. By contrast, if you believe the immediate future looks dark, and if you have no idea when things will get better, you will hoard cash and postpone investment. In the span of less than a month, everyone around the world has dramatically downgraded their assessment of the future and is headed for the exit simultaneously. When combined with the present-day drop in demand from social distancing, this is shrinking the economy substantially.

Some companies have strong enough balance sheets that they can afford to take the long view and will endure, even if they spend less today. But a lot of companies are overleveraged – they made the bet that since the economy was good and no apparent threats loomed on the horizon, the chances of a dramatic drop was remote. But what once seemed remote is now here, and those overleveraged companies now lack the cash to make it on their own – and with everyone so justifiably pessimistic about the future, they are unlikely to find anyone willing to lend them the money they need. The failure of those overleveraged companies will result in more layoffs, more lost activity, and less confidence in the future.

Financial markets are pricing in this reality. And because the markets do not know when things will get better, prices need to fall farther than may otherwise be justified. Eventually, prices will go low enough that nobody will want to sell any more. You will not be able to buy Apple for a dollar. But there may still be some ways to go before prices reach their bottom, and everyone who looks at their investment holdings will discover they had less savings than they thought – which of course will not help anyone’s confidence.

How might the economic and financial consequences proceed from here?

This depends critically on the government.

In times like these, only the federal government can inspire the needed confidence. Uncle Sam isn’t going away: the government can send out as many dollars as people need and can make enough investments and commitments to restore confidence. And in this very special case – very unlike most recessions – the federal government could do wonders by explaining to people exactly when and how the virus will be sufficiently tamed to allow people to stop social distancing. But whether it will do so is another question.

It is certain that governments around the world will provide a huge amount of economic stimulus, including here in the US. But two things are much less certain:

1. Will the stimulus be effectively designed?
2. Will governments explain to citizens when and how the virus will be defeated?

The situation around policy design reminds me much of 2008. It is easy in hindsight to nitpick at the mistakes that were made then, but in the moment it was extraordinarily difficult to figure out how to deal with the situation. The good news is that the memory of 2008 is still fresh, and so everyone understands the need to go very, very big. But the bad news is that events are moving faster and the economic shock is greater. Also, while the leadership at the Federal Reserve is very capable, I’m not sure how true this is for the rest of Washington. We will have to see what the economic stimulus bill looks like. I very much hope it is effective.

Even more frustrating is the extraordinarily poor communication from the White House. Unfortunately, it is hard to talk about President Trump without triggering people’s partisan feelings; people either feel he is the enemy and leap to attack him, or they feel Democrats are the enemy and leap to defend him. And as full disclosure you should know that I do not like Mr. Trump. But I do believe it is objectively true that this is a moment in history where the communication skills of the President could make an enormous difference for good or ill, and at this moment unfortunately we find ourselves in the latter category.

What people need more than anything is to know what the plan is. How long will this last? Why are we taking these actions? What progress can we expect on what timescale? How will we know when we have made enough progress that we can return to work? A clear, credible, fact-based plan, relentlessly communicated, would make a world of difference. Yes, people would still hold off on future plans, but they would do so with a definite timeframe in mind, rather than an indefinite one. Plans and commitments could be preserved: workers could be furloughed rather than laid off, businesses could be paused rather than shuttered. And everyone could cooperate and comply more readily – not just out of fear, but out of understanding and patriotism. All of this hinges on the communication from our leadership. Great leaders excel at this; competent leaders try. And then there is Trump.

One of my best friends shared with me a theory that strikes me as highly plausible. He believes that the critical path to lifting social distancing is manufacturing ventilators. While a vaccine may be 18 months away and the time line for effective anti-viral drugs is uncertain, simply having sufficient ventilators to handle critical cases plus enough beds and trained attendants will save most lives who contract a critical case of COVID-19. And ventilators are not hard to produce: on the timescale of months, many can be produced from repurposed manufacturing plants. A little Googling turned up this story in Wired magazine that seems to me to support this theory: https://www.wired.com/story/ventilator-makers-race-to-prevent-a-possible-shortage/. If true, this is an example of a critically important thing for every single person to understand. Why is nobody telling us? But anyone who pays attention knows why, of course.

There is a wide range of possible paths forward for the economy. We may be facing a temporary, sharp slowdown with a sharp rebound, we may be facing a severe, drawn-out recession, or anywhere in between. No matter which path ultimately unfolds, we will certainly eventually recover. But the economic pain that results could be greatly multiplied, with deep implications for the lessons we learn, depending upon which path we follow.

Patrick