Mental Models discussed in this podcast:
- Second-Order Effects
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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.
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.
- Joshua Kennon’s question: What Price Should We Pay to fight COVID-19?