Market challenges posed by Covid-19

Politicians and epidemiologists get most of the headlines in the battle against Covid-19 and deservedly so on the public health front.   Fear and shutdowns have plunged the economy into unimaginable depths.  Although some macroeconomists have received attention regarding advice on fiscal and monetary policy, two basic concepts from MBA-level microeconomics are probably even more critical as we plan our path toward recovery.

Concept #1: testing and contact tracing are public goods.  There will need to be testing at large scale and frequent intervals to be able to build confidence and contain future outbreaks.  Right now we have 50 states each developing their own protocols and numerous firms selling tests, many of which are of dubious effectiveness.  No private sector firm on its own would have the resources or the credibility to carry this out.  There are two ways out: (a) Congress and the President provide one of the large tech firms with a monopoly license to devise and implement a plan or (b) federal agencies such as FDA and CDC take on the task.  Yale economist Zack Cooper's WP op-ed provides further insights about what we need to do to correct this market and government failure.

Concept #2: economies of scale for vaccine manufacturing.  You may think this is putting the cart before the horse or that I am just taking vaccine discovery for granted.  Consider, however, what will happen once a viable vaccine has been discovered.  How much slack capacity does Big Pharma have?  Who is going to produce vaccines on a scale that will allow worldwide, equitable distribution?  Stanford b-school economist Susan Athey and three co-authors argue in an NYT op-ed that the federal government needs to invest $70b now to build the capacity we will eventually need.  You might say, why not let the firm that develops the vaccine create the capacity?  Problem is there are dozens of firms worldwide doing vaccine research and only a handful will achieve breakthroughs.  What CFO would ever approve a massive expansion of capacity without knowing whether it will be needed?

Most of the spending from the three pandemic spending bills passed and signed so far has focused on support payments to businesses and individuals.  There are genuine investments that need to be made as well.

Giving away oil

Tuesday oil producers had to pay other parties to take their oil off their hands.  Well, not exactly.  What did happen is the price for May delivery of West Texas crude fell to -$38 per barrel.

So what gives?  Keep in mind these are futures contracts that are used for risk management; these are options to sell.  Oil companies purchase these futures to hedge against the risk of price drops.  For instance if the price of oil today was $30 per barrel and you were worried about the price dropping below $25, you might want to buy an option that lets you sell at a price of $28.  Most options are never exercised; they either expire or are traded.

On Tuesday there were not any buyers for May delivery at prices above zero.  This is happening because (1) global demand for oil has collapsed as people shelter at home to avoid COVID-19, (2) major producers such as Russia and Saudi Arabia have yet to cut back on production despite the demand situation, (3) it is costly to shut down a well so many producers have procrastinated, and (4) we are about to run out of storage space.

In a nutshell, a simple supply and demand story.  Looking ahead, expect prices at the pump to drop in the coming weeks, perhaps falling below $1 per gallon.  For more insight, see this video clip of my interview with local news channel WRAL.

Maybe you should stock up on toilet paper

Shortages of certain goods were easy to anticipate as a result of COVID 19, including hand sanitizer and disinfecting wipes.  An early run on "critical" household supplies is also no surprise; in North Carolina eggs, bread, orange juice and milk vanish from the shelves whenever the local weatherman hints at snow or ice.  

But toilet paper?  Initially many experts assured us that this was a simple inventory management issue and that more product would be rolling out soon.  Now I am less sure, for two reasons brought up in this WP article.  

First, people are spending less time away from home working, traveling, or socializing.  This means a shift in demand from using other people's paper to using your own.  Second, TP away from home is not a perfect substitute for TP at home.  Think about it -- the rolls at work, restaurants and airports are often a foot in diameter.  Even more critical, they are usually single ply.  In other words, there is a mismatch in the specs of much of the TP being produced and the specs of what people want to buy for home use.  

In time I am sure that the makers of Charmin and Cottonelle will figure out how to expand capacity.  But the makers of away-from-home TP will need some time to reconfigure their production lines and distribution channels so that they can sell directly to consumers.  This may take almost as long as it is taking GM and Ford to switch from cars to ventilators.  

This same phenomenon is happening in food production.  Companies that make ten pound bags of shredded mozzarella for Sysco are not going to be able to turn on a dime to make smaller bags for consumers.  

My advice: don't wait until you are down to your last roll before restocking.  

Robots did not overtake the world. But what about artificial intelligence?

Labor markets have been upended over the centuries by technological change.  Only John Henry could compete with the steam-powered drill, and he paid dearly.  In the not too distant past, there have been concerns about the impact of software and robots on wages and employment.  Now the big worry is artificial intelligence.

Stanford economics PhD student Michael Webb has developed a framework that can evaluate the impact of new technologies on different occupations by matching words between patents and job descriptions.  Looking at data between 1980 and 2010, he found wages and employment declined the most in jobs that were most exposed to competition from software (broadcast equipment operators) and robots (forklift drivers).  These are jobs that do not require a college degree.

Based upon patents related to AI, Webb finds that the occupations most likely to be endangered include clinical laboratory technicians, chemical engineers, and optometrists.  All of these jobs require post-secondary education.  Overall, the risk of displacement from AI is greatest for those with college and graduate degrees.

Technical change and globalization have resulted in the loss of a number of middle class jobs.  AI could be coming after the upper income brackets.

Economic actions to fight the coronavirus

The expected economic damage from the coronavirus is starting to become apparent.  Many sectors of the economy have shut down or will do so soon.  Within 48 hours of Governor Cooper’s announcement that closed bars and restaurants in North Carolina, 18,000 people filed for unemployment benefits.  This is more than the number that filed in all of February.  These numbers will only accelerate in the coming weeks.  

The need for economic action is now, but what actions will best serve our citizens?  Many in Washington are calling for a replay of the actions that were effective in past recessions, including cuts in payroll taxes, direct payments of $1000 to all citizens, bailouts to specific companies, and lower interest rates.  

The generals of our economy are fighting the last war.  Although everyone no doubt will like having Washington send them an extra $1000 to $2000, most of those checks will be saved, not spent because most of the service economy is shut down.  Payroll tax cuts will help those with jobs to a small extent but will do nothing for those out of the labor force.  A further problem with these approaches is that they are not targeted toward those who will have the greatest need, especially those unable to work and without savings to tide them over.  Owners of small and medium size businesses are at risk as well.  

From an economic perspective, I see three challenges that can be addressed through wise policies: public health, income maintenance and financial stability.  On the public health front, Congress needs to make sure that Dr. Anthony Fauci and his colleagues get whatever they say they need, including test kits and vaccine research support.  The bill passed last week is a good start.  

Income maintenance can be achieved through a variety of actions, but the primary focus should be on expanding the eligibility and generosity of unemployment benefits and making paid sick leave more widely available.  The average unemployment benefits check in North Carolina is $250 per week and they run out after 20 weeks.  Thanks to actions taken by the NC General Assembly to reduce benefit generosity in 2013, the state system has $4 billion in the bank.  It is time to put that surplus to work.  

The Federal Reserve will need to think outside the box on financial stability.  Job one will be to maintain liquidity in financial markets, just as it did in the Great Recession.  But the virus poses an additional challenge.  Businesses such as airlines and hotels were healthy a month ago and will be healthy again in six to 12 months.  Owners of hair salons and local restaurants operate on thin margins and many have little in the way of savings to fall back on.  What can we do to keep them going in the interim?  

Some politicians are calling for direct payments to the companies.  A better idea would be to loan Delta Airlines and Marriott Hotels the funds needed to pay off loans and roll over bonds over the coming months, with the Fed or Treasury accepting planes and buildings as collateral.  The Fed ended up in the mortgage market in the Great Recession; it may need to provide bridge funding to some cruise ships and casinos this time around.  Special programs for small to medium size businesses will be needed as well.  

Whisky business: tariffs and their consequences

In March 2018 the US imposed tariffs on steel and aluminum imports.  In reaction the European Union imposed tariffs on American goods to maximize political damage to Republicans, including tariffs on bourbon made in my home state of Kentucky.  In response the US announced in October new tariffs on Scotch whisky and French wine.

In a recent WP column, Catherine Rampell examined the consequences of this escalating tariff war.  Overall US whisky exports dropped 16 percent while EU exports fell 27 percent.  There also are domestic losses associated with declining wine and Scotch imports -- namely fewer jobs and lower profits for the firms that import, transport, and retail the goods in question.  

In the meantime employment in primary metals manufacturing is actually down since the US started this escalating tariff war, which is proving not so easy to win.

Powell on labor force trends

Today's WP summarizes FRB chair Jerome Powell's analysis of why the labor force participation rate of prime age adults has (1) declined over the last 60 years and (2) become lower than the rate in most other well-to-do nations.  This is an important issue for the prospects for continued economic growth.    With the unemployment rate at all time lows and job vacancies exceeding the number of job seekers, future gains in GDP are contingent on more people entering the labor force.

In the 1960s, virtually all men between the ages of 25 and 54 worked or were looking for work.  Today that rate has gone down to 89 percent.  Labor force participation hinges on the rewards for working versus the value of not working.  One might argue that the rewards for not working have risen, leading to more labor force dropouts.  But single men do not qualify for many income maintenance programs and the inflation-adjusted payout from these programs has declined over the last 40 years.  Also, income maintenance programs are far more generous in Western Europe than the US.

Powell points to two trends that have driven more men to drop out of the labor force: education and opioids.  Today's jobs require more skills than those one or two generations ago, but education levels have not kept up.  Research on the impact of  opioids is just getting geared up.  To date it shows a correlation between low (high) labor force participation with high (low) opioid use across communities.  This begs the question of which came first.

To this list I would add two more items: a declining marriage rate and video games.  Married men are more economically active and make higher wages than unmarried men, although again establishing cause and effect here is challenging as women are less likely to marry men who are unlikely to contribute to a household's economic well-being.  As for video games, research shows they provide a low cost mechanism for passing time with some social interaction that increases the payoff for not working.  

Saving NCAA men's basketball

This has been anything but a great season.  There is no Zion Williamson or Anthony Davis on the court.  The ACC has three good (not great) teams and then a lot of mediocrity.  Most other conferences are the same way.  Lots of fouls getting called and lord help us when the officials have to visit the monitor to review a play.

Mark Story, a sports columnist for the Lexington Herald-Leader (which along with the Kentucky Sports Radio blog are your go-to sources for the winningest team of all time) has some great suggestions on how to improve the game:

1) Let players who enter the NBA draft and are not selected return to college.  This would shift some talent back to the college game that will otherwise play overseas or in the NBA G League.

2) Let players make endorsement deals.  It's their name and number on the t-shirt; give them a cut of the action.  Again this will make a difference for the stay-in-school versus bolt-for-overseas decision.

3) Reduce the use of video replays.  Story recommends giving each coach the right to request two replays per game.  I would add this -- require replays to be complete in two minutes.  If there is not a clear case for overturning a call by then, the call should stand.

Trade deficit shrinks, so what?

The trade stats for 2019 show that the trade deficit shrank by $11b, a 1.7 percent drop.  This is an economically significant number.  But what does it mean?  Trade deficits reflect the difference between exports and imports.  They shrink if exports grow, holding imports constant, or if imports decline, holding exports constant.

Nothing is ever held constant in the real world, however.  In 2019 the volume of both exports and imports became smaller, reflecting the trade barriers created by the US and some of its trading partners.  But imports declined more than exports, so the deficit shrank as well.

Are we better off with a smaller deficit?  Exporters would say no.  Nor would the companies with global supply chains that have had to play guessing games with tariff timing and exemptions.

Protectionism has sprouted up in a number of countries as part of a portfolio of nationalist, inward-looking policies.  Politicians promised that trade wars would lead to domestic job growth.  So far, there is no evidence in the US of a recovery in manufacturing in response to a smaller volume of imports.

Should we get used to slower growth?

Yesterday's GDP report indicated that growth slowed to 2.1% in 2019:4.  This is basically the same rate as prevailed in the last two quarters.  Most economists believe this indicates the long term growth potential for the US because (1) the economy is at full employment, (2) labor force growth is likely to remain modest because of population aging and immigration restrictions, and (3) declining productivity growth.

Will this be the new normal?  It is clear that the cut in corporate taxes in 2017 so far has not launched the GOP-promised surge in corporate investment.  The stimulus from the household tax cuts is in the rear-view mirror.  As for the Fed, it is hard to cut interest rates when rates are near zero.

Coronavirus may very well result in a dip in GDP growth in 2020:1 and election uncertainty could be a drag for the coming year.  On the plus side, 3.5 percent unemployment has resulted in rising incomes for those who have not fared well since the Great Recession.  Continuing that trend would be no small accomplishment.

Records of the year

Now that we know that the Grammys are rigged, where can you find the best music?  As the former rock critic of the Michigan State News, I offer you my favorite albums of 2019:

1.  FKA Twigs, "MAGDALENE," a blend of R&B and electronics with a dash of medieval church music and hip-hop
2.  Sharon van Etton, "Remind Me Tomorrow," following in the steps of Bruce and Bon Jovi in the Jersey pipeline
3.  Weyes Blood, "Titanic Rising," songs about romance in our digital age
4.  Angel Olsen, "All Mirrors," Asheville's own keeps turning out amazing stuff
5.  Lana del Rey, NFR, I cannot spell out the title for this PG blog
6.  Jamila Woods. "LEGACY! LEGACY!" tributes to artists who inspired Woods including Zora Neale Hurston, Miles Davis and Frida Kahlo
7.  Aldous Harding, "Designer," the best yet from this singer-songwriter from New Zealand
8.  Stef Chura, "Midnight," the next great rocker from the Motor City (but she is originally from the U.P.)
9.  Sleater-Kinney, "The Center Won't Hold," still going strong after 25 years
10.  (tie) Big Thief, "Two Hands" and Thom Yorke, "ANIMA," it would be wrong to leave one out.

The careful reader will note that the performer on all but one of these albums is either a female solo act, a band consisting entirely of women, or a band fronted by a woman.

Honorable mentions (multiple playlist-worthy tracks): Floating Points, Crush;" Black Keys, "Let's Rock;" Jenny Lewis, "On the Line;" Billie Eilish, "WHEN WE ALL FALL ASLEEP, WHERE DO WE GO?"

AND WHY THE ALL CAPS IN SO MANY ALBUM TITLES?

And U.P. stands for Upper Peninsula (of Michigan).

Let's make a trade deal 2: China

To evaluate the trade agreement with China that was signed last week, the fairest comparison to make is between where trade relations between the US and China stood on Inauguration Day 2017 and where they stand now.  On Inauguration Day 2017 the US had negotiated the Trans-Pacific Partnership with Australia, Chile, Japan, New Zealand, Peru, Singapore, Vietnam, and four other countries in the Pacific Rim.  It would have lowered or eliminated tariffs and other trade barriers among the partners and posed a strong counter-weight to China's ambitions.

Since that time, the US walked away from TPP and the remaining 11 members signed the agreement on their own. The US started imposing tariffs on China, which countered with its own tariffs, including significant tariffs on US agricultural products such as soybeans.  In game theory, this is known as a tit-for-tat situation, where each side replicates the moves of its opponent and there is a risk that both parties impose tremendous costs on each other.

So where are we now with last week's trade agreement with China?  The best news is that the tit-for-tat tradeoff has moved in the opposite direction; both sides have agreed to de-escalate and roll back some of the tariffs.  The not so good news is that (1) there are still a lot of tariffs and (2) businesses face uncertainty about future tariffs, which will slow investment and make sourcing decisions riskier.

The good news for American farmers is that the Chinese say they will buy more agricultural products from them.  That might mean US taxpayers will not have to send another check to farmers to offset the damage from the tariffs.  The not so good news for Brazilian farmers is that their sales, which surged when the tariff war started, will now drop off.

The good news is that the new agreement has stiffer rules for intellectual property protection in China.  The not so good news is that words on a page need not be strictly enforced by the Chinese government which has its eye on who will win the 2020 election.

Bottom line: Are we better off with this trade agreement compared to another tit-for-tat escalation?   Most definitely.  Are we better off compared to Inauguration Day 2017?  Definitely not.

Let's make a trade deal 1: USMCA

Now that all three countries have approved USMCA (US-Mexico-Canada agreement), what should we expect?  The best analysis I have seen to date comes from the Cato Institute's rating of which parts of USMCA will be helpful, which will be ho-hum and which will be dreadful.

Economically speaking, the best news is that the difference between USMCA and NAFTA is fairly modest.  President Trump did not terminate NAFTA, as he had threatened.  The one tangible gain from USMCA is that Canadian markets will be more open to US agricultural products, including wine.  This is great news for Wisconsin dairy farmers, who could have a large voice in whether the President will be around to make more trade agreements in 2021.  There also appear to be improvements in using regulations to create trade barriers, improving dispute settlement procedures and boosting digital trade.

The worst news is that automobiles are going to cost more.  To import a car from Canada or Mexico duty-free, 75% or more of its value must be created in North America, up from 62.5% under NAFTA.  That means fewer parts will come from Asia and manufacturers will have to shift to higher-cost suppliers in North America.  Also on the minus side, there is a sunset clause that could lead to the entire agreement being renegotiated or terminated in six years.

The International Trade Commission did an analysis last April that projected a 0.12 percent in US GDP as a result of the USMCA.  Based on my visits to Mexico over the last 30+ years, I think the biggest gain from NAFTA is that it has helped open up the Mexican economy which has in turn led to dramatic increases in well-being, at least in urban areas.  Having a more stable, more prosperous neighbor does not show up in the GDP statistics, but it might be the biggest gain from these trade agreements.

Another great jobs report, but ...

Today we learned that employers added 145k to their payrolls while unemployment remains at historic lows.  One would think that when economists gathered in San Diego last weekend for the annual meetings of the American Economic Association, it would be laissez le bon temps rouler.  

Au contraire!  NYT reports that many leading economists are worried that the ten year expansion is near an end.  Concerns cited include large government budget deficits, trade wars and ultra-low interest rates.   The low rates discourage saving.  They also limit the ability of central banks to stimulate the economy in any future recession; when rates are close to zero already, you cannot lower them much more.

As of now, no prominent economists are predicting recession for 2020, but the consensus is that growth will slow down.  Keep in mind that no prominent economists were predicting the market crash and subsequent recession in 2008.