Byron Wien: Speculating on the Secular
It is hard for all of us to believe how rapidly and totally everything has changed. None of us has experienced anything like this before. While there have been warnings about a pandemic for years, the current situation seems to have caught us all unprepared. I recall listening to pandemic alarmist Laurie Garrett at the Council on Foreign Relations fifteen years ago. In 2015 Bill Gates advised us of the dangers of a pandemic based on his experiences dealing with medical crises in Africa. In some cases in the past, we have had drugs to minimize the symptoms of the disease, but in the case of COVID-19, we have none. Hopefully, we will have developed some pharmaceuticals to deal with the symptoms in a few months, but a vaccine is at least a year away.
The key imperative naturally must remain saving lives. Our immediate objective is to safely scale back the lockdown and to return to some semblance of our normal lives as soon as possible. At this point, that still seems weeks away. We would have to see the number of new cases fall into a steady decline and the number of deaths drop sharply. Need-based testing would have to be easily available, and beds for anyone requiring hospitalization. The health care system in certain cities is highly stressed now. Our only defense is to avoid getting the disease and that is why we are all hunkered down and wearing masks whenever we go out. During previous flu epidemics, 9/11, World War I and II, we have usually been able to go about our daily lives in a reasonably normal way. We have never before been confined to our homes. Some believe when the crisis is over, everything will quickly return to what life was like in January, but I think there will be some lingering effects. We will be worried about a second wave and we will be more conservative in our movements. Dr. Anthony Fauci, the top government medical official monitoring the situation, also cautions us not to expect a quick return to our previous life patterns. I think the recovery will look like a square root sign, a “V” at the beginning and then a gradual recovery.
Most of us have been working remotely for a month and have no idea when our lives will return to normal. We can be sure that some aspects of our lives will undergo profound change, so I thought I would reflect on what might be some of these changes. We all realize that our jobs and income might be impacted negatively by the lockdown. Even those of us still drawing paychecks will want to have more of a savings cushion and more cash on hand. We are also likely to keep more food in the house and more gas in our cars. In our investments we are likely to use less or no leverage and reduce our riskier holdings. Our vacation plans are likely to be, at least for a while, less venturesome. Little foreign travel, more time at destinations we can drive to and get home from without worrying about flight disruptions and crowded airports.
On a national level, we are clearly going to want to have more hospital beds and a backup plan for creating emergency beds at auditoriums and sports facilities. In hospitals we will need to stockpile more personal protective equipment. Almost all our generic drugs are produced abroad. We will want to bring production of these drugs and thousands of other component parts and finished goods back home, particularly technology products.
I also expect a major change in the government attitude towards pharmaceutical companies. We all know we need drugs to treat COVID-19 as soon as possible, and a vaccine to prevent contracting the disease as soon as it can be developed and properly tested. While the Federal government may provide some aid in this effort, it will be up to the private sector to do the research and lab work associated with these important medical breakthroughs. I expect to hear less inflamed rhetoric against the drug industry during the forthcoming presidential campaign and beyond.
Unemployment is likely to reach the highest levels on record. Many Americans, having lost their jobs, are struggling, and are waiting for assistance which may not come because of the ineligibility of some workers. I think some of the major long-term issues like climate change, inequality and immigration may not be addressed for a while. The news media is totally focused on medical and economic issues. We are in lockdown because we are waiting for the situation to improve, but we lack the testing or medical facilities to accelerate that process. Until we get through this difficult period, these longer-term issues are unlikely to get serious attention. Some believe that environmental, social and governance issues will get more focus at the policy level and among investors, but I think health and economic matters will dominate private and public sector initiatives for several years.
I have long believed that the more than satisfactory growth that we have experienced around the world in the past decade is a result of globalization and monetary policy. Manufacturing has been outsourced to the lowest-cost producers wherever they might be located, and companies have had confidence that transportation sources could bring component parts back to various locations for assembly into finished goods. This will change dramatically. Companies will want domestic control of manufacturing, and globalization will decline. This has to result in higher costs of production, but I doubt that the inflationary effect will be significant. There are too many disinflationary forces going on at the same time, not the least of which is that the price of oil, the most important commodity in world commerce, is in the $20’s.
Historically, crises have stimulated research and creativity. The current situation should be no different. Genomics and gene editing may become an important tool in dealing with pandemics in the future. As we learn more about the various diseases threatening us, we may be able to alter our susceptibility to illness through gene therapy. There are ethical issues involved in the process, but we will figure out a way to address them.
I have also thought that remote learning through the use of the internet was underutilized as a way to educate more people at a lower cost. The cost of private college education has risen twenty times in the last half century and that makes no sense to me. I value the interaction with professors and students at a residential college, but some combination of on-site and remote learning may broaden the availability of a quality education and lower its cost. With students at every level going to school remotely after the spring break, we will have an opportunity to work through some of the problems with the remote approach, so that it will be more effective when it is an option and no longer mandatory. Companies are also learning that face-to-face contact, while desirable, isn’t always necessary. This should result in more virtual meetings and less travel, which is both costly and time-consuming. This obviously will have implications for airlines and hotels. There is, however, no real substitute for a physical meeting with a client in a marketing situation.
Because the coronavirus is a global phenomenon, one has to wonder what impact it will have on geopolitics. The hope would be that there would be more international cooperation. That is not, however, clear. Henry Kissinger argues in a Wall Street Journal op-ed that countries need to cooperate in times of crisis, but my worry is that they will become more insular. We already have examples of authoritarian governments ruling by edict. There may be a widespread move toward building facilities for a country’s own population, restricting border crossings and not sharing information or medical supplies freely. The world is an interdependent place and the free flow of ideas and commerce benefits everyone. If we turn away from that, growth is likely to be slower and political harmony is likely to suffer. Fiscal and monetary policy in the United States is likely to have some influence on the dollar. Rising budget deficits should be a negative, but that depends on what other countries are doing. So far, the dollar has been relatively strong, which has added to the problems of the emerging markets.
I count myself among the previous China bulls. Their goal was to be self-sufficient in technology by 2025 and the leader in the world militarily, economically, politically and technologically by 2049. With some companies reconsidering their supply chains and outsourcing in a post-pandemic world, China’s position in the world will surely go through a period of reevaluation. China is well aware of the friction the coronavirus has caused. Cui Tiankai, the Chinese ambassador to the United States, reached out through an op-ed in the New York Times to re-establish a more cooperative relationship. In 2019 China accounted for one-third of world growth. For the first and second largest economies in the world, finding a way to work together in the future is imperative.
Turning to economics, we have all believed that the American economy and corporations were in very strong shape going into the health crisis. GDP was about $22 trillion and corporate profits were at an all-time high. 13D Global Strategy and Research quotes a Hoisington Investment Management report that says, “In the third quarter of 2019 Corporate Profits after tax and other adjustments were at $1.87 trillion, up from $1.7 trillion in the first quarter of 2012, the after-tax gain was $163 billion but the before tax gain was only $53 billion over eight years.” Perhaps, on a real basis we were not in such great shape, because inflation rose faster than profits so real earnings were actually down. Lower taxes accounted for a large portion of the earnings increase over the past decade, and rising multiples because of lower yields inflated stock prices.
In spite of the government support, the labor force is likely to be seriously affected. Unemployment could rise to 20%, meaning 30 million American workers could be out of work for some period. Many will require continuing checks from the Treasury. Mark Zandi of Moody’s did a study for The Wall Street Journal that determined the April economic shutdown was at an annual rate that would knock out three-quarters of U.S. GDP. The country clearly has to get back to work as soon as possible, but to do so it is essential that the threat of the disease be substantially eliminated.
At the Federal level we were already running a deficit of $1 trillion before the economy entered the current recession. Estimates are now $5 trillion or higher. The Federal Reserve balance sheet is likely to increase from $4 trillion to $9 trillion. Nobody has truly assessed the implications of these increases, but they are likely to be significant. Modern Monetary Theory is here whether we acknowledge it or not.
The effect on interest rates is likely to be substantial. If our debt exceeds $30 trillion and rates rise to 2.75%, we could see debt service rise from $400 billion to $825 billion later in the decade. In a recession, incomes fall and tax receipts decline, making it harder for the government to collect the revenues needed to service that debt. Increasing taxes won’t solve this problem. At this point, assessing the impact of the lockdown on state and local governments in the United States is difficult. Their deficits will be increasing while their tax bases are declining and they are likely to look to Washington for more help, but the Federal government will be experiencing its own financial problems and cannot be counted on to come to the rescue.
As we look ahead, life will be different and for a time at least more subdued. My conclusion is that we will survive this, learn some lessons and be much better prepared if there ever is a “next time.” We have been forced to think about the importance of friends and family and to put material things in perspective. That is certainly a positive aspect of the present challenges facing us.
The views expressed in this commentary are the personal views of Byron Wien and do not necessarily reflect the views of The Blackstone Group Inc. (together with its affiliates, “Blackstone”). The views expressed reflect the current views of Byron Wien as of the date hereof, and none of Byron Wein or Blackstone undertake any responsibility to advise you of any changes in the views expressed herein.
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