COVID-19 Is a Supply Interruption—Not Demand Driven

Will the U.S. and global economies bounce back from the Coronavirus scare?

Or have we entered a new normal?

The answer resides in why the economy contracted in the first place.

Perhaps the greatest insight we can provide is to take a step back in time to the financial crisis of 2008.

In 2008, the economy was running hot—and had been for years.

Effectively, the economy leading into the contraction of 2008 was unsustainable.

Oil prices had climbed steadily, from $40 to a peak price of $147 a barrel in July of 2008.

Oddly, the inflationary pressures from oil should have slowed the global economy—it didn’t.

The reason was over-leveraged capital.

The financial industry was leveraging capital at an unprecedented rate. Still, even this extreme rate of capital leveraging shouldn’t have been enough to create a hot economy.

There were two additional factors that fueled the hot economy.

Those factors were double digit increases in home prices and low mortgage rates.

It was the increasing home valuations and low mortgage rates that drove the public to continue to spend like drunken sailors even in the face of the inflationary pressures of rising oil.

The over-leveraged capital, largely from the creation of derivatives, had the consequence of driving up home prices by double digit figures. In addition, the liquidity in the system drove interest rates to remain historically low—permitting homeowners to refinance their home mortgages.

Many, who refinanced, took out equity from their properties. The issue, the increase in equity was largely fictitious.  

Still, homeowners had the perception they were wealthier than in fact they were.

The dilemma: the increase in property values led to uber confidence by consumers, even in the face of mounting inflationary pressure due to rising oil prices.

Ultimately, the musical chairs had to end.

By the end of 2008, the liquidity shell game played by Wall Street blew up—sending the entire global financial market into free fall.

In a word, the economy of 2008 was unsustainable and had been for quite some time.

Now we fast forward to 2020—and the Coronavirus scare.

Was the economy running hot prior to the COVID-19 outbreak?

Certainly with unemployment at a historically low rate of 3.5%, the economy in the U.S. was robust, but there were signs it was slowing.

The seminal question: Was the U.S. economy running at an unsustainable level?

No.

The economy prior to the contraction caused by the COVID-19 outbreak was not running hot—it was sustainable.

The more important issue: Was the contraction driven by waning demand/consumer confidence, underlying weakness in fundamentals or something entirely different?

The contraction in 2020 was in fact due to a supply interruption.

The outbreak in Wuhan, China led to supply shortages.

Companies couldn’t get their products to market—due to labor issues in China. This in turn caused a ripple effect throughout the global economy.

It is important to note: this was not a fundamental softening of demand or consumer confidence—this was solely a supply issue.

It is worth pointing out, the U.S. economy like all economies is driven by demand.

If demand and consumer confidence remain in place—the supply will strive to meet that demand.

This bodes well for the U.S. economy—at least for the next couple of years.

Could demand dry up?

Could consumers be so shocked by the Coronavirus scare to pull back?

Possibly.

But there is no evidence either demand or confidence have evaporated.

In fact, demand has been suppressed by the actions of governments globally in an effort to control the spread of the COVID-19 virus.

Once the artificial measures to suppress demand are lifted, it is more than likely the economy will bounce back.   

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