Examining COVID-19 Shutdowns and Economic Tipping Points As Unemployment Skyrockets and Supply Chains Are Broken
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Examining COVID-19 Shutdowns and Economic Tipping Points As Unemployment Skyrockets and Supply Chains Are Broken

At some point, the shutdowns won’t be temporary because supply chains will be broken and businesses will be permanently destroyed.

Recently, I wrote about how a prolonged COVID-19 economic shutdown could cause many businesses to exhaust their liquid cash reserves.  Few businesses, even the smartest ones, are equipped to handle a sudden and total loss of revenue over an indefinite period, nor should they be.  Instead, businesses, especially small businesses, should generally deploy their available capital to try and generate a return.  But that means many small businesses may not be able to survive a long government-mandated shutdown— even if they furlough all employees and cut spending because they still face fixed costs, like rent, insurance, etc.

That means the longer coronavirus-prompted economic shutdowns continue, the more businesses will fail. Over the last three weeks, 17 million Americans have filed unemployment claims. When Americans re-emerge from their homes after the shutdown, they may find massive structural unemployment and an economy that cannot simply be turned back on.

Some of the most hopeful economists forecast a quick bounce-back once the quarantines are lifted and people are allowed to return to work.  However, that view depends largely on the assumptions that supply chains remain intact and that people decide to quickly go back to spending levels similar to what they were spending prior to the shutdown.

In other words, these rosy-eyed economic analyses believe the coming recession will primarily result from a temporary decline in consumer demand during the time many people are forced to go without an income.  Government support to families and businesses will help prop up this demand and allow people to purchase the things they need, the theory goes.

I’d very much like to believe this.

However, the longer the shutdown continues, the more likely it becomes that the recession could be driven by a collapse in the supply of goods and services leading to a lengthy worldwide scarcity of almost everything.

Most economists like to envision supply and demand as a chart with two smooth curves that imply what is known in mathematics as continuous functions—the notion that all the data points coalesce into a single line.  These mathematical abstractions of the real world allow economists to perform numerous calculations and lead some to believe they can manipulate markets with the correct interventions to get things quickly back on course.

The problem is that, as we are seeing right now, neither supply nor demand is really continuous functions that would allow for such calculations—they can have jumps and holes.  In reality, each curve is just an aggregation of many discrete, decision-making units.  The discrete production units are businesses, while the demand curve is a similar representation of billions of discrete decisions made by both households and businesses. If a large proportion of businesses exhaust their cash reserves to service their fixed costs during a prolonged shutdown then the theoretical supply curve collapses entirely, leaving even the best calculations by economists mostly meaningless.

This phenomenon can compound quickly.  For instance, among the several businesses I advise as an accountant, one is deemed “essential” during this time. It is permitted to remain open during this COVID-19 shutdown and has even experienced a slight uptick in demand.  However, this manufacturer also relies on a supply chain to provide it with raw materials, packaging and other necessary components to make its products.  Some of the vendors it relies on are not considered “essential” by the government, the supply chain is fractured for the business that is allowed to be open.

So, even a business that is healthy, profitable, and benefits from legal privilege right now can suffer when it becomes incapable of producing completed inventory.  If its suppliers are forced to close permanently during the shutdown because they cannot meet their fixed costs, even the healthy and “essential” business can suffer.

Similarly, some dairies have found their supply chains disrupted even though they produce an essential food product for which demand is outstripping supply.  USA Today reports on how dairies that wholesale their products directly to restaurant chains have suddenly found they have no customers.  Without existing bottling and customer relationships to produce for grocery store chains, they cannot quickly pivot their operations. As a result, some dairies are literally destroying millions of gallons of milk for which they have no distribution channel.

This phenomenon isn’t unique to the United States. Reuters reports that the global food supply chain has become hampered by shutdown orders around the world.  Even though it is harvest time in the southern hemisphere, farmers have found there aren’t enough workers to pick and process the crops or move them to market.  As a result, farmers in India are feeding high-value crops like strawberries to livestock since they cannot move them.

There are no easy solutions to these problems.  If the federal government, i.e. taxpayers, agreed to pay all American businesses’ bills for the duration of the government-mandated shutdown, it would require so much creation of new money by the Federal Reserve that it would likely severely impact the value of the dollar, throw financial markets into far more confusion than they’ve already been in, and could potentially result in rampant hyperinflation unseen in the developed world since Germany in the 1930s.

Conversely, if authorities ordered the forgiveness of rent, insurance payments, and other obligations to help these businesses, then landlords, financiers, and insurance companies might fail en masse, leading to equally disastrous economic results. Rebuilding the world’s supply chains could take many years if a large proportion of businesses do fail during the shutdown and the contagion of those failures spreads to vendors and customers alike.  The worldwide drop in production and incomes could force households and businesses to consume capital to meet their ongoing needs throughout the shutdown and the ensuing recession.  So, less capital will be available to build new companies and individuals may no longer have the confidence to make long-term investments.

In the worst-case scenarios, the collapse of global supply could leave people around the world hungry and in search of medicines, clothing, and other real goods.  Few people living today have experienced a global depression of that sort. But, as impossible as that scenario seems to most of us, it could be in the offing if the shutdowns continue for many months on end.

The record-setting unemployment numbers show the toll this pandemic is taking on workers and businesses. At some point, the shutdowns won’t be temporary because supply chains will be broken and businesses will be permanently destroyed. There’s a tipping point where a quick economic bounce-back becomes impossible and a host of negative impacts for the world become more likely.

No one knows exactly when we’ll hit that tipping point.  And reopening the economy won’t be an easy decision. Nearly 100,000 people, including over 16,000 Americans, have already been killed by COVID-19, a number that many forecasting models say could still grow significantly. As lawmakers are making decisions about flattening the pandemic’s curve and when to let businesses and sectors of the economy reopen, they should consider all of the human costs and trade-offs, including the massively negative impacts that a global depression would have on lives and health.