A Fascinating Explanation of the Crisis We Face
What just happened? We have rarely had such a violent stock market correction. We have rarely had such massive hysteria with people hoarding toilet paper in the face of a respiratory infection. We have never seen Sam’s Club only allowing 15 people at a time in their stores.
What’s going on here? Does the oft-joked about expression “this time it’s different” hold water?
Let’s take a step back and look at the situation objectively through our scientific lens.
The information below is adapted from Alastair MacDonald, a brilliant entrepreneur and economic analyst in Arizona.
It’s truly fascinating. This crisis did not read the book at all!
There are 3 classic phases in a typical recession.
1. Demand compression
Because of the questionable economy, one Wednesday evening, Joe tells his wife Sally: “Honey, I’m a bit concerned about our finances, let’s skip Wonder Whopper Wednesday OK?”
Sally gets it, and agrees with Joe.
The couple stays home.
But they’re not the only one. Ten “regulars” decide not to go out that day.
Susie Q, the waitress, of course notices that she has fewer customers that night. She knows it’s going to hurt because she will have fewer tips.
As a consequence, Susie Q changes her own lifestyle. She skips her weekly manicure.
And her manicurist skips her massage.
And her masseuse skips her hair appointment.
Joe and Sally’s seemingly insignificant decision has a ripple effect through the local economy.
Imagine similar ripples in each neighborhood of each town of each county of each state.
As more and more people behave similarly, the ripple effect takes a toll on the national economy, then quite possibly the international economy.
So stage 1 of a typical crisis is contraction of demand.
2. Supply compression
Paul, the owner of Wonder Whopper, also notices that his “regulars” are not showing up as much. As a wise business owner, aware of inventory management, Paul orders less food from his suppliers. Less meat. Less mustard. Fewer buns. Fewer French fries.
Regretful, Paul is also a realist. He has to lay off a cook and a couple of waiters, because there are fewer meals to prep and serve.
Paul’s seemingly insignificant decision has a ripple effect through the local economy.
Similar ripples occur in each neighborhood of each town of each county of each state.
As more and more business owners behave similarly, the ripple effect takes a toll on the national economy, then quite possibly the international economy.
Stage 2 of a typical crisis is contraction of the supply chain.
3. Financial contraction
You’ve heard it a million times: our economy is driven by consumers – us.
If consumers consume less, there is less money circulating in the economy. The money supply dries up, which leads to a liquidity issue.
To “fix” the problem, the Federal Reserve and central banks typically will cut interest rates and increase credit to financial institutions and businesses.
And hopefully this is the beginning of a cure to the crisis.
Stage 3 of a typical crisis is contraction of the money supply.
But this time around, the coronavirus did not at all read the book, and the crisis did not follow the usual pattern.
Let’s recap what happened this time.
It all began with supply contraction in China after the outbreak in Wuhan.
Wuhan is a city of 11 million people in East China, that few people had ever heard of.
By itself, Hubei province, of which Wuhan is the capital, produces over 4% of China’s economy.
This region is critical for global manufacturing. Supply abruptly decreased by almost 40%.
This affected the entire world.
You experienced some of it, possibly in your personal and definitely in your professional life. This is the reason you cannot get surgical masks, and may have difficulty ordering caps, gowns and other medical supplies.
So this crisis started with step 2, a supply contraction.
Empty bread shelves.
With less money circulating in the economy, central bankers applied their usual solution: print more money.
As you may remember, they lowered interest rates by 50 basis points (translation: 0.5%).
As mentioned, this ripple effect is worldwide. The Bank of England quickly followed suit (with the same amount). China had done the same.
So this time around, step 2 (supply compression) was followed by step 3: liquidity contraction.
Empty pasta shelves.
The crisis was so rapid and violent, that we didn’t see a compression of the demand until later on.
But now you’re starting to notice it: schools are closing, travel is dwindling, gatherings are canceled.
Concerned (or terrified) consumers will stay home more.
People are afraid, and they will stop shopping (well, except to load up on toilet paper of course). They will stop, or at least delay, superfluous expenses such as self-care, going out, watching movies, etc.
And just like that, step 1 (contraction of the demand) followed stages 2 and 3.
Empty potato display.
So for once it’s true: “this time it’s different.”
But sadly, the end result is similar: trillions of dollars have vanished from people’s investment accounts.
The Dow Jones just suffered its worst week since 1987.
Some people’s retirement will be greatly delayed.
Sadly, many people will be affected, directly or indirectly, by the virus.
So what should you do? The answer may be different for each of you.
Here are some important thoughts to keep in mind:
- Take care of your health and your family.
- Don’t shake clients’ hands.
- What is your time horizon? When do you need the money you’ve invested in the stock market?
- Watch your trailing stops (you have some in place, correct?)
- Can you stomach a downturn without losing sleep or jeopardizing your retirement?
- And gosh darn it, stock up on toilet paper!
Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit
*Note: all pictures in this blog post were taken in local stores in PA mid-March 2020.