“Seems like things are getting back to normal.” Not exactly. Folks with that view are not looking very closely.
In this episode, Keith takes us on a journey through the forest…and the so-called economic recovery that’s currently in play.
Using more than one analogy, he illustrates just how unrealistic the “nearly back to normal” expectation really is. And why.
Additionally, we go down a rabbit hole regarding the human – and very stateful – impact involved, discussing how that human impact will likely soon affect the folks who are least prepared for it.
NYT article, 3 Oct 2020 – The Pandemic Depression Is Over. The Pandemic Recession Has Just Begun.
YouTube interview, Feb 2020 – COVID 19 Impact – Cause vs Catalyst
Keith Weiner: Many people incorrectly believe that in the wake of the COVID virus, you can shut down the economy, or significant parts of it, and then easily resume the economy later.
Like hitting pause on the VCR. You just stop it for as long as you need, and then you restart it, right?
These same folks are looking at the economy, and projections now from Wall Street analysts. And those analysts are saying that there’s going to be huge growth ahead. So people think, OK, we did fine. We’ve made it through!
But we haven’t. Yet.
Sure, a lot of small businesses – bars, restaurants, nightclubs, theaters, retailers – they declared bankruptcy. But everyone else survived, right?
Think of it like making it through an arduous ordeal. You go hiking, you get lost. It gets dark. You’re climbing over mountains. You’re stuck in the forest at night and experience a few moments of terror. You hear noises in the forest that you’re unfamiliar with.
But you make it to the road by morning. You get picked up, you go home, and within a day or two you’re back to your life as it always was, unchanged.
And that’s the concept I want to discuss. This incorrect idea that nothing is different than it was before.
But Things Are Different
Sure, life goes on as it did before, assuming you didn’t get attacked and maimed by a wild animal while lost in the mountains. In that case, life hasn’t really changed for you.
But in the case of lockdown – in the wake of COVID – life has changed. For a great many people. Obviously, for those restaurateurs and bar owners and nightclub owners and retailers and many, many others who are bankrupted, life is not the same.
Because in most small businesses – unlike corporations – the owners personally sign up to guarantee the debt.
So, if the business goes bankrupt, then the owner is personally taken down. He’s forced into a court directed process in which he’s stripped of his assets, his house, cars, bank accounts. Other belongings taken away from him and sold in order to satisfy the bank creditors. And when he’s done, not only he lost his business, but he’s lost his shirt.
So it’s obvious that those folks are not going to “recover” quickly. Those former business owners now have to get jobs, if they can find them in this economy, and spend the next 10 or 20 years working to accumulate the capital that’s been destroyed.
And eventually, if they still have enough youth, enough energy, enough motivation, and they haven’t gotten sick and tired of the whole thing, THEN they could reopen another business and employ people at that time.
But certainly, for now, those people are wiped out and taken out of the equation.
But what about the companies that have survived thus far?
What about the ones that made it through the forest? Are they really, truly unscathed?
Is it simply that they had a scary moment, but now they’re back to the same place they were before?
No. Not at all.
To make my point, let’s consider a software development concept. There are two terms involved: “stateless” and its opposite, “stateful”.
A program that does not save data generated in one session for use in the next session is considered “stateless”.
Whereas one that does retain data about each session for the next time it’s called up is called “stateful.”
Many people are assuming that things in the economy are stateless because it’s an easy assumption. It’s a facile, convenient, tempting way to think of things, this idea that no experiential data is retained by the people who have been severely, economically impacted at this point.
So let’s look at this now, the idea of an experience being stateless or stateful. We’re dealing with human beings here and these are the actors in the economy that are supposed to take the excess money that’s created by the Fed and just go use it to better prices.
But people are stateful. If there’s anything in the universe that ought to be stateful, human beings – and their brains – definitely are.
And those brains remember things. And I’ll get to the balance sheet in the moment. But forgetting everything else, we have memories.
The 2008 Crash
For example, the crash of 2008 placed a greater premium on people having cash in the bank, versus what their habits back in 2006, before everything busted. And that reason for prioritizing having that cash could be pretty diverse.
Sure, you always want to have savings on hand because when a crash hits, and you have liquid cash, you can pick up things for a great deal. You can get a bargain. That’s one type of reason.
And the other is if you’re leveraged up to the hilt with millions of dollars on your family farm or your small manufacturing business, then it’s good to have many months of monthly payments in the bank, because you’ll need it when the market goes haywire temporarily. As it did in fall 2008 through spring of 2009, similar to March and April of 2020. You want to have enough of a cash buffer to ride that out. Individuals, small businesses, and major ones.
This is a big part of banking regulation and so-called stress tests. Can a bank survive with whatever cash it may have on hand with the explicit assumption that the market is closed? The bank can’t sell any assets at any price in order to raise cash in order to go on. So can you make it with just on your cash on hand?
People Are Stateful
The point being that people are not stateless, they are stateful. Their brains retain state or state information, including what happened to them when they got burned in 2008.
Just like a cat that jumps on the hot stove pipe, it quickly learns never to jump on hot stove pipes. Mark Twain also observed that cats learn never to jump on cold stovepipes either. Just in case. Humans also learn these things and may also sometimes learn never to jump on cold stovepipes.
Whereas The Fed does whatever it does. People don’t necessarily react the same today as they would have reacted in 1979. And we see that in the fact that prices are not rising ferociously and relentlessly and aggressively as they were in the 1970s.
It is not true that every item in every grocery store every week is up noticeably from the previous week, week after week after week after month after month after year after year after year.
But that’s what it was in those days. And that’s what people are trying to claim it is today, but it just isn’t so.
The Affected Businesses
So getting back to all of these all of these affected businesses. I look at the hotel industry – they had to climb an arduous mountain. They got lost, in the woods, and heard some scary noises. Let’s say they’re back to exactly the same place they were before they were locked down.
And so everything’s fine and the economy is rosy. Put on your rose-colored glasses, folks. There’s nothing to see here. Move along. Is that really true?
The answer is no. These companies all had significant expenses. They were burning cash for every day that they were closed. So if the government locked you down and said you’re not allowed to operate your restaurant, your revenues went to zero. But of course, your expenses don’t go to zero.
They have non zero expenses. Rent and utilities and insurance. And even if you lay off your hourly workers, you don’t necessarily want to let go of your head chef, accountant, a few other key people. It’s taken years to build a quality team. That’s how you deliver a quality experience.
So you have all these expenses that are persisting and yet your revenues are zero. So how could any restaurant or any bar or nightclub or theater or any number of other industries, how could they survive through that dark period of getting lost at night in the mountains, in the forest?
What Would They Do?
The first thing they do is burn their cash. So perhaps in some cases, if they were good savers and if they were maybe a bit lucky, perhaps prior to the lockdown, let’s say a small restaurant chain had $3 million in cash and no debt on the balance sheet.
That’d be kind of extraordinary, actually. Because most businesses tend to be leveraged up for a lot of reasons.
But let’s assume they have $3 million dollars in cash and no debt. And then let’s say that for every month of lockdown, they burn one million. And that’s running on a skeleton crew, paring everything down to the bone. And let’s say they’re locked down for three months, March 12 to June 12.
They reopen in June, having burned through the $3 million, so now they’re at zero. Now let’s say they were fortunate enough to get some sort of loan or credit….say $2 million. And some of the purpose of the $2 million is obviously to pay for that fourth month of burn as they re-open the restaurant, deal with all the ongoing expenses, they buy a whole new fresh set of food. They hire a new bunch of people probably weeks in advance, retraining the servers and other staff that have turned over. Because not everybody stuck around waiting for their job to hit un-pause after months. So there are a multitude of expenses before revenue can begin again, as they ramp up.
So in our fictitious business example, this restaurant chain has gone from $3 million dollars in cash, with no debt, to a post-lockdown situation of half a million in cash and $4 million in debt.
You Can’t Un-Pause
That prior paragraph is precisely the condition that most people – including trained economists and the salesmen & promoters for Wall Street – are going to say on financial television. This is what we’ll see all over the place, including the free market economists (or even the otherwise free marketers). Everyone is going to say,
“It’s fine, this restaurant chain reopened. They didn’t close anything. They’re now recreating the same number of jobs they had before, the same number of locations are open. Everything is back to normal.”
We hit un-pause and it worked, right? Sort of.
But that business went from $3 million in cash with no debt, which is a pretty good position to be in, to half a million dollars in cash and $4 million in debt, which is definitely not a good position to be in.
And still, at the very least, there are several aspects to this that change the state. This business is stateful, it’s not stateless.
The Implications of Statefulness
There are several aspects to be discussed here. The one that I want to emphasize is that there has been an increase in what could be called brittleness or fragility or peril for the business.
Pre-lockdown, that business robust. Almost anything could happen to it & it would survive. Even being completely shut down for months. It had the resiliency to bounce back after something horrendous like that.
But because it now has only half a million in cash with $4 million in debt, it has lost all of its resiliency.
So yes, it has reopened and yes, revenues have restarted. But nowhere near their original levels, especially being limited to run at only half capacity. Plus, many restaurants are not even filling the half capacity because the customers haven’t returned. Decent revenues have not returned.
But even assuming the revenues were the same and the jobs were the same, this business has gone from being robust to now being brittle. Or perhaps perilously close to closing its doors permanently. It certainly doesn’t have the means to survive more adversity. It can’t absorb any further impacts.
The next time something challenging happens, once we add one more straw to the camel’s back, it breaks. The camel’s back breaks and the camel collapses.
And what gets reported? We’ll hear that it was only one straw.
The Camel’s Back: Stateful
But that was the straw that broke the camel’s back. And that’s why this concept is so useful. The camel’s back is stateful.
The first dry straw you put on it, no problem. Nobody expects a camel to buckle under the weight, but you keep piling one after the other, after the other, after the other. The hits keep coming at some point. No longer can bear the weight and it collapses.
And so this is a partial answer. There’s a lot of a lot of other things to be said. But this is a partial answer to why the economy is not in nearly as strong a position as it was on March 11th.
In addition to the companies that have failed, in addition to the tens of millions of people who’ve lost their jobs. In many cases, those jobs have gone away permanently, even for the businesses who survived, they’ve burnt cash, they’ve taken on more debt.
Another Example: NYC Hotels
I recently read an article about the closing of the Hilton Hotel in Times Square in midtown Manhattan. You know, clearly one of the busiest tourist spots in the country, if not the world. Times Square Hilton is closing its doors, defaulting on its debts. And that has an impact on somebody else’s state, which I’ll get to in a moment.
This hotel is defaulting and turning over whatever assets it has to its creditors.
I don’t know if it owns the building or is just renting the building, but whatever assets it has, go to its creditors. That hotel is finished.
The article also mentioned that a number of other hotels, perhaps 30 or 40 more in New York City are going to close permanently. But again, the “surviving” hotels…there’s no guarantee they’re going to continue to survive.
All the hotels that have survived so far have been taking on debt in order to stay alive. Many of them are in default on existing loans. They’ve reached at least some of their covenants which govern things like revenues, the ratio of revenue-to-debt, service costs and so forth. The “survivors” are getting into deeper trouble with their existing debt and they’ve taken on more debt in order to continue to survive as long as they have.
Let’s assume that there was a magic wand that the New York state governor and the New York City mayor were able to waive and restart Manhattan tourism, these hotels all now have significantly more debt than they did before. And as a consequence of that, are significantly less robust than they were before.
So they’re much, much closer to the edge of failure and insolvency and turning everything over to their creditors.
What About The Creditors?
The last step in this chain: the lenders. The hotels that have defaulted and handed the keys over to their lenders, as it were. That affects the lenders.
The lenders aren’t stateless, either.
Lenders, banks, insurance companies, pension funds, annuities. There’s always somebody on the other side of the trade.
For every debtor, there’s a creditor. And to the creditor, that debt is their money.
So now, these entities – banks, insurance companies, particular pension funds and annuities – now have giant losses on their balance sheets.
Let’s just look at the pensions for now. Back in March, most pensions – to use their euphemism – were “underfunded.”
Underfunded means they don’t have enough assets to meet their liabilities. In other words, they can’t pay all their pensioners.
And now, any pension funds were invested in the bonds of X number of the hotels that have just defaulted, those bonds are no longer good. That would drive a loss on the fund’s balance sheet. So, post-default, the pension fund now owns the hotel building in Times Square in Manhattan. A place where all the theatres are closed, and tourism has dried up for the foreseeable future.
That building comes with a mortgage, but no tenant. Which definitely isn’t the same as owning a bond that’s paying a coupon every month.
So that pension fund is suddenly now in a more perilous position than before. And by perilous, I don’t just simply mean they have a little more debt.
By perilous, I mean they’ve gone from a little bit underfunded to more underfunded, which means they’re getting closer to the day when they’ll stop paying their pensioners.
And The Pensioners?
Typically a pension fund keeps paying its obligation to its pensioners until it runs out of capital. And then abruptly things fail. Or in some cases, they can petition the court and reduce disbursements.
If approved, and they used to pay $3000 a month, now they send letters:
“Dear Pensioner, You know that $3000/mo pension upon which you rely? Well, it’s not $3000 anymore. Now it’s $1400. Best of luck.”
And what are the pensioners going to do?
Some will default on their car payments, their mortgages. They may be forced to move out of their apartments and move into something less expensive. They’re definitely going to spend less on cell phones bills and cable TV, or going out to restaurants, and all of the other things until the economy contracts further.
All of these forces are now baked into the cake and it’s still too early to really see the majority of the effects, the follow-on second and third order effects from all of this.
None of this is the sign of a robust economy. And it’s definitely not a “return to normal.”
That Ordeal in the Woods
So back to our analogy of wandering, getting lost off the path and going through this arduous ordeal in the woods.
Perhaps the overall ordeal, due to the combination of dehydration, climate, being out of shape, the terror and the heart rate running to 200 beats per minute, maybe you suffer just a little bit of brain and heart damage as a result.
But soon thereafter you’re safe, out of danger and everything is back to what it was. Sort of.
At that point, as you walk around, you can feel that your heart doesn’t have the strength it had before. And you feel some loss of mental acuity that you didn’t experience prior.
Meanwhile, everyone is saying, “Oh, you’re fine. You’re restored to what you were before.”
But internally? Not quite. You’re not the person you used to be before going through that.
And that’s because, as humans, we are stateful.