It’s Only Paper, Market Report 27 Apr

The response to the virus has added a new mechanism of capital consumption to the many we have documented over the years. Businesses are shut down, yet they continue to incur expenses. There is a popular misconception out there that this is merely a paper loss. One can almost picture a neutron bomb that somehow wipes out only paper, leaving all the physical assets and plant unscathed. It’s a pleasant fantasy. And it’s quite a popular one—not only amongst all the usual suspects, but even an Austrian school economist of our acquaintance asserted it.

As an aside, this illustrates that, too often, economists are unfamiliar with business. The economist looks at a closed restaurant and thinks there’s no reason why this restaurant can’t be mothballed for a day, a week, a month, or a year. The owner of the restaurant would object that he’s still paying certain expenses, even if he’s laid off all of his staff. And the economist retorts, “That’s just paper!”

The economist—and politicians—are tempted to think that the government and its central bank can restore the lost paper capital by extending a loan, or even doling out free money. This is simply not true.

One thing should be bloody clear: whatever expenses this restaurant pays, is a transfer of real resources from the restaurant to the recipients. Those recipients are buying food, fuel, clothing, shelter, etc. It’s not just paper.

Looking deeper into the restaurant, we see that, even when it’s closed, it’s still burning some electricity (even if not as much as when it’s operating). There’s insurance premiums. And building maintenance. Over time, exposure to sun, wind, rain, and snow damages the roof, windows, and even the walls. In extremes of summer and winter, even unoccupied buildings must run the air conditioning and heating. So, it’s burning still more electricity and gas. Plus, these mechanical systems wear out and must be maintained and replaced. The hardscape, such as parking lot and sidewalks, also must be maintained. And, even the landscape.

The above assumes that all the employees are furloughed or laid off (otherwise, there would be much bigger expenses for payroll). But this leads to another form of capital destruction. Hiring a team takes time and money. Training a team takes time and money. To see this, think of what you would need to do to open a restaurant. For how much time would you be paying rent while you searched for a chef and general manager? Once you put them on your payroll, how much time would they need to find the rest of the staff and teach them to work as a team? Keep in mind that on opening day the food has to be good, delivered quickly, and served with grace. Diners do not give bad restaurants a second chance.

There is real capital invested in a functional team. If the people leave, then this investment is wiped out.

Moving from a restaurant to a shopping mall, there are a number of additional expenses that the restaurant does not have. The obvious one is on-site security personnel. A shopping mall would be a tempting target if left totally abandoned. Air conditioning is much more significant in a large commercial property than in a stand-alone, small restaurant. As is maintenance of the many mechanical systems.

Airlines have come to the public’s attention because they asked for tens of billions of dollars of bailout. We have read that the bailout came with an insane string attached: that the airlines must continue to fly the same routes as before, despite massive drop in passengers. This, of course, means slowly wearing out the planes and paying for expensive maintenance along the way. Even leaving this aside, any operator of large, complex machines faces the same dilemma. If the machines are continued in operation, they burn energy and consumables and slowly wear out. If they are shut down, the subsequent restart can be both expensive and very hard on the machines.

An airline has a much more severe case of the dilemma of laying off staff. Airlines employ many skilled specialists, such as pilots and mechanics. The challenge of hiring new ones when business resumes is much greater than for a restaurant. An airline is a much larger enterprise than a restaurant and, consequently, a much more complicated operation. The know-how embedded in its human resources is exponentially greater than that in the cooks and servers in a restaurant.

It’s also tempting and pleasant to think that one can stop and start an economy. We suppose that people are thinking that the economy is like a music player—you just hit the pause button and, whenever ready, hit the play button again to resume. A better analogy is to a living organism. You cannot stop the heartbeat of an animal and restart it a day, a week, a month, or a year later.

The reason why this analogy is more applicable is because an economy consists of innumerable people, things, and processes that are in constant motion: flow. If you stop those people, things, and processes—if you shut off the flow—restarting it requires a whole new investment and great effort.

The common thread that runs through the above discussion is that, even when put on mothballs, much less when it is restarted, a business is consuming real resources.

There is one last principle to keep in mind. In order to consume, one must first produce. This means, if one is consuming in the present but not producing in the present, then what one is consuming is what was produced in the past. That means capital. Seed corn. Every closed business is consuming capital. If the business runs out of its own, then it must either shut down entirely or be given capital that is looted from another business that has not depleted its own capital, yet.

In this light, we now say that the panic response to the virus adds a whole new and very large driver of capital consumption to all the other drivers of our monetary system. And then, to compensate for that wave of capital consumption, they offer subsidies to enable yet more consumption of capital.

We are reminded of an old Febreze commercial. The announcer describes conventional air fresheners as just covering odors, in a witty way: “Now your house smells like fish and flowers!” Now, you have subsidized capital-consuming businesses and consumption of the capital of businesses that are miraculously still operating in this environment.

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