A few months ago, I was provided with the opportunity to teach a debt markets class to undergraduate finance students. It was my first semester as a teacher. I was struck by how much I enjoyed discussions with students. Unfortunately, those discussions became less frequent when the university moved to online instruction due to the Covid-19 health crisis. However, working from home has offered many benefits, the biggest being more time spent with our teenage daughters, whose classes also moved online.
Teenagers and young adults are refreshing. They have so much energy. They have big dreams. They are intellectually curious. And they never cease asking why.
My students have asked me many questions recently, including… How do you determine if and when to buy bonds of so-called fallen angels? How does The Federal Reserve convert $454 billion in money from the U.S. Treasury into $4.5 trillion of firepower? What will the economic recovery look like, will it be a V shape like the bulls suggest or an L shape like the skeptics suggest?
To their great credit, the students all realized that if I knew the answer to the last question, I would be much better known, might even be famous. But I do have an opinion where the answer will be found. In the supply chain. Let me explain.
Today vs. 2008: Supply is the Difference
When a negative shock hits an economy, demand declines. In other words, business spending and consumer spending decline. The fiscal and monetary authorities can provide a demand boost, as we witnessed during the 2008 financial crisis and are observing again this year. (I am ignoring the long-term costs of such actions.) The Federal Reserve can also help meet the demand for credit when the supply dries up as happened during the banking crisis in 2008. But 2008 is not a good analogy for today. It did not involve a broad-based supply chain shock.
The Poster Child: Toilet Paper
Yes, some people hoarded toilet paper. Yes, people were spending more time working from home. However, toilet paper demand didn’t dramatically increase. It shifted. The supply chain of manufacturers and retailers could not transition volumes of toilet paper immediately from businesses to retail outlets. Toilet paper for businesses is generally thinner, sized differently, wrapped differently, and packaged differently than toilet paper for the home. BTW...my own experience bears this out. I couldn’t locate toilet paper at any retail stores, but courtesy of a workout buddy, I discovered a paper products wholesaler who sold me a box of 96 individually wrapped rolls. However, toilet paper is not where the enduring supply chain pain resides.
Logistical Issues Will Present Near-Term Challenges
Several meat processing plants are temporarily shut-down and will require a new operational design in order to re-open in a Covid-19 world. Food distribution networks geared for restaurants and businesses will need to find a new outlet for their food products as restaurants close permanently and work from home becomes more prevalent. Schools will initially struggle to educate students efficiently. The court system will face challenges processing cases and then whittling down the backlog of cases. Brick and mortar stores will be forced to implement enhanced customer safety practices.
Global Sourcing and Just-In-Time Inventory will be Rethought
U.S. manufacturers and service companies will struggle to obtain commodities, equipment and supplies for service, especially if the items are coming from other countries. Political, economic, and trade disputes between the U.S. and China and heightened national security concerns related to healthcare equipment will only exacerbate the supply chain problem. The U.S. economy’s just-in-time inventory processes have provided efficiency and cost advantages, but with the trade-off of less flexibility to handle a large supply shock.
The Labor Market Disruption is Likely the Most Enduring Impact
From a human capital standpoint, furloughed workers who decide not to return to work leave a knowledge and personnel gap, translating to the time-consuming processes of hiring and training. Others who lose their jobs may retire or pursue new careers and will not be available when demand rebounds, e.g., Class 8 commercial truck driving industry where there already was a looming driver shortage. New safety procedures for workers will impose some deadweight costs.
Ultimately the Economy will Adapt, and SaaS will Lead the Way
Technology solutions will arise. SaaS (Software as a Service) companies are the shining light, as their supply chain of software delivery over the internet is largely pandemic proof. But SaaS does not an economy make. Few can proclaim “We’ve seen two years’ worth of digital transformation in two months” as Microsoft recently did. Telehealth solutions are likely to experience more rapid adoption. They will provide wider access to healthcare and potentially lower system wide costs.
Unlike Demand, Supply Chains are only as Strong as Their Weakest Link
As the saying goes, chains are as strong as their weakest link. The weakest link has broken in many global and domestic supply chains. Time is needed for repair and redesign. Redesign takes time, especially with a large, complex system like the U.S. economy. Higher costs will impede economic activity in the short term and maybe the intermediate term. Conflicting price signals due to policy uncertainty and increased government intervention in the economy will also impede the supply chain readjustment. For these reasons, I would be surprised if the U.S. economy undergoes a V shaped recovery. Sadly, the skeptics may be right.
PS. Some Examples of Supply-chain issues: