The world is at war.

The world is at war.

Like in all wars, lives are at stake. Unlike military conflicts, however, humanity fights together against a pandemic to save lives where possible.

The cost of war comes in many forms – not only the lives lost to the virus itself but the economic effects of those deaths and the effort to suppress its spread. This week we continue to see the economic impact with the second weekly jobless report in the United States after the shut-down in broad swaths of the country. In just two weeks, there are nearly an additional 10 million people who are filing for unemployment. Small businesses around the country spent most of the week scrambling to understand and apply for the support offered under the recently passed stimulus package. Banks started accepting applications on Friday with several banks still delaying participation in the process until they had the systems in place. The US government offered significant incentive for bank participation, not only federal-backing of every loan and excluding them from the calculation of capital requirements but paying a hefty commission to the bank as a fee for processing (a capital injection into the banks themselves). As needed as this package is to help fill the income gaps for a brief period, we are sure to see later that there are unintended consequences from a complicated program put together so quickly.

This week we also took time to review research on the economic effects of wars and pandemics – specifically works published by the Institute of Economics and Peace regarding war and a working paper just released by the San Francisco Federal Reserve on pandemics. As we all observe the immediate effects, we look to history to understand potential longer term impact. As expected, there are data challenges. While we consider ourselves at “war,” pandemics are different. Military conflict re-directs resources, but is really about mobilization of production. The economic issue of suppressing the virus is about immobilization. During a physical war, there is destruction of physical capital. During a pandemic, we are trying to understand the destruction of psychological capital – how confidence in consumption, savings, and investment will shift. The challenge of studying pandemics is the sparse data spanning centuries (the study begins in the 14th century).

Despite the challenges, there are some insights that we can glean to help inform our view of the future. While many observe that GDP levels rise during war, it is driven purely by government spending. Consistent with war time, we are seeing investment and consumption of private individuals and businesses fall. The deficit spending by the federal government was financed by debt and monetization then as it is now. On the other side of conflict, there was typically a rise in tax revenue (in percent of GDP) as there is a need to recoup revenue and work off the counter-cyclical spending. We are likely to see bigger government (in budget and influence) this time too.

Resolution of war often brings inflation. This is where pandemics are different. A historical review of pandemics indicated to the San Francisco Fed that business investment tends to fall after a health shock (i.e. decrease the demand for money) while at the same time individuals save more to help protect against a future shock (i.e. increase the supply of money). This implies a lower level of the “real natural rate of interest” (or the interest rate which brings equilibrium to the supply/demand for money after adjusting for inflation) but to us it also implies a lower level of inflation too. While it has been argued since the Financial Crisis that a significantly increased money supply would cause inflation at some point (but has yet to materialize), the argument is weakened when every country prints. Low nominal interest rates are likely here to stay for a while more, which will factor into asset prices again in the medium term as financial markets settle and have a better view on underlying fundamentals.

We also continue to watch the rising combination of nationalism and populism around the world. It is a powerful combination to reshape economic relationships forged during a time of unbridled globalism. Attention paid to Chinese transparency on data is further damaging their brand. The widening split between German fiscal strength and Italian austerity fatigue being accelerated by their different COVID-19 experiences once again bring the European Union’s integration into question. It all makes for slower trend of growth as new economic arrangements are made.

Fighting a war takes tactics and leadership. We are encouraged by the health advancements we see each day – the declining new case count in Italy, the release of quick testing with results in five minutes, the experimental use of existing treatments to reduce the severity of cases, the start of vaccine trials, and, importantly, the increasing use of anti-body testing to understand how many asymptomatic carriers are out there (and thus silently building “herd immunity”). It is a global effort at a massive scale to resolve a challenge everyone is facing. The strategy of suppression has its place for now. As the curve flattens, the tactics will shift towards understanding who, when, and how we re-start some normalcy to life. Remember until then…

This is a war we will win.


Will Skeean, CFA

Partner – Investment Management Team Chair