Going Sideways

You spoke at The Council’s Legislative & Working Groups Summit back in February, and you were giving us a fairly optimistic outlook economically. I wanted to tick through your reasons for hope and see how you think each one is faring today and whether or not you still have that optimism. The first one on your list was job growth.

In February we didn’t know too much about COVID-19. The crisis in America hadn’t yet begun. You might remember that, as of February, the stock market was still rallying and investors weren’t terribly concerned about COVID-19. But on March 9, the Dow Jones Industrial Average fell more than 2,000 points, and that was when I think people started to realize that this was a major economic event and obviously a major public health event as well. So the outlook from February to March changed massively.

In February, the unemployment rate was 3.5%. It was a 50-year low, and we actually had more job openings coming into the pandemic than we had unemployed people. That was the basis for that ongoing optimism. Obviously, as the economy began to shut down in early to mid-March, everything changed. It was a supply shock.

In March, we lost 1.4 million jobs, and then in April, we lost 20.8 million jobs. Which means that during those two months, we lost over 22 million jobs in the aggregate, which is equivalent to the number of jobs we had added through the previous 113 months. Basically, those two months erased all of the gains from the previous economic expansion cycle, which was the lengthiest economic expansion cycle in our nation’s history. But as I was indicating to folks in March and April, when the economy began to reopen, one would see something akin to a V shaped recovery, and that’s exactly what happened in May.

Contrary to expectations, the nation added 2.7 million jobs in May and 4.8 million in June. Unfortunately, the key to a V-shaped recovery is flattening the infection curve. And America did not manage to do that on a sustainable basis. And so the economy began to move sideways.

With respect to the specific aspect of your question, on March 24, the Federal Reserve Bank of St. Louis delivered a report analyzing which workers were most at risk of being laid off during the crisis, and they identified food service workers—meaning those who work at restaurants—they identified retail workers, and they identified many others, including workers in hotels. And as it turns out, three of the segments that have been most negatively impacted are indeed, the hotel sector, the restaurant sector and the retail sector. The leisure and hospitality category has been smashed by this crisis.

So there was reason for optimism, but there’s always a chance of that so-called black swan threat, and COVID-19 is that low-probability risk that once in a while occurs and completely alters the trajectory of the economy.

Do you think those sectors will come back to be what they were once we get a vaccine, or do you think they’ll be forever changed?

This is a big debate in the economics community, of course. I think they will not be forever changed, at least not in a material fashion. In other words, I think people will still want to go to restaurants. I think people will still want to attend conventions and meet people face to face. A lot of people are just waiting for the opportunity to re-engage life fully. They want to go to baseball games, they want to go to restaurants, they want to see movies in theaters. There will be some change here. The fact of the matter is the crisis has revealed that more people can work remotely, more people now have accounts with Grubhub or Doordash, more people have Netflix or Disney+. There are some things that will change, but fundamentally COVID-19 won’t change us more than SARS, Ebola, the bubonic plague, and so forth.

What about consumer spending? It seems like people are still spending money.

Oh, people are still spending money. Did you see the new retail sales numbers? They were fantastic. They were almost back to pre-crisis levels. One of the things that happened was we had stimulus during the early phases of the pandemic. Congress got right to work. The first stimulus package was initiated in early March. The CARES Act, which came less than a month later, provided $2.2 trillion in stimulus funding. On top of that there was a weekly supplemental unemployment insurance payment of $600 offered by the federal government on top of routine state benefits. So as it turns out, in April, many households were actually stockpiling cash.

The U.S. savings rate went from 8% pre-crisis to 33% by April. And as the economy began to open up in late April and into May, that patch hit the economy. And lo and behold, we saw a real jump in retail sales and also the job creation in May and June. It shows that the appetite to spend is there in the consumer sector.

The housing market has been very strong recently. Home sales have been quite brisk, sales of used cars have been very strong, sales of new luxury vehicles have been very strong. The consumer is out there, and that’s why I don’t think, even with the recent surge in infections, that another recession is necessarily likely. The consumer is spending money, so that’s been very promising.

And by the way, another reason to be somewhat optimistic is the performance of the stock market. The Dow Jones has been doing splendidly; the Nasdaq has been hitting record highs recently. And generally, investors don’t seem as excessively concerned. They might be insufficiently concerned as it turns out; investors may be collectively under-appreciating the risks that the economy faces. Nonetheless, money talks, and the money is saying right now, things are not disastrous.

Do you think there’s any risk of insurer insolvency due to market investments?

Investments have returned quite handsomely during the latter stages of this pandemic, to date. Bonds have done well, equities have done well, gold has done well. One issue is exposure to commercial real estate, which is one of the weakest segments of the economy and will be for years. That’s a semi-permanent change, because this crisis will leave in its wake many empty storefronts, vacant office suites, shuttered restaurants—we are in the midst of a commercial real estate crisis.

From an investment perspective, that’s deeply problematic. Second, there could be a fair number of unpaid premiums. We’re looking at mass bankruptcies across the United States in certain segments of the economy. So the money is drying up in certain segments.

One of the things about which insurance brokers will be concerned is the lack of premium payments for all kinds of insurance. People are probably deciding that they want to sell their life insurance policy to raise cash, those kinds of things. There are some risks out there, but I don’t think we’ve heard anything particularly dire from any major insurance company regarding insolvency.

Commercial real estate is on this list of nine things you had mentioned—specifically, the amount of new construction. The top two non-residential growth sectors were lodging and office. As you just talked about, these office buildings may be permanently shuttered. It sounds like that is an area for concern.

That’s definitely an area for concern. In fact, spring started the vulnerability, because we built a lot of office space. Just before the pandemic, we built many hotels, and those properties are set to underperform for quite some time. I think the office market is more problematic than the hotel market, because I think people will want to travel again eventually and the hotel sector will come back. But we’ve built so much office space and really nice Class A office space. I don’t think that can be a strong sector going forward, because many companies will be looking to cut costs. Many companies want to take advantage of remote work, and some are going to move into Class B space going forward. A lot of firms moved into the Class A because it was a source of prestige for businesses and they could afford to spend to generate that prestige.

There was a problem with recruiting people, and the firms are trying to recruit the best and the brightest. When people come in for interviews, it’s important for them to be impressed with the space, because that’s where they’re going to work. So I need to upgrade my space as a recruitment and retention tool. But now those dynamics have shifted because the unemployment rate in July was 10.2%. The class of 2020 is looking at the worst economic circumstances since probably at least 2009, and it could be even worse than that. So that commercial real estate sector is really in tough shape, in part because so much property was delivered to the market just before the crisis.

OK, the last thing on your list was interest rates, which are still very low. Thoughts on that?

Interest rates are even lower now than they were in February. This is another reason the stock market has done well. It’s because people just cannot derive yield from fixed-income assets. So they’re forced into equities. So investors have basically built in low interest rates for the foreseeable future.

Here’s the issue: I think it’s important for insurance companies to recognize that this is another source of risk, at least portfolio risk. It could be the case that in one or two years, interest rates will be meaningfully higher than they are now. Generally speaking, as an economy improves, interest rates rise. That’s not always the case and actually was not the case in the 2010s. Interest rates fell for much of the decade even as the economy was improving. But, again, this time is likely to be different.

The economy will be better. We have increased the supply of money, and we’ve done it around the world, not just in the United States, to deal with this pandemic. On top of that, global supply chains are buckling, so trade tensions are high with a lot of re-shoring back to the United States. The American worker is still more expensive than the Chinese worker or the Mexican worker or the Vietnamese worker, and so on. So the buckling of the global supply chain will tend to drive costs higher.

When you put all this into place, general economic recovery, all this new money supply creation, and the fact that global trade is fragmenting, all of that suggests that inflation could become significantly more problematic over the next one to two years, and that will tend to drive up interest rates. There is, for the first time in decades, some inflation risk out there. And I think insurers and others need to be aware of that.

Moving away from those optimistic points to the few concerns you mentioned, one was U.S. manufacturing being in decline, which was kind of spotlighted during this pandemic. What do you think the future holds for U.S. manufacturing?

When I was speaking [in February], I pointed out that, though the headline numbers in the economy were quite strong—strong job growth, low unemployment, strong retail sales, things that we’ve talked about thus far—there were some emerging vulnerabilities. For instance, not all segments of the economy had been participating fully in the expansion. Agriculture was one of those sectors, and so was manufacturing.

Manufacturing has been hobbled by trade wars, issues at Boeing, the fact that the U.S. auto sector peaked in terms of activity in roughly 2016, and also the strong U.S. dollar, which among other things frustrates export growth. So now, though manufacturing has been stumbling and though Boeing still has its issues, late last year things happened. We got the first-phase trade deal with China, we got ratification of the United States-Mexico-Canada trade agreement, and we got Boris Johnson’s resounding victory in United Kingdom, which gave us more certitude regarding Brexit. We don’t talk much about Brexit anymore, do we?

So the notion was that, yes, manufacturing had been weak and hobbled but things might get better in 2020. And they did. By January, manufacturing was out of recession, and based on a leading index, things were looking better. But then as those global supply chain issues began to emerge because of COVID-19, beginning with China but then spreading throughout the rest of the world, with the global economy shrinking probably 5% or 6% this year, obviously manufacturing has fallen back into recession.

Remarkably, over last two months, we’ve seen a resurgence in U.S. manufacturing activity. You know, there was not a lot of inventory investment in March and April. So inventories became depleted of all kinds of things. So all of a sudden, U.S. manufacturing is pushing forward. You know Ford, General Motors, Chrysler and others shuttered their plants in the worst of the pandemic. You could argue we’re in the worst of the pandemic now from a public health perspective, but from an economic perspective, we’re not in the worst of the pandemic. That was April.

So as these trends have re-emerged, manufacturing has come back to life, and as long as the U.S. consumer is spending, manufacturing faces some meaningful demand. Unfortunately, the global economy is not ready to rebound, as nations are not yet able to fully connect with one another economically. Manufacturing seems to have been a relative bulwark of stability recently in the U.S. economy, so the outlook is not particularly bad.

Do you think there will be a push for less of a global manufacturing trend and bringing back more of that to the United States, even though manufacturing is more expensive here?

Yes, that’s actually been happening for the last decade. There were a growing number of firms over the last 10 years that have been concerned about supply chain disruption, intellectual property issues, and transportation costs, and they were already beginning to think about moving more of their supply chain back to North America. The ratification of the U.S.-Mexico-Canada trade agreement, with the supply chain disruption becoming even greater recently, is an indication of that. So we’ve seen a lot of jobs already re-shored to the United States and to North America, and I think that will continue.

From the pandemic perspective—the public health risk versus the economic risk—how do you define the line of not putting people at more risk, health-wise, but making sure the economy is not going to go sideways again?

That’s the challenge, right? I mean, that’s why the economy is going to be sideways for a while. There are some things that haven’t happened that needed to happen for the V-shaped expansion to persist beyond June. Number one, schools are not reopening in large measure for in-person instruction. For many people, schools are their daycare. Schools offer more than daycare services—don’t get me wrong—but with schools unable to open, with people reluctant to use mass transit, and with there continuing to be a reversal of reopenings as COVID-19 cases surge and the death totals continue to rise, the economy simply cannot recover as rapidly as we would like.

At the same time, there are a lot of people hurting out there. One of the reasons that Congress passed that $600 federal government supplement for unemployment insurance, to be paid each week, was that that would provide people with sufficient funds so that they would not be tempted to try to go back to work. We didn’t want them to go to work, particularly in the lodging, restaurant and retail segments, because they would risk their own health and therefore the health of others. It is still the case that by working in the mall, by working in restaurants, by driving Uber or Lyft, they’re risking their health. So people are going to be walking on eggshells. They can’t fully engage with the economy.

Many people still do not feel comfortable going to a restaurant, even dining outdoors. This is on the supply side, this is on the consumer side, and it’s a negative. We needed to have flattened this curve. What will we need in America to recover? I don’t think we can count on good behavior, not when we hear talk about COVID-19 parties. So what do we need here? We need a vaccine. Otherwise, America simply cannot really begin to recover in earnest.

Is there anything else you think brokers can be doing to prepare for the months ahead?

I’m sure many of the insurance agents and brokers are monitoring some of these high-frequency data. They should be doing that. They should be monitoring daily restaurant reservations, they should be monitoring the number of people going through checkpoints each day—those kinds of data points that tell us whether or not the economy is stalling again. It’s something to keep in mind as you’re thinking about what 2021 is likely to look like. So many people are probably already planning for next year to be a better year than this year. That’s my presumption as well.

From the perspective of social determinants of health, for those folks who really do rely on, for example, schools for feeding their kids, do you have any thoughts or suggestions on how we make sure people are still getting what they need even as we continue to remain shut down?

The only thing that people can do who have highly constrained resources is to be highly aware of the resources available to them outside of their households. If the issue, for instance, is lack of broadband access for their children, what resources are in their environment for them to be able to access broadband so that their kids can participate in school in a fruitful manner? If they’re worried about their health but they need to go to work, then what are the CDC guidelines? What are the guidelines being proffered by other experts in terms of keeping one safe? How does one wear a mask properly? How often should one wash one’s hands? What kinds of risks are presented by ventilation systems? What are the symptoms of COVID-19? It’s awareness.

There’s no winning here. The fact of the matter is, one has to choose. It’s a choice between risking one’s health and risking one’s economic well-being. The fact of the matter is, for most people, they’re going to pursue economic viability, because if the virus doesn’t get them, hunger will. Homelessness will.

And so as the unemployment insurance benefits have run out now, people are going to be re-engaged in the economy because they have to, not necessarily because they want to. The best thing to do is to be informed. It’s really unfair, isn’t it? It’s really unfair, because so many of us white-collar professionals can work remotely. We don’t have to risk our health to generate our income. And we don’t worry about broadband for our kids to attend school remotely and productively. This whole circumstance is so fundamentally unfair.

One of the things that’s most frustrating is the lack of universal broadband access. For more than two decades we’ve been talking about the digital divide. And we still have a digital divide in rural areas and urban areas and so forth. Whatever the socioeconomic disparities were coming into this crisis, they’re much wider now. No wonder there’s so much anger in America.

To that point, could you discuss the racial justice movement going on now, what you see in Baltimore, or in general?

This is a tough one for me, I have to say. I could say, obviously, there’s economics afoot, but it’s bigger than economics. It’s hard to wrap one’s mind around this fully. As an economist and just as a human being, what would I want to see? I would want to see the sum total of violence reduced in the society, and when that violence is against human beings, when that violence is against animals or against the environment, you’d want to see the sum total violence decrease.

Baltimore recently has been quite a violent place. Some of that is due to police action, there’s no question about that. Baltimore has not had as professional a police department as it has required and as professional as its citizens and taxpayers deserve. There’s no way to deny that. The city’s police department has been rife with corruption, with police officers who don’t know how to do their jobs properly and don’t have enough respect for people in the community.

At the same time, this is a city with more than 300 homicides per year. Most of those homicides are not perpetrated by the police. There’s a need for significant law enforcement in Baltimore. What we need is leadership, and what we need is an exquisitely trained police force that understands how to de-escalate situations when de-escalation is possible. One that is able to engage in productive community policing while, at the same time, making arrests of the people who create too much madness and mayhem on the streets of Baltimore. This was a city that had fewer than 200 homicides in 2011. And at that time, the needle was moving in the right direction.

The last decade has been a period of enormous setback, and part of that is because the lack of professionalism in the Baltimore Police Department. There are some incredibly great law enforcement officers in Baltimore City, don’t get me wrong. I’m not trying to try to paint with a broad brush. But the fact of the matter is, as a department, they have underperformed. At the same time, there are a lot of troublemakers, and they need to be dealt with too. The goal is to reduce the sum total violence in the city. And we haven’t made much progress.

Is there a role for the insurance industry to help with that?

That’s an interesting question. There is an economic component to this. And the insurance industry is a massive industry. The insurance industry is also an industry that has an exceptional entrepreneurial component. So to the extent that more of these opportunities can be made known to kids from challenged socioeconomic backgrounds, to the extent the insurance industry is able to help infuse more financial literacy into curricula, all of that, I think, makes for a very positive difference.

There is an opportunity here for the insurance industry to reach more aggressively into communities that are underrepresented economically, in terms of business ownership, and to reach into those communities to create opportunities for the people in those communities. I think a lot of value can be created there.

I would not have thought that in 2020 we would be dealing with these kinds of issues or this kind of inequity. But here we are. For some reason, we have stepped back in time.

There’s no question that the insurance industry is large enough, influential enough and entrepreneurial enough to make a big difference in communities—to open up offices in these communities and to have people represented from often underserved communities to be in charge of those offices, to be those entrepreneurs and to be role models, and to generate significant income and wealth for the community would be a step in the right direction.