A Contagion Is Spreading Through the Economy Too
As government agencies open the floodgates for bailouts and payouts, the sober reality is the present economic crisis is only going to get worse, and is quickly “infecting” supply-chains and financial systems already severely weakened by epidemic related work-interruptions.
A prescient framework for understanding “supply-chain infection” was mapped out in 2012, in a paper by risk consultant David Korowicz, titled Trade-Off Financial System Supply-Chain Cross-Contagion: a study in global systemic collapse.
The paper examined how the interrelated nature of the global economy can quickly lead to massive failure because of the reliance of production of goods and services on a limited number of essential but vulnerable systems—in particular in the financial and energy sectors. The financial sector has already contributed to the compromised nature of our present economy because of a constantly increasing debt-to-product ratio. In other words, the amount of actual money being lent out in the global economy far exceeds the monetary value of actual goods and services, and this is particularly bad news in crisis situations.
If major agencies default on debt payments, the credit market could quickly freeze up. Withheld letters of credit could quickly threaten basic trade, as such guarantees are used to insure the safety of transactional agreements. This would lead to severe shortages very quickly. It is possible authorities may manage to stave off such a crisis in the United States, as they just barely managed to do in 2008. But even in this optimistic scenario, it would be unreasonable to believe the fundamental problems underlying the crisis would be resolved.
Furthermore, while the mess of our financial system in crisis will be difficult for authorities to untangle, Korowicz convincingly argues that production and supply-chain relations are even more complicated. The complex interrelation of goods and services required for creating the basic necessities of life, including food, transportation and other commodities, is nearly impossible to fully map-out. One example of this complexity is that on average 15,000 individual parts are necessary to produce a single car. The loss of even one critical component for producing such an item can lead to massive interruptions, as this would result in paused production on this and all other lines requiring that component, or which require components that incorporate that critical part.
This is already starting to occur, as large scale work interruptions around the globe are creating shortages of goods. In one case, Boeing’s 787 and 767 planes require parts from a manufacturer in northern Italy. General Electric, which supplies 90% of Boeing’s engines, also requires parts from Italy. Production of a whole series of goods has ground to a halt in Italy while the country is on lockdown due to the Coronavirus. Coupled with Boeing’s ongoing safety and reliability problems, this has pushed the company to the point of collapse.
Korowicz convincingly argues that the highly interrelated nature of our global economy makes it even more vulnerable to crises. In Boeing’s case, had the company maintained its traditional vertically-integrated manufacturing strategy (i.e. primarily in-house, U.S. based production of its various components) that it abandoned in the early 2000s, it would now face less immediate fallout from the present loss of production capability in Italy. Interestingly, the company’s move towards aggressive outsourcing was not merely part of a larger global trend, but was promoted by its partners in the U.S. military in the mid 1990s.
Following the hundreds of deaths resulting from the company’s 737 Max engineering disaster, the company has tried to reverse its decades long shift away from vertical integration. However, it has faced major obstacles in doing so.
While limited shortages have already been reported for food and other supplies, breakdowns in supply chains have likely only just begun. Stores and agencies generally have a certain reserve capacity on hand for sudden interruptions in supply or for increases in demand. Right now many stores and other businesses are using such reserves to restock depleted supplies, but this will not be tenable long-term. It is essential to grasp the non-linear impact of a crisis. Operations will increasingly fail because of a lack of cash-flow or because of a lack of labor. Already many people laid off from jobs are worried about how they will buy food even with a mostly stable situation at supermarkets at present. Disconcertingly, if food supply chains start to crumble, Korowicz states that cities only have about a three day food supply on hand at a given moment, and that without serious pre-planning, authorities will not be able to establish alternatives for weeks.
Likewise, the impact from serious disruptions caused by the last several days of U.S. work stoppages will have major implications in the weeks ahead. As Korowicz states, “Pandemic modeling has shown that removing at random only small numbers of a population can cause cascading failure of functions across an economy.” He states that these failures would soon threaten to disrupt the functioning of large infrastructure such as power plants. Such pieces of infrastructure require thousands of specific parts to operate, as well as specialized skills to carry out repairs, possessed by people who may well be unable to work now because of sickness or quarantine. The impact of disruptions are magnified when they occur in a major economic power such as the United States, which provides many irreplaceable skills and services to the global economy.
Such shockwaves are likely to increase in the near future, driven by an economic system made even more vulnerable by its reliance on debt. As Korowicz states “A contracting economy is incompatible with the credit backing the global economy.”
In one example of how the pandemic crisis is already cascading into a financial crisis, New York’s Metropolitan Transportation Agency (MTA) yesterday requested a federal bailout of $4 billion. The MTA requested this nicely rounded figure based on a projected decrease of “$3.7 billion from lost fares in the next few months, should ridership trends continue” and for “coronavirus-specific expenses, like disinfecting subway cars and stations” estimated to reach $300 million.
These numbers do not add up.
According to the MTA’s own numbers, the agency collects about $741 million in total fares, tolls, and advertising per month, meaning that the $3.7 billion figure is closer to a situation in which the number of NYC commuters was reduced to zero for a five-month period. And this is without even factoring in operating savings that would accrue to the MTA given reduced bus and train schedules due to future interruptions.
As the New York Post pointed out, the MTA is hiding its obvious debt problem. One of the MTA’s biggest expenses is simply paying back interest on a debt which is projected to rise to $52 billion in 2023, up from $35 billion last year. Simply paying interest on its debt approaches the total annual amount the agency pays for labor. As a result, a relatively minor immediate loss of revenue can be disastrous to the agency, making it unable to make payments to its creditors. Put another way, the agency even in normal times is barely solvent, creating a scenario in which a ripple, such as present difficulties, threatens to quickly submerge it and its financial backers, putting them beyond a point of no-return.
“The gist of it is that the risk of debt is just the same for the MTA as it is to a person,” said John Kaehny, executive director of Reinvent Albany, quoted in the Post’s article.“You can’t afford to have anything go wrong. You can’t lose your job. The MTA can’t have any setback of any kind or you won’t be able to pay off your debt.”
And the same applies to the economy on a wider scale. It is extremely vulnerable to disruption.
As Korowicz stated in a blog post earlier this month, “The government will no-doubt do everything they can to support businesses and the banking system with credit and stimulus, adding yet more debt to an already overindebted system. That will constrain future economic growth, increase the likelihood of future financial crises, and make the country less resilient to the next shock, from whatever the source. It is also straining political legitimacy, adding further uncertainty.”
In other words, the government will attempt to continue to plug up the vast numbers of holes in what amounts to a doomed ship, rather than creating a solid foundation to address the present medical and economic catastrophe.
Tellingly, as part of an apparent organizational hope within the New York Times that large-moves by the state and federal government can resolve the present crisis, the paper yesterday did not see fit to include any reporting about the MTA’s debt burden in its coverage of the agency’s bailout plea.
As crises continue to flare related to the pandemic, it is important to comprehend the even greater perils that may soon emerge. From Trump, to state government, to liberal critics, it seems that these risks presently are simply not being taken into consideration.