How the U.S. Economy Just Lost 33% of its Value

the u.s economy has contracted 32.9 percent in the second quarter is the worst performance since records have been captured worse for a single quarter than we ever saw a really really terrible number on gdp economic plunge in history last thursday on the 30th of july 2020 the u.s bureau of economic analysis released its second quarter gross domestic product report the report noted a 32.9 contraction in annual gdp growth in the months of april may and june a 32.9 drop in any financial statistic is massive an individual company whose stock price dropped by 33 in three months is concerning if the entire stock market dropped by this amount it would make headlines and it did but gdp is something else entirely it's not a company or even a pool of companies it reflects the entire u.s economy so this kind of figure is concerning on a proportionately larger level for reference the 2008 subprime mortgage crisis saw an 8 drop in annualized gdp figures at its peak the great depression kicked off in 1929 to date the largest economic downturn in modern history saw a reduction in u.s gdp of around 30 percent this period could reflect the largest pullback in u.s prosperity since gdp figures were measured the fallout of the coronavirus has of course been devastating but could it really be a driving force significant enough to push the us all the way back to where it was in 2008 for close on a century developed economies have almost assumed growth is a given there are ups and downs obviously but the march of technical innovation in industry means that the markets will grow at eight percent per year the economy will grow at four percent per year and children will live richer lives than their parents did over the generations that these assumptions have held true they have cemented into the minds of politicians investors and regular families people model their retirement strategies off these figures investment funds try to outpace these arbitrary figures and economic policy is based around these figures so is this all just a great big hiccup or is this the modern sacking of rome the catalyst that will see the end to the holy growth empire this episode of economics explained was made possible by our fans on patreon if you'd like to gain early access to these videos before they're uploaded to youtube as well as participate in our exclusive q a sessions please consider supporting our channel on patreon.com economics explained now of course this all sounds very alarmist and the media has never been known to downplay issues before especially when it involves big scary numbers that people scarcely understand even on this channel we have pointed out many times that gdp figures are not the be-all and end-all in an economy especially during times of massive turmoil in the interest of managing concern it is responsible to first approach these horrifying headlines with just a pinch of skepticism is it all that bad now we are not in the business of patting people's heads and telling them it's all going to be okay so yes it is that bad but it's important to understand for whom it is that bad gdp is measured using this formula gdp equals consumer spending plus government spending plus investment plus net exports now the overall 33 drop has come from a few specific places government spending for example has actually increased driven primarily by the massive stimulus packages that have been given to businesses and individuals impacted by the economic fallout trade is the first area of concern the actual net figure of net exports only saw a reduction of about 12 percent which doesn't seem so bad but this is a net figure both imports and exports fell by over 50 primarily due to travel restrictions it just so happens that exports fell 12 percent more than imports which is all that shows up in these net figures drops in these major industries are extremely concerning and if anything the severity of this figure is downplayed by gdp but of course the biggest factor here is consumer spending consumption fell by some 39 which is terrible although there are some interesting takeaways here for starters the consumption of goods only fell by 11 the major drop was in consumption of services which fell by 49 now services like an uber ride a night at the movies or even a semester of college are actually quite hard to purchase regardless of consumer sentiment right now it's reasonable to expect this service spending should shoot back up to more reasonable levels once it is safe to do so we can be even more optimistic about this assumption due to a strange bit of good news that has come buried amongst all of these doom and gloom figures household incomes have actually increased that's right despite all of the headlines about unemployment and forced pay cuts the average household is bringing home more cash now than it was at the start of 2020. since they are spending slightly less on goods and considerably less on services this additional funding is either going to savings or to pay off debt we explore this more in our video on can saving too much cause and economic downturn but the key takeaway is that saving money might slow down the economy right now but it means people have more to spend later on what this then means is that the economy could be poised to come out of hibernation filled with a renewed energy and a stockpile of cash right well yeah potentially a good litmus test for this theory is to consider your own plans for when this whole ordeal blows over sure for some of you it will be to go out and find a job and get life back on track but a majority of people watching this still have regular employment which means their plans probably involve travel or hitting the club with friends or maybe just remodeling the house that they've been trapped in for so long and all of this adds to gdp which means that this figure could shoot back to a more realistic level it won't go all the way back to where it was before 2020 but it will come back another huge point that must be clarified here is that this negative 33 gdp figure is annualized what this means is that no the economy did not actually shrink by 33 percent in three months it shrunk by about nine percent which extrapolating that figure out over the full 12 months would lead to a 33 reduction in gdp of course this is often overlooked because this looks much scarier than this finally the last little bit of good news is that the second quarter results were actually better than expected given all of the turmoil in the world this figure was actually expected to be about negative 36 so it's better than it could have been so hopefully this has provided some much needed comfort for people that were anxious about all of these concerning headlines take a nice deep breath relax a little and let me tell you why we're all this very well could be the end of growth as a given the first concern that must be addressed is that demand has shrunk despite an increase in household income this household income has been almost entirely driven by government stimulus which has not only made up for lost employment dollars but actually surpassed it these programs cannot last forever they will either end up causing crippling debt or runaway inflation if genuine economic output does not at least keep up with the level of money creation all this means sure everything else being equal consumption will bounce back and the economy will be saved by people once again buying their smashed avocado toast and lattes but of course the assumption of ceteris paribus is not always a responsible one to make the most obvious example of where everything is not going to be held equal is welfare most governments around the world have set end dates for specific relief packages that have been attempting to bolster their respective economies in the united states for example the 600 per week supplementary federal unemployment benefit ended earlier on the 31st of july with no specific replacement yet confirmed this will very quickly turn the additional funds that people could have used for post lockdown spending into emergency funds that people will need to hold on to out of fear of losing their income this is all coinciding with a wave of rental and mortgage relief periods coming to an end which will either see people out on the streets or having to contend with repayments that have been stockpiling over the last few months this is all ignoring the problem of investment investment is the final component of gdp and it fell by an unbelievable 49 percent this means a few things the first is that new businesses are not getting funded because well now is hardly the time to be picking promising new startups conversely it also means that a lot of that extra cash is just sitting idle normally if people save money it's okay because financial institutions can just use that money as the foundation for an investment strategy be it writing loans or investing into other assets the sheer drop in savings indicates that not even banks the ones that are collecting all of this extra cash are compelled to put it into use in any way in the economy in turn this means that there is a lot of cash sitting idle which sounds like a good problem to have but it is a problem while this cache has not been used for anything it may as well not exist but if it suddenly falls into widespread circulation very quickly it will cause inflation let's take a wine country bed and breakfast as an example right now this kind of operation would be shutting down or working on very limited reservations because well not many people are willing to frivolously spend a few hundred dollars on a weekend away at the moment and even if they could they might not be allowed to instead they would just sit on this extra cash that they are saving by not having to commute to work or by earning through generous government relief programs if and when everything goes back to normal they might finally decide to book that weekend away and find that unfortunately every other yuppie on the west coast had the same idea the bed and breakfast is booked out for weeks and the only available nights that they have are at a steep premium due to the surge in cashed up demand and the fall and supply of all their competitors going out of business take this oversimplified example and apply it to every service out there and inflation could start to become a real problem who knew the money printer could have some side effects say now in the same vein if and when everything goes back to normal institutions and wealthy individuals might be more tempted to go out and invest again and they will find that hey only a few investment-worthy businesses exist anymore so they will drive up the price of what might have been a reasonable investment to such a level that it no longer is for example tesla is an attractive investment because it is a company championing genuine innovation and adding value to an otherwise stagnant market it might have had great investment potential at 400 per share where investors could reasonably foresee 20 year-on-year growth this would have actually been a fantastic investment since the market normally only returns about seven to eight percent annually at fourteen hundred dollars per share though those same prospects are looking less enticing the same nominal returns would only give you a five point seven percent return on investment in which case you may as well have just bought a broad market index fund for less risk and better returns we don't want to pick on tesla here because nobody can predict the future regarding any individual stock but again in this bigger picture this effect will happen everywhere institutions and individuals will buy into mediocre investments because they have to they have too much cash at their disposal and they don't want to hold on to it due to fears of inflation this whole problem of too much cash sitting idly by ready to over inflate any attractive stock that passes by has a name it's called dry powder anecdotally it's called this primarily amongst people in finance because a little bit of a spark is good to get promising things going but too much can have some explosive results okay fantastic this problem is all going to get worse because average people won't have enough money and rich institutions will have too much money what else is new well the big difference this time is the center of the devastation the 2008 subprime mortgage crisis was led by male investments into mortgage-backed securities that were ultimately worthless and heavily impacted financial institutions this male investment was ultimately driven by easy access to cash and a lot of government support the fallout of this crisis hit financial institutions particularly hard and that trickled down to regular consumers the 2000s tech bubble was led by mao investments into tech companies with little real world promise this was driven by easy access to cash and a lot of government support the fallout from the subsequent market downturn primarily impacted those invested into financial markets rich people and institutions but it trickled down to regular consumers as well the economic fallout of 2020 will likely happen the same way but this time it started on main street the shutdown forced people out of their jobs which prompted massive stimulus which led to easy access to cash through a lot of government support this will lead to malinvestment which will lead to market crashes which will then trickle down to regular people most economic downturns ultimately amount to a hangover from a period of drunken excess the good times feel great the economy regrets it in the morning promises to never drink again and only goes on to inevitably repeat the whole thing 10 years later the only problem is that in the 90s and early 2000s the economy was getting drunk off cognac and champagne it might have been temporary but it did feel good while it was going this caused what is known as a balance sheet recession basically it all took place on the balance sheets right now the economy is drunk of lighter fluid and methyl it doesn't feel good now and it's going to feel a hell of a lot worse later on we are in a structural recession right now caused by tangible limitations like not being able to go outside if a regular balance sheet recession comes after this it will compound to have some very dire consequences at all levels of the economy will a regular recession follow this well who knows again nobody has a crystal ball but the thousands of businesses only propped up by generous government support relief packages coming to an end record unemployment mountains of idle cash and genuine losses in productive potential are not great signs but this all begs the question should we or even could we do anything differently what are the alternatives of course this whole problem would be a lot less severe if it wasn't for a global pandemic but the reality is that the economy was likely overdue for a recession anyway record levels of household and business debt were piled up over 10 years of record low interest rates and the bill had to come in eventually hindsight is obviously a luxury but this problem really needed to be addressed five years ago when the going is good low interest rates are a dangerous tap to keep on it means that people and institutions are tempted to borrow or rather overborrow to buy that new house or car or whatever stock portfolio it also means they are less likely to be incentivized to save because that two percent in a high interest savings account will barely keep up with inflation of course this was addressed in early 2016 when the feds started to raise rates again but it was probably too little too late this was also probably more of a surface level issue to the deeper underlying problem investing should be hard how many times has it been said that investing is easy just buy broad market index funds or good residential real estate wait enough time and hey presto you are historically guaranteed returns this flies directly contrary to what is supposed to be the role of an investor in an economy which is to use their knowledge and intuition to effectively allocate capital towards productive businesses or promising ventures investors in modern economies are rarely rewarded for being savvy or prudent their returns are almost exclusively determined by how much they are investing on top of this investments normally attract lower taxes or at least accommodate more loopholes than regular earned income a popular albeit controversial solution is just to make investing difficult be that through higher interest rates making leverage less lucrative or through higher taxes on unearned income people should not necessarily be able to set and forget a portfolio of vanguard etfs and live the rest of their life off passive income and capital gains these investors don't contribute towards productivity but they do feed off it now in the interest of full disclosure i am a passionate advocate for the financial independence movement but it doesn't necessarily mean that that movement is great for the economy informed people investing into hopeful businesses that have a plan to add value to society that's great wealthy investors blindly throwing money into dollar-cost average portfolios comprised of the same inert assets or established companies that everybody else is investing in potentially less great again this is a highly controversial idea but one that deserves discussion let us know how you would handle earn versus unearned income in a comment below and we will discuss the most upvoted answer on this week's q a session a wise man once said that this illness is just the uv light shining to reveal a fundamentally broken economy could this be the end of the holy growth-based empire well the sacking of rome in 410 was not the end of the roman empire but it was a major symbolic loss the spiritual foundation of the empire had gone over a thousand years without falling into enemy hands a 34 drop in gdp probably won't be the end of the age of innovation but it does show that things may not always be as easy as just throwing money into the abyss hi guys i hope you enjoyed this latest video if you did please consider liking and subscribing this video was as always made possible by our patrons over on patreon if you want to help the channel out while also sharing in some cool perks please consider supporting the channel at patreon.com economics explained like these awesome people did thanks guys bye

Channel: Economics Explained

Views: 1,307,856

Keywords: how the us economy, how the us economy just lost 33 of its value, the end of an empire, how the us economy just lost 33 of its value explained, the end of an empire explained, coronavirus stock market crash, coronavirus pandemic, the 2020 market crash, the covid economic disaster, covid market crash explained, the economics of covid19, the economics of the coronavirus, how the coronavirus affects the economy, economics explained

Id: Im0rzTWplwU

Length: 19min 9sec (1149 seconds)

Published: Sun Aug 02 2020