A Disastrous Chain Reaction
Here in Singapore, the government unleashed an unprecedented third budget in a short span of months, and at least for the month of April, is paying 75% of wages (capped at the median salary of 4,600). With the bigger landlords stepping into the gulf by giving some rental waivers, hopefully the cost burden is relieved, and hopefully businesses can retain at least some of the employees. But why is this so important?
First, consumer confidence takes a hit...
The thing about all modern economies, is that confidence keeps it growing. When individuals are not so confident about their own financial futures (will I still get a paycheck? will I still be able to make rent?), they tend to constrain spending more, not just on discretionary stuff (e.g. entertainment, eating out etc), but also start redefining what's "essentials". Will you still be shopping for a new 4K TV if you just witnessed your next-door neighbour company lay off 50% of its workforce?
Next, business dips...
So even for businesses that theoretically shouldn't be affected too badly (e.g. TVs, croissants etc), they are getting a huge hit because consumers are constraining spending. So business revenues take a hit, and unless the government steps in quickly in a massive way, the management starts crystal-ball-gazing as well: how long is this going to last, how long can we take the hit, what's the most sensible business-thing to do right now? Consequently, in many countries around the world, companies are either outright firing or furloughing their employees, en-masse. Which leads to the first point again: consumer confidence takes even more hits.
and then, savings take a hit...
As businesses start cutting salary, or furloughing employees, the average person will need to start dipping into the piggy banks (assuming they have the desired "6 months of emergency funds"), but inevitably some will have to start prioritising which bills to pay first, and which to pay later. Some may start pawning off assets (which they may have taken quite some time to build up). This affects their confidence even more.
Finally, banks loaning less.
Added to this is the fact that banks and other financial institutions may start raising their bar higher (as their confidence in borrowers are reduced) for both individual loans and businesses. For individuals, as their salary gets cut or he starts selling off assets (to get cash to pay for immediate needs), he's even more unlikely to get a loan (credit-worthiness goes down; less collaterals), resulting in even more reduced spending. For businesses, they will find it harder to borrow the same amounts as their revenue is demonstrably lower.
A downward spiral begins!
... and so a vicious downward cycle begins. And this flywheel of downward spiralling spending and confidence is dangerous, and may take years to get out of. Precisely why most governments have intervened in a HUGE way, unveiling unprecedented stimulus budgets.
Understanding this cycle and its underlying factors is crucial to any investor, because as confidence drops, asset prices (stocks, properties) will start dropping, and sometimes it may drop irrationally faster than reality dictates. This may be a good time to consider buying some of these assets.