This essay is about the economic problem created by the coronavirus pandemic.

Here is the situation. There is a new disease that spreads like the flu or common cold, but with significantly worse symptoms. It floods hospitals with patients and kills about 3% of those infected. It spreads around the world. Stopping or slowing the spread of the disease is now a major goal of every government, and avoiding the disease is now an important goal for most individuals. Governments in most places introduce measures to slow the spread of the disease. They shut down travel, outdoor gatherings, restaurants, and other public activities. Individuals also change their behavior to avoid infection, mostly by reducing their exposure to others.

The pandemic has effects on both production and consumption, both supply and demand. Certain goods and services are no longer produced, either because of new regulations or because of decreased demand. A huge number of businesses shut down and a huge number of people are out of work. Even if the disease disappeared tomorrow, the economic effects would linger for a long time. Entire economic sectors, such as tourism, will probably be reduced for a long time.

The pandemic will cause a major recession and financial crisis, but this crisis is very different from a typical economic crisis. It is nothing like the financial crisis of 2008 or the Great Depression. Those crises were internal systemic failures. This is an external shock, more like a war or a natural disaster. However, unlike a war or natural disaster, we don't want to increase production to deal with the problem. We want to decrease economic activity. We "fight" this disease by staying home and doing less. We have to reduce consumption and production.

Normally, when there is a recession or financial crisis, the government attempts to solve it by "stimulating" the economy with government spending or low interest rates. The idea is to grow the economy, or prevent it from shrinking, and thus create employment and allow individuals and corporations to repay debts. I think this approach has harmful long-term consequences, but it can work in the short term to reduce the depth of an economic crisis.

In this situation, however, we don't want the economy to grow. We want it to shrink. The government can't deal with this situation by stimulating economic growth. We want the economy to shrink and people to be unemployed, in order to stop the disease from spreading. However, that will cause businesses and individuals to go bankrupt. It will also make it difficult for many people to pay their rents, feed their families, etc. What can governments do?

Unfortunately, there is no simple answer.

The problem is not just with the production of goods and services. We can survive without a lot of the things our economy produces. The real problem is distribution. We rely on the market to distribute goods and services, and to create the incentives that regulate production and consumption. The market is an allocation mechanism, and it works very well -- far better than top-down allocation could work. However, it means that distribution is based on flows of money that are tied to income from market transactions. If we are going to shut down a significant part of the economy, we have to find a way to distribute essential goods and services to people who are no longer getting income from market transactions.

It would be easier to ride out this crisis if people and businesses had more savings. Unfortunately, our financial system is based on debt rather than savings. Few people have adequate savings to ride out a month or two without income. They will not be able to pay their rent, pay bills, buy groceries, make debt payments, etc. Few businesses have enough savings to last a month without revenue. They will be unable to pay their wages, rents, and interest payments. Our financial system is fragile because it is based on debt, and because we have socialized risk and discouraged saving with decades of financial bailouts and prolonged low interest rates. Businesses and individuals do not have enough savings to weather a crisis by themselves. They expect the state to bail them out. But what can the state do?

The state has no independent source of wealth. All it can do is transfer wealth from some people to others. When a natural disaster hits a small region, a society can bail out the affected region with wealth from the rest of the country. If a disaster hits an entire society, or the entire world, there is no large unaffected population to provide wealth to bail out the affected. The state can socialize the costs of the disaster, but it cannot make them disappear. Individuals will bear those costs no matter what.

We have existing welfare schemes that distribute goods and services to people by giving them money, but we can't easily expand those schemes. They aren't designed to work in a crisis like this. Instead, governments will use ad hoc bailout schemes, funded by money printing.

Large-scale welfare/bailout schemes cause large-scale problems. If the payments are big enough to fully replace lost incomes, the government will have to print a lot of money, and that creates the risk of inflation. It will also create perverse incentives and frustration among those still working. If the payments are smaller, then many people will not be able to cover their expenses, such as mortgage payments, rent, etc. Businesses and individuals will go bankrupt anyway, and there will be economic chaos.

Putting cash into the hands of people is not the same as bailing out already insolvent banks and financial companies, as the state did during the financial crisis of 2008. The bailouts of 2008 were, for the most part, a replacement for lost (financial) capital. They did not create inflation. Instead, they prevented existing asset prices from falling, and eventually caused a new bubble in stocks and real estate. In the long run that had harmful effects, but it didn't cause a short-term inflationary disaster, and it did prevent a short-term financial collapse. This crisis is very different, however. Printed bailout money would be a replacement for income and revenue, not a replacement for lost capital.

Normally, money flows in a circle from producers to consumers and back again. Producers pay people wages for their labor, and those wages are then used to buy the products of the economy. This cycle can be virtuous or vicious. If the flow decreases, then businesses shut down and individuals are laid off, which reduces the flow further. If the flow increases, then new businesses open up and employ people or increase wages, thus increasing the flow more. For the last 50 years or so, the conventional wisdom has been that the state should try to prevent the flow from decreasing by injecting newly created money if the flow slows down. Central banks do this by purchasing financial assets such as bonds and by lending to banks at low interest rates. In a typical financial crisis, the circular flow of money slows down rapidly, and the state responds by injecting money. This usually works, at least in the short term, although it has harmful long-term effects.

The current pandemic crisis is very different from a typical financial crisis, however. There is a sudden slowdown in the economy, but that slowdown is deliberate. We don't want to get the economy back to its previous level. Instead, we want to shut down certain kinds of production and consumption, while maintaining other kinds of production and consumption at their normal levels. We want to enable people in the shut-down sectors to continue consuming goods and services without receiving income. The goal is a temporarily depressed economy with high unemployment, but one without mass bankruptcy and poverty. This is a very tricky problem to solve, and it is nothing like a typical recession or financial crisis.

The state could print money and give it to individuals and businesses to replace lost income and prevent mass bankruptcy. However, that would flood the financial system with new money. And the state would have to keep injecting money until the crisis is over, because the injection would not cause economic growth and put people back to work. More and more money would accumulate in the financial system, while the levels of production and consumption would remain the same. That would create a big risk of inflation.

There is no easy way for the state to replace the market as a distribution mechanism. When the economy is functioning normally, money flows from producers to consumers in wages and then back to producers as revenues. If half the economy is shut down, total wages and revenues are cut in half, because (roughly) half the workers are laid off and half the businesses shut down. Now suppose the state creates money to replace the lost wages. That money would replace half of the previously circular flow with a linear flow out of nowhere. (Money created by fiat.) Actually, things are a bit more complex, because normally a lot of money flows into the banking system as debt payments, and out of the banking system as credit. During this crisis there won't be as much money flowing out of the banking system as credit, so the banking system could absorb some of the new money as debt payments, effectively destroying it. Some would also accumulate in savings, albeit creating the potential for inflation later. But to replace wages with fiat money for a long time would require a massive injection of money that would have nowhere to "go", so to speak. It couldn't all be spent on existing production without raising prices. And it wouldn't be flowing around and around in a circle. It would be flowing in and accumulating somewhere. Thus, it would create a serious risk of inflation and eventually hyperinflation -- a currency collapse.

There are other problems with a long-term, large-scale welfare scheme. It would naturally create resentment among those who work, since they would be working hard and taking risks, yet receiving the same essential goods and services as everyone else. Existing welfare schemes don't create that much frustration because (a) they provide benefits to a relatively small percentage of the population, and (b) those who work get more money and can spend it on luxuries that the welfare recipients can't afford. Shutting down half the economy and putting the workers on welfare is totally different. It would create frustration on both sides. The employed would be angry that they have to work and take risks for no additional reward. The unemployed would be frustrated and bored. Social unrest is a likely consequence.

We're in a difficult predicament. There is no easy solution. The point of this essay is to explain the problem and its difficulty. I want to dispel the notion that UBI or any other welfare scheme is a simple and easy solution. There is no effective way to put half the economy on hold. No matter what we do, this crisis will have serious long term economic and financial consequences.