Martin Langeveld | Corona Diary: We're looking at a recession on a par with the Depression
Back on Jan. 15, I visited my financial adviser to see how our nest egg is doing, as I do every year. As usual, the conversation included speculation about whether a recession might happen sometime soon. As usual, we decided that nobody knows, so we should maintain the same investment strategy. I observed that in past recessions, the trigger has usually been some major policy or regulatory failure (like subprime mortgages in 2008 or the savings and loan crisis in 1990), or some kind of irrational market behavior (like the dot-com boom in 2001). Neither of us (nor the stock market as a whole) saw anything like that looming.
Of course, another kind of potential market disruptor, also not foreseeable, is some small or large event external to financial markets. When small, it's the "butterfly effect" which is classically illustrated by the metaphorical butterfly in Hong Kong flapping its wings, the effects of which spin into a hurricane on the other side of the world.
Little did we know at in mid-January, the butterfly was already flapping, in Wuhan rather than Hong Kong, and that the storm would come to us in due time. The virus was first reported in the New York Times on January 8 ("There is no evidence that the new virus is readily spread by humans, which would make it particularly dangerous, and it has not been tied to any deaths.") Within days, of course, it was clear that it was certainly dangerous and deadly, and was spreading rapidly. Within weeks, it reached U. S. shores, and finally, probably belatedly, markets around the world tanked in the realization that this "outbreak" was actually a pandemic, and that its economic effects would be significant.
But the question now is, how significant an economic downturn will we see? Well, if you believe one respected analyst, Mike Wilson of Morgan Stanley, it's time to get back into stocks. On Friday, the stock market seems to have followed his thinking and rose 9.36%.
But you know what they say about dead cats. I don't know what Mike Wilson is smoking, but he hasn't talked to the hot dog man outside his office building, or to the bartender at the fancy joint where he drinks his martinis, both of whom probably have a better perspective on things.
The reality is that we now have a complete shutdown mentality spreading around the world faster than the virus did. Central governments are officially putting lids on travel and mass gatherings or all kinds. The private sector and local governments are following suit by shutting down small events, schools, churches, museums, conferences and the like. Seniors are advised to cocoon at home. Pretty much everybody else seems to be planning the same, emptying supermarket shelves not only of toilet paper, but also of water, frozen foods, meats, and cereals.
Now, all of this might be good policy and good behavior. We are told (and I believe) that this "social isolation" will "flatten the curve" by slowing down the transmission of the disease, so that the peak active infection counts will be lower and the health system will have a better chance of dealing with it.
But how long will this holing-up have to last, and what will the economic effects be? Who can we trust to tell us when it's OK to go out and about our business again? The administration's track record in calling the shots so far is terrible — witness the latest debacle involving repatriating Americans stuck for hours at multiple airports.
The reality is that hunkering down is going to cause an unprecedented drop in the GNP, from which the economy will not easily recover. Ultimately our response to the virus, whether it's good policy or bad, will bring huge misery to many people; it will bankrupt an enormous number of businesses; it will disrupt every aspect of our society.The picture that Mike Wilson's hot-dog vendor, or his bartender, or his housekeeper or barber, might paint for him include these likely outcomes of the current rush to close and cancel virtually everything:
With little cash coming in from sales of goods and services, many retail businesses and restaurants will be unable to pay their workers and will have to lay them off. The same will happen at events and entertainment venues ranging from stadiums to sports bars, from museums to community centers (for-profits and non-profits), and at schools and universities — even if they resort to virtual classrooms, their revenue and cash flow will be impacted and they may be forced to cut staff. Add to this the same effect in other sectors like transportation, construction and government services, and in factories shut down because demand for their goods has evaporated.
Most of these laid-off people may qualify for unemployment benefits, but that compensation is far lower than their usual paychecks, and their propensity to spend cash on anything but essential goods and services will be nil.
Vast numbers of people will be unable to pay their rent, their mortgages and other monthly basics, which in turn puts a cash squeeze on banks.
Real estate transactions will slow down to a trickle because of price (and income) uncertainties.
With little demand in many sectors of the economy, prices will fall, along with wages. This could put us into a deflation situation, which is one of the nightmares economists have, because a "deflationary spiral" is very hard to stop. Alternatively, we could see a "stagflation" scenario in which prices rise (because production is severely cut) but the economic shrinks.
In short, this will quickly turn into a very serious recession, certainly worse than the 2008-09 "Great Recession." It's not a pretty picture, and there is no road map for getting out of it. National leadership not accustomed to sound policy thinking is not likely to choose strategies that will work. Some of the potential tactics they might consider are almost as scary as a mega-recessionary scenario outline above.
The question really is, what can turn this around and how fast will it happen? Basically, that depends on how soon people will stop corona-cocooning, and how fast they can be put back to work. Let's break this down into two possible scenarios, which I see as opposite extremes:
SCENARIO ONE: Social isolation stretches out for a very long time. We've seen a lot of closings for two weeks, three weeks, or "through the end of March." While this will slow down transmission, it will not stop it. Right now there are plenty of hidden cases, not found because of the test kit shortage, or not yet noticed because people are in the incubation period. So in this scenario, two or three weeks from now, with the number of reported cases mushrooming, there will be recommendations (or even mandates) for people to stay in social isolation. The status quo continues for months, rather than weeks, and the economic devastation I've described above gets worse and worse. It's not hard to imagine resulting breakdowns of civic order, riots to protest a variety of shortages bound to occur as supply networks break down, and ultimately, dare I say it, martial law and all its implications for individual rights. The problem with this scenario, besides the potential for absolute chaos, is that because of its duration it is economically the most damaging, and ultimately, it may not work at all, with the pandemic roaring back as soon as restrictions are finally lifted.
SCENARIO TWO: Social isolation begins to be gradually relaxed after two to three weeks. Frankly, I don't think Americans have the patience for more than a few weeks of doing nothing much. So perhaps, here and there, venues for small events and gatherings (like churches and bars) will reopen first, followed by larger venues like theaters and restaurants. No doubt, this will bring an uptick in transmissions, But somewhere along the way, the realization will sink in that most likely, we'll all be exposed to the virus and most of us will get it, for better or worse. Angela Merkel has warned that up to 70% of Germans are likely to become infected. Harvard virus expert Marc Lipsitch says 40-70% of the world's population will catch this bug. When it becomes more obvious that that will happen, a few weeks from now, people as well as policymakers may realize that continued absolute lockdowns only postpone the inevitable, and will, very cautiously, begin to return to normal activities. (And major league baseball starts back up!) "Normal," in this scenario, would still mean extreme caution regarding personal contacts and public activities; it would be quite constrained by the cash crunch most people, businesses and institutions will have endured; it will mean the virus will continue to circulate until most of us have had the disease; and there will be an ongoing death toll until the pandemic has run its course.
Are there other possible outcomes? Probably nothing more draconian and disastrous than Scenario One. And probably nothing more relaxed than Scenario Two. We're going to land somewhere in between, and probably closer to Scenario Two than One. Neither picture is pretty, but a consensus will emerge around moving back toward normal sooner rather than later.
So finally, what's the economic hit? In your usual, garden-variety recession since 1950, the GDP drops by a few percent (the range is -0.3 percent to -4.3 percent — the latter was the "Great Recession" of 2008-09), and the duration of the recession ranges from 6 to 18 months (again the latter was 2008-09). But in none of those recessions did we shut down most schools and colleges, most entertainment venues, most organized sports, and see huge slowdowns in travel and tourism.
Rather than a GDP slowdown of few percent, and an average duration of 9-12 months, our response to the virus is on track to engineer a double-digit GDP drop. As long as the virus is rampant, no amount of fiscal stimulus will mitigate that drop very much. And since the virus won't just cease to spread one day, there will there will not be a rapid end to the recession. People laid off will only slowly be able to get back to work; businesses bankrupted will only slowly be replaced by startups, people will only slowly regain the confidence to start buying non-essentials. What the numbers will look like in the end is anybody's guess. Mine is that we'll see a GDP drop of more than 10 percent, and a recession that lasts at least two years. Basically that puts us in the same territory as the double dips of the Great Depression in the 1930s (in the first of which, the stock market lost nearly 90 percent of its value).
Martin Langeveld of Vernon is a former Reformer publisher and current member of New England Newspapers Inc.'s board. This article was first published on Langeveld's blog, News after Newspapers. He can be reached at firstname.lastname@example.org.
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