The Fog Of Pandemic War

There is no doubt that U.S. economic growth in the current quarter will be dreadful. We see it in soaring jobless claims, in dismal retail sales, and in plunging oil prices. The real question is what comes next. 

Here the level of uncertainty is extraordinary. To illustrate, consider a flash survey of 45 economists by the National Association of Business Economists released last week. For Q3, the median forecast was for U.S. GDP growth at a modest 2.0% annual rate. Far more striking was the range of the forecasts (and this is for July-September; not terribly far away). The five lowest forecasts for Q3 averaged ‑12.6% annualized growth; the five highest averaged 20.7%. That’s an astonishing level of disagreement. 

Why is the uncertainty so extreme? Two reasons. First, most modeling works by finding an appropriate historical analogy and adapting it to the present circumstance. But there are no very good analogies to the present circumstance. The pandemic may be comparable to the 1918 Spanish Flu, but the world economy then had very little in common with the economy of today. 

The second reason is that there are strong opposing forces at play and the depth of the recession will depend on which prevails. While we cannot call a winner, we can at least identify the forces. 

Optimists could cite stimulative forces supporting forecasts of a strong, rapid rebound. The first has to do with the provenance of this recession; it was a slowdown of choice. This is very unusual. If we look at the last 50 years of U.S. recessions, there were underlying economic causes in each – the bursting of a housing or .com bubble; a savings and loan crisis; raging inflation; soaring oil prices. Those problems take time to sort out. The leading argument for the optimists is that there was nothing fundamentally broken in the economy heading into this crisis. Therefore, it should not take extra time to sort things out. We shut this economy down; we can start it back up again. 

The second major force underpinning cheerier assessments has been the magnitude of the U.S. government’s financial response. First and foremost, the Federal Reserve has been extraordinarily aggressive in its response. It has lowered interest rates, dramatically expanded its balance sheet, and created new facilities to keep financial markets functioning smoothly. There is an old Wall Street adage – “Don’t Fight the Fed.” That is likely a large part of the explanation why the Dow Jones Industrial Average just had its best 2-week performance since 1938, despite the growing drumbeat of negative economic news. 

Beyond the Fed, there was a $2.3 trillion stimulus law intended to forestall layoffs and bankruptcies and to allow for a quick rebound. It was a dramatic amount – roughly 10 percent of U.S. annual GDP. While the funding for small business loans was exhausted this past week, there are ongoing negotiations to provide further funds. 

On the other side of the ledger, the depressive forces are both epidemiological and economic. For the former, until a reliable treatment or vaccine is developed for Covid-19, there will be public health arguments to limit activity to some degree. While this might be partially alleviated with an extensive system of testing and contact tracing, those systems are not yet in place in the United States. And there will be persistent worries about a second wave of infection. 

Even if we were to get past all such medical concerns, there are serious economic challenges. If companies go bankrupt, they will not be around to bounce back. And even for businesses that do not succumb, there is the difficult problem of coordination. A modern economy relies heavily on coordination. Businesses order supplies, hire workers, and produce goods with the expectation that customers will show up. The very act of ordering creates demand for other businesses. The wages paid to workers fund their spending at other stores. Thus, optimism about demand can be self-fulfilling. In the same way, if businesses hold back, worried that they might face weak demand, that, too, can be self-fulfilling. 

Two recent surveys provide interesting evidence of the extent of this problem. In the first week of April, Gallup asked a panel how quickly they would return to normal activities once government restrictions on activity are lifted. 71% responded that they would “Wait to see what happens with the coronavirus before resuming.” Only 20% said they would resume activities immediately. 

The second survey was from a Flexport webinar last week, in which we asked about getting businesses back to full operation. Respondents were asked about the biggest obstacle they faced: staffing and employees; sourcing parts and materials; logistical concerns; credit and financial constraints; or uncertainty about demand. Among the 200 respondents, 58.5% picked demand uncertainty, easily dominating all other worries. 

Thus, even if medical concerns are set aside, even if businesses do not succumb to bankruptcy, even if governments align on a resumption date, coordination concerns could prevent a quick snapback in activity if companies hold off on ordering and re-hiring until demand concerns are resolved. 

There is no clear way to sort out the interplay of these forces. They lay too far outside our past experience. Hence, the extreme uncertainty in forecasts. We don’t know what comes next. What is clear is that we are embarking upon an extraordinary and tumultuous time.