With the COVID-19
pandemic still spiraling out of control, the best economic outcome that anyone
can hope for is a recession deeper than that following the 2008 financial
crisis. But given the flailing policy response so far, the chances of a far
worse outcome are increasing by the day.
NEW YORK – The shock
to the global economy from COVID-19 has been both faster and more severe than
the 2008 global financial crisis (GFC) and even the Great Depression. In those
two previous episodes, stock markets collapsed by 50% or more, credit markets
froze up, massive bankruptcies followed, unemployment rates soared above 10%,
and GDP contracted at an annualized rate of 10% or more. But all of this took
around three years to play out. In the current crisis, similarly dire
macroeconomic and financial outcomes have materialized in three weeks.
Earlier this month, it
took just 15 days for the US stock market to plummet into bear territory (a 20%
decline from its peak) – the fastest such decline ever. Now, markets are down 35%, credit markets have seized up, and credit spreads
(like those for junk bonds) have spiked to 2008 levels. Even mainstream
financial firms such as Goldman Sachs, JP Morgan and Morgan Stanley expect US GDP to fall by an annualized rate of 6% in the
first quarter, and by 24% to 30% in the second. US Treasury Secretary Steve
Mnuchin has warned that the unemployment rate could skyrocket to
above 20% (twice the peak level during the GFC).
In other words, every
component of aggregate demand – consumption, capital spending, exports – is in
unprecedented free fall. While most self-serving commentators have been
anticipating a V-shaped downturn – with output falling sharply for one
quarter and then rapidly recovering the next – it should now be clear that the
COVID-19 crisis is something else entirely. The contraction that is now
underway looks to be neither V- nor U- nor L-shaped (a sharp downturn followed
by stagnation). Rather, it looks like an I: a vertical line representing
financial markets and the real economy plummeting.
Not even during the
Great Depression and World War II did the bulk of economic activity literally
shut down, as it has in China, the United States, and Europe today. The best-case
scenario would be a downturn that is more severe than the GFC (in terms of
reduced cumulative global output) but shorter-lived, allowing for a return to
positive growth by the fourth quarter of this year. In that case, markets would
start to recover when the light at the end of the tunnel appears.
But the best-case
scenario assumes several conditions. First, the US, Europe, and other heavily
affected economies would need to roll out widespread COVID-19 testing, tracing,
and treatment measures, enforced quarantines, and a full-scale lockdown of the
type that China has implemented. And, because it could take 18 months for a
vaccine to be developed and produced at scale, antivirals and other
therapeutics will need to be deployed on a massive scale.
policymakers – who have already done in less than a month what took them three
years to do after the GFC – must continue to throw the kitchen sink of
unconventional measures at the crisis. That means zero or negative interest
rates; enhanced forward guidance; quantitative easing; and credit easing (the
purchase of private assets) to backstop banks, non-banks, money market funds,
and even large corporations (commercial paper and corporate bond facilities).
The US Federal Reserve has expanded its cross-border
swap lines to address the massive dollar
liquidity shortage in global markets, but we now need more
facilities to encourage banks to lend to illiquid but still-solvent small and
need to deploy massive fiscal stimulus, including through “helicopter drops” of
direct cash disbursements to households. Given the size of the economic shock,
fiscal deficits in advanced economies will need to increase from 2-3% of GDP to
around 10% or more. Only central governments have balance sheets large and
strong enough to prevent the private sector’s collapse.
deficit-financed interventions must be fully monetized. If they are financed
through standard government debt, interest rates would rise sharply, and the
recovery would be smothered in its cradle. Given the circumstances, interventions long
proposed by leftists of the Modern Monetary Theory school, including helicopter
drops, have become mainstream.2
Unfortunately for the
best-case scenario, the public-health response in advanced economies has fallen
far short of what is needed to contain the pandemic, and the fiscal-policy
package currently being debated is neither large nor rapid enough to create the
conditions for a timely recovery. As such, the risk of a new Great Depression,
worse than the original – a Greater Depression – is rising by the day.
Unless the pandemic is
stopped, economies and markets around the world will continue their free fall.
But even if the pandemic is more or less contained, overall growth still might
not return by the end of 2020. After all, by then, another virus season is very
likely to start with new mutations; therapeutic interventions that many are
counting on may turn out to be less effective than hoped. So, economies will
contract again and markets will crash again.
Moreover, the fiscal
response could hit a wall if the monetization of massive deficits starts to
produce high inflation, especially if a series of virus-related negative supply
shocks reduces potential growth. And many countries simply cannot undertake
such borrowing in their own currency. Who will bail out governments,
corporations, banks, and households in emerging markets?
In any case, even if
the pandemic and the economic fallout were brought under control, the global
economy could still be subject to a number of “white swan”
tail risks. With the US presidential election approaching, the COVID-19 crisis
will give way to renewed conflicts between the West and at least four
revisionist powers: China, Russia, Iran, and North Korea, all of which are
already using asymmetric cyberwarfare to undermine the US from within. The
inevitable cyber-attacks on the US election process may lead to a contested
final result, with charges of “rigging” and the possibility of outright
violence and civil disorder.1
Similarly, as I
have argued previously,
markets are vastly underestimating the risk of a war between the US and Iran
this year; the deterioration of
Sino-American relations is accelerating as each side blames the other for the
scale of the COVID-19 pandemic. The current crisis is likely to accelerate the
ongoing balkanization and unraveling of the global economy in the months and
This trifecta of risks
– uncontained pandemics, insufficient economic-policy arsenals, and
geopolitical white swans – will be enough to tip the global economy into
persistent depression and a runaway financial-market meltdown. After the 2008
crash, a forceful (though delayed) response pulled the global economy back from
the abyss. We may not be so lucky this time.
As the COVID-19
pandemic escalates, and its effects reverberate around the world, Project
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