The economy craters
Edition 2: Don't bring a knife to a gunfight
By now you have probably developed a cadence for #socialisolation, figured out the dynamics of remote working, are catching up with loved ones over video calls (hopefully avoiding snafus), binge-watching the shows that have piled up on Netflix or pondering over existential questions.
However, in the world outside, the economy looks grim. The drumbeat of media reports has detailed the hardships faced by the smaller businesses and the bleak global economic outlook. The IMF has released a statement referring to the pain that is likely to come.
A key part of the statement -
First, the outlook for global growth: for 2020 it is negative—a recession at least as bad as during the global financial crisis or worse...
Second, advanced economies are generally in a better position to respond to the crisis, but many emerging markets and low-income countries face significant challenges. They are badly affected by outward capital flows, and domestic activity will be severely impacted as countries respond to the epidemic…
Four things stand out.
1) We are looking at a recession at least as bad as 2008 as per the IMF. How bad was 2008?
The median family net worth in the US had fallen off a cliff by more than 40%!
Early signs are ominous. The Chinese mobile carriers have lost 21 million users over January and February indicating consumer cutback even in essential spending. Meanwhile, the US labor department released the most striking chart of the current economic scenario –
This succinct piece in Axios puts it
If unemployment claims continue at this pace for another four weeks, we'll end up seeing half as many workers laid off as lost their jobs during the 2008–09 Great Recession. On the other hand, if these numbers continue for 16 weeks, it will be twice as bad. The only way to tell which way we're going is to wait and see.
Which brings us to the second point.
2) Unlike 2008 which kickstarted with the collapse of Lehman Brothers, no major bankruptcies have yet taken place. Due to the medical nature of the crisis, the duration of the economic pain seems unclear. As Ellen Zentner – chief economist Morgan Stanley puts it, “During previous recessions, no one’s been told you can’t go outside, or you can’t gather”.
A longer lockdown will start leading to bankruptcies, freezing credit, as lenders become risk-averse. A study from JP Morgan Chase estimated that a median small business in the USA held 27 days of cash buffer.
Source: JP Morgan Chase Institute
3) Emerging markets such as India and China remained relatively unscathed in 2008, are now facing strong headwinds. Nationwide lockdowns, like the one, declared in India (the largest human lockdown in history) can tip over an already tottering economy. As economist Jayati Ghosh puts it in this excellent interview (video), the supply shock in India is likely to be worse than demonetization since this time both the formal and informal sectors have been shut down.
Sajith Pai, a partner at an early-stage VC fund Blume Ventures collated the second-order impact of the crisis, such as disruption of food supply due to limited availability of packing materials and shortage of truck drivers.
The IGM Forum at Chicago Booth, which polls economic experts in the US and Europe for their views on public policy, invited them to express their views on the likelihood of a major recession. The experts were asked whether they agreed or disagreed with a statement. The responses are telling
4) Contraction is already underway. Policymakers need to ensure that this is a V-shaped recession (sharp dip, swift recovery back to pre-crisis trend) than a U-shaped one (long period of pain leading to growth never reaching the pre-crisis path).
The U-shaped recession in 2008 which caused permanent damage to countries like the USA (refer to the chart below), happened when the banking crisis froze credit to the real economy, shuttering businesses, creating unemployment, which became structural, reducing long term output.
(I do not want to, but…) To sum up, on a grim note, things are bleak, the vulnerable are being hard hit and the pain will get worse. Now is time for policy bazookas, which we will explore further in the next newsletter.
