Might U.S. GDP Contract as Sharply as It Did in 2008-09?

March 17, 2020

At least two consecutive quarters of falling gross domestic product in the United States now look unavoidable. Even President Trump has acknowledged the probability of a recession and postulated that the coronavirus outbreak may not recede until well into the third quarter. Late in 2019, few analysts were predicting a recession, but now most do. It is unusual for recessions to be predicted before what, with the benefit of hindsight, becomes the officially recognizable start of a downturn.

Unlike the global Great Recession which sprang from a dysfunctional financial system, the cause of the world economy’s problem this time was created by a real-side shock that is depressing both aggregate demand and impeding the production of goods and services to meet demand. Inevitably, the evolution of the coming recession depends on the epidemiology of the virus outbreak. Since medical experts do not know the latter, economists have been reluctant to attempt quantifying the duration and magnitude of either the coming global or U.S. recessions. But it is not so far-fetched to postulate that this downturn at least in the United States might be as great or deeper than the one that lasted six quarters from 1Q08 until 2Q09. Here’s some reasons why we could be looking at an even bigger event than the Great Recession.

Macroeconomic policies will not directly address the root cause of this new recession, only the economic fallout of the pandemic’s disruption. Treating the medical crisis forces government to amplify the economic cost by imposing social distancing. Even in the digital age, so much of economic activity necessitates people gathering together, whether at a work place, a store, in modes of transportation, at school or daycare, in worship, hospitals and doctor waiting rooms, at a restaurant, museum, show, or sporting event, at the beach, a park, a town meeting, family picnic, or when visiting with friends or relatives. The uniqueness of the coming recession is that whole brands of activity will be shut down or almost so, and that’s being done voluntarily because it’s the only way to contain the eventual loss of life.

U.S. policymakers made an early mistake in waiting too long to begin taking major steps to slow down the progression of the infection. As a result, hospitals are apt to be over-taxed, and more life sacrificed in the swim back to a semblance of social normalcy. An axiom of economic policymaking is that when faced with a crisis, it is better to attack a problem early and hard rather than gradually to conserve one’s ammo. The Fed’s full percentage point cut in interest rates this past Sunday and accompanying slew of unconventional monetary steps to promote bank lending, maintain low long-term interest rates, and assure orderly financial market conditions is an example of this fast-and-hard approach.

Speaking of the Federal Reserve, a separate ominous aspect of the coming recession is that even if the cause had been another breakdown in financial market functionality, there would be much less scope to counter economic headwinds because interest rates were at atypically low levels at the onset of the crisis. From a political standpoint, the same problem may impede the response of fiscal policy. The massive tax cut bill in late 2017 was ill-timed to coincide with a period of very low unemployment and poorly constituted because it mostly helped people unlikely to spend much of their incremental disposable income. The tax cut yielded scant bang for the buck in higher business investment when juxtaposed to the ballooning of the federal deficit that ensued. The responsible thing for Congress to do now is to open the fiscal spigots widely and deal with the short-term vacuum of private demand that will result from social distancing. But don’t be surprised if concern about the fiscal deficit delays the bill and results in an inadequate overall response.

We are just getting a third reason to brace for a downturn on a scale commensurate to what America experienced in 2008-09 from global economic data. Chinese investment, retail sales and industrial production in the first two months of 2020 were 24.5%, 20.0%, and 13.5% lower than a year earlier. The German ZEW investor expectations index fell 58.2 points between February and March and, in conjunction with a 59.9-point plunge in perceived current conditions, constitutes the worst month-to-month deterioration in at least 29 years. U.S. retail sales fell 0.5% last month, compared to forecasts of a small uptick, and this and other recent data suggest that U.S. growth was slowing even before the magnitude of the pandemic’s threat became apparent.

Fourth, the ascent of political nationalism both in America and other countries and anti-government sentiment in the United States have sapped Washington’s ability to handle a crisis against which the private sector is totally helpless. America-first thinking is incompatible with the government-to-government cooperation to contain a virus that knows no border. America’s hostile actions on the climate crisis inspires pessimism that it will do the right thing now.

Fifth, the U.S. experienced a shorter and less pronounced drop in real GDP during the Great Recession than Japan or most countries in the European Union. Between the last quarter in 2007 and the second quarter of 2009, real U.S. GDP fell 4.2%, and the annualized slide in three of the five negative quarters was less than 3%. GDP even grew 2.0% at an annualized rate in 2Q08, and the drop in 2Q09 was by just 0.5%. Most of the pain was condensed into the last quarter of 2008 and first quarter of 2009. Because America’s testing for coronavirus has been so much less thorough than testing in other countries, it seems doubtful that it will experience less economic fallout than countries that were more vigilant in that regard.

And finally, markets seem ahead of the curve in understanding that the most menacing health pandemic in a century has caught mankind at a particularly bad time. At the epicenter of the Great Recession between the collapse of Lehman Brothers on the weekend of September 13-14, 2008 and the DOW’s closing low on March 9, 2009, that index fell a total of 42.7% and posted daily declines of 4.0% or more twelve different time. That was a period of just under a half year. Since February 12, 2020 when the DJIA closed at a record high of 29,556, through this morning’s intra-day low of 19,882, the index fell 32.7%, and most of that slide was in the space of the most recent three weeks.

There have been five daily declines of the DOW since February 27th of 4.0% or more. Seven of the dozen daily slides in the aforementioned 2008-09 span of six months were smaller than 5.0%, and the largest was a decline of 7.9% on October 15. Only one of the five largest drops this year since February 27th was smaller than 5.9%, and it occurred on that day. The size of the other four declines were 5.9% on March 11, 7.8% on March 9, 10.0% on March 12, and 12.9% on March 16. The stock market bottomed out in 2009 just four months before the end of America’s year-and-a-half-long recession. Similarly, a 45.1% decline of the DOW in 1973-74 ended about a calendar quarter before the end of the recession associated with that bear market. It’s highly likely that we are not just 3-4 months away from the current recession’s end. We probably will not even have a good guesstimate at midyear regarding the end of the pandemic, so it seems most probable that we haven’t yet seen the U.S. stock market’s ultimate floor.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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