There can be little question that once the coronavirus lockdown is fully lifted, we will get a very meaningful bounce back in the U.S. economy from its steepest drop in living memory. The real question now seems to be how strong a bounce might we get and how long might it take for the U.S. economy to regain its pre-coronavirus strength.
The market optimists are hoping that the lockdown’s ending will result in a sharp V-shaped recovery that will allow the U.S. economy to regain its former strength by 2021. This optimism might go a long way to explaining the stock market’s recent exuberance despite the currently dismal state of the economy. Rather than concentrate on how the economy looks right now, the market seems to be looking ahead towards what it believes will be a very much brighter 2021.
The optimists are likening the coronavirus economic depression that we are now experiencing to what might occur as a result of a natural disaster like a hurricane or an earthquake. They are also positing that there were no real imbalances in the economy prior to the body blow that the pandemic delivered. This induces them to believe that much as economies have proven quick to regain their former levels after natural disasters, so too will the U.S. economy quickly regain its pre-crisis level after the lockdown is lifted.
It would be wonderful if the optimists’ rosy scenario proves to be correct. Unfortunately, there are many reasons to think that their optimism will prove to be misplaced.
Among the more important of these reasons is the fact that not since the Great Depression has the U.S. economy experienced as deep and as sudden a downturn as it has over the last few months. Even in the Great Depression we did not have GDP falling at the annualized 40 percent rate that is widely expected for the second quarter of the year. More striking yet is the fact that while it took three years after the Great Depression’s start for unemployment to reach 25 percent in 1932, we have managed to reach such shocking unemployment levels in the space of barely three months.
With such a large and sudden drop in output, there is bound to be a wave of corporate and household bankruptcies that must be expected to badly dent investor confidence and make banks that are more reluctant to lend. This will be especially the case in those parts of the economy – such as the travel, hospitality and entertainment sectors – that are highly unlikely to regain their former strength as long as a vaccine has not been developed.
It will also be the case in the U.S. shale oil industry that has been decimated by the collapse in international oil prices and in the commercial real estate sector of the economy, where a coronavirus-induced trend to work permanently from home might result in a substantial overhang of excess office space.
One might also expect households to be very much more parsimonious following such an abrupt and large rise in unemployment as that which we have now just experienced. Consumers might prove very much more reluctant to make big-ticket purchases or rush back to the malls than they were before the pandemic in order to build up some cushion of savings against the next possible economic downturn.
The optimists also appear to totally discount the possibility that there might be a second wave of the pandemic that will again stop the economy in its tracks. They are doing so even though the World Health Organization is warning that the premature and hurried way in which the U.S. is lifting its lockdown might very well bring on a second wave of the pandemic by as early as this fall.
Yet another set of risks to a V-shaped recovery that the optimists choose to ignore are those that could come from abroad. This is all the more surprising considering the recent heightened U.S.-China tensions over Hong Kong that could very well lead to another damaging round of the U.S.-China trade war. It is also surprising considering the parlous state of the European and emerging market economies that could lead to another round of the European sovereign debt crisis and to a full-blown emerging market crisis later this year.
With so many risks to a V-shaped recovery, U.S. economic policymakers would be advised to hope for the best but plan for the worst. They would also do well to stand ready to provide the economy with additional fiscal stimulus should any of the risks to the recovery mentioned above materialize.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.