Why are we facing a 1930's Economic Depression?
The world is currently facing the prospects of an Economic depression akin to that of the 1930’s, perhaps 10 times the size of the Great recession of 2009. For most of us, it will be the biggest economic event of our lifetime.
The pandemic that has attacked us is comparable to the 1918 Spanish flu, which infected about 1/4 of the population and where 50 million people had died. Only two months ago, most of us believed that the coronavirus will be a Chinese phenomenon, or at most an Asian phenomenon, like SARS. Little did we expect that it will explode in the rest of the world. Compared to 1918, modern medicine and technology has advanced, but we also have vastly greater interconnections around the world, with 12 million people flying each day .
What we are potentially facing is not a 5% drop in U.S. output, as was the case of the Great Recession in 2009, but a 40% drop in U.S. output and economies around the world. This time around, it is not a paralysis of the banking system where credit is squeezed, and lack of spending spills over to the real economy. Today, it is that a large part of the real economy will be in a complete stall, which will in turn break the financial system, and then come back to affect the real economy a second time round.
During the height of the Great Recession of 2008, the U.S. economy was losing 800,000 jobs per month. Today, it is losing millions of jobs per week. Policymakers balked at a peak of 10 % unemployment rate in the U.S.; today, they are talking about a number that hovers around a 30% unemployment rate. In a typical recession, businesses lay off workers because consumers do not spend enough. Today, businesses destroys employment because they cannot and should not bring people back to work. And then----when distressed families and businesses cut back on spending, there is a second round of layoffs.
Take the restaurant sector alone. In the U.S., it is a trillion dollar sector. This does not take into account air travel, tourism, entertainment, education, and face to face services. The service sector as a whole is about 80% of GDP. It is easy to see how a 40% evaporation of output can occur in no time. The main difference is that fundamentally sound businesses today may go bankrupt because there is no business. In 2008, a few major banks were on the verge of default. Today, the government has to come out and rescue its people, its businesses large and small, and its banks.
The financial assistance packages that major governments around the world are promising are already on a much larger scale than during the whole of the Great Recession. The Fed has already promised to buy US bonds of `infinity and more’. The Treasury is currently trying to pass a 2 trillion dollar fiscal stimulus, which is the largest fiscal stimulus package in modern U.S. history. The European central bank, which been historically stingy, has pledged to buy about 1 trillion euros worth of European debt. Its motto is : do whatever it takes. They have claimed that they are facing the biggest crisis since World War II!
But it is easy to understand why monetary policy will be limited in its efficacy despite their rapid response and scale. The reason is that in 2007, it was spending and credit that was frozen. Consumers and businesses cannot afford to replay loans or get new ones. So monetary policy aimed at cutting interest rates and making credit available can help jumpstart borrowing and spending. But when businesses are effectively shut down because of social distancing, because businesses cannot get components, or because quarantines limits people’s ability to work, it is not monetary policy that can jumpstart economic activity.
I would not be so concerned if all countries can take as draconian measures as our country has taken, or even the more moderate but effective measures that Singapore, Korea and Japan have adopted. But the Western countries are not like Asian countries. First of all, they have not had the experience of SARs, and are slow to react and to recognize the severity of the problem. Second, the people are already complaining of being quarantined after only a few weeks or in many cases a few days of mandatory social distancing. Attention: it is not even quarantine---it is social distancing. Days after the UK prime minister Boris Johnson announced social distancing measures, his father had said suggested that going to a pub may be a `necessity’, and that he would go anyway. My British friends over 70 years old who are staying at luxurious countryside estate have told me that they will go crazy if they are required stay there for one more month. My former classmates in New York said that there is no way that New Yorkers can be kept in their homes for too long. They’d rather get the disease. And---what is most likely going to happen is that they will be fed up, and everyone will end up developing herd immunity.
Thus, it is not only that our culture, political systems, public infrastructure are different. Our people are different. Compared to Westerners, East Asians are a more compliant group. So are the Germans—compared to the Italians. Compared to Europeans, Americans crave and need less socialization. Last weekend saw good weather for Paris, and the Frenchmen could not miss the opportunity to leave their homes for the beach. But from Americans to Europeans--virtually all of them hate perceived notions of suppression. They are also skeptical of technological surveillance even if it is their lives that are at stake.
All of this means that different countries will take very different approaches in fighting the epidemic. Most industrialized countries have taken the approach of mitigation, delaying the peak, rather than radical measures to contain the virus. But that would mean that they delay the resumption of work and the economy. In China, we stopped all activities for about a month or so, and businesses are springing back to life, with much of the operations fully recovered. That would not be the case for Western economies. With their strategy, it will take at least 6 months for the economy to go back to normal, if not longer. If there is a second wave of infections, then it may take 18 months, or whenever a cure and a vaccine is available. If we are facing a 12-18 month halt in economic activities in major economies around the world, we will be facing a challenge even greater than the Great Depression.
Thus, we cannot analyse the prospects of the world economy based on our own experience. Even though there are barely any more new cases arising inside China, social behaviour has fundamentally altered. We will still need to see if a resumption of work can spark off a second wave of infection. If not, I would be more optimistic of China's economic recovery. As soon as we see the infection rates starting to decline in Western countries, the stock market will start to come back. So far, 6 trillion dollars of stock market value has already been wiped out and we have yet to see the worst.
The size of our domestic economy is sufficient to prevent a major decline in our output. But the rest of the world will be tanking as we come back to life. It is an opportunity of the century for us to help the rest of the world, not only out of strategic interests, but also out of a moral imperative. The trust that has been so difficult to build in the international community will come about through our genuine and practical efforts of humanitarian assistance.
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