Despite an unprecedented intervention over the weekend from the Federal Reserve, which cut short-term interest rates to close to zero and introduced emergency lending measures, the U.S. stock market fell sharply again on Monday. By the close of trading, the Dow Jones Industrial Average had fallen almost three thousand points—the worst single-day points loss in history—or thirteen per cent. The market is now down by almost a third from its peak, in late February.
Clearly, investors are spooked by the widening coronavirus outbreak and the likely impact of the public-health measures that are being taken to deal with it. But what exactly is going on in the markets and the economy? In search of answers to this question, I spoke on Monday with Ian Shepherdson, the founder of Pantheon Macroeconomics, a firm that advises Wall Street firms, hedge funds, and institutional investors.
Shepherdson, who was formerly the chief U.S. economist at the international bank H.S.B.C., said that some investors were alarmed by the fact that the Fed felt obliged to act just a couple days before one of its regular policy meetings, and that they were also fretting about the delay in getting both chambers of Congress to pass an emergency spending bill. But Shepherdson also suggested that there were other factors at play, including some psychological ones. “To be brutally honest,” he said, “I think a lot of people on Wall Street didn’t take the virus seriously enough until it was their towns where cases were being discovered and their kids who were being sent home from school.”
Now the virus is impossible to ignore, and so are its economic consequences. “It’s going to be catastrophic,” Shepherdson said bluntly. “This is an economy built on discretionary consumption.” He was referring to all the nonessential purchases that people make in their daily lives, things ranging from new clothes and appliances to personal services such as spa sessions, meals in restaurants, and Uber rides. According to Shepherdson, all this nonessential stuff amounts to about forty per cent of the U.S.’s gross domestic product. In other words, it is enormous, in terms of both its dollar contribution to the economy and the number of people it employs.
As of yet, we don’t have any over-all figures for how shutdowns and curfews and self-isolation are impacting spending, but there are some preliminary indications. Over the weekend, movie-ticket sales fell forty-four per cent compared to the previous weekend. Shepherdson has been monitoring the number of people eating out through the booking site OpenTable. On Sunday night, the amount was down forty-eight per cent compared with the previous year. He read out some of the figures for individual states: “Alabama: down thirty-eight per cent. California: down fifty-five per cent. New York: down forty-seven per cent. New Jersey: down fifty-six per cent. This is just unbelievable.”
That was when most restaurants were still operating. Now that many states, including New York and New Jersey, have ordered them to close, apart from making deliveries, business is going to fall even more dramatically. The same is going to be the case for countless other enterprises, small and large. As they shut down, many of them are going to furlough their workers or let them go permanently.
This will result in a sharp rise in unemployment and in negative G.D.P. growth—in other words, a recession. “The U.S. economy is shrinking as we speak—I have no doubt at all about that,” Shepherdson said. On Monday, some Wall Street economists suggested that the G.D.P. could fall at an annualized rate of five per cent in the second quarter of this year. Shepherdson believes the downturn could be even more severe than that, with the G.D.P. contracting at a rate of about ten per cent. A collapse in discretionary consumer spending isn’t the only danger, he noted. As businesses react to the crisis, they will likely postpone a lot of capital spending, too. “We have no information about that yet,” he said. “But it is definitely going to get hit badly, as well.”
To alleviate some of this damage, economists of many different political persuasions agree that the Trump Administration and Congress need to introduce a substantial stimulus package on top of the coronavirus spending bill that the House of Representatives passed on Saturday. How big should these measures be? “I am in the one-trillion-to-two-trillion-dollar camp, preferably by dinner time,” Shepherdson said. “I think they should be just throwing money at people and businesses that are in the front line. Cash has to be given out to households. Cash has to be given out to small businesses. Cash has to be given out to gig workers. I don’t know what the figures are for Uber drivers, but they are probably catastrophic.”
It’s not just small businesses that are being affected, of course. Airlines, hotels chains, and other corporate entities are hemorrhaging money. Shepherdson said that some airlines could go bust “very quickly” if they don’t receive some sort of aid. “People say don’t bail them out—they’ve made billions of dollars in profits and paid their senior executives enormous sums,” he said. “I’m very sympathetic to that argument. But we are going to need an airline industry in September. So bail them out and sack the C.E.O.s. You can’t think in normal terms. This is more like a wartime crisis than a normal economic situation.”
Shepherdson isn’t the only economist making an allusion to the emergency measures that governments make in a war economy. “The world is de facto at war (against the virus, rather than against each other—this is the good news . . .),” Olivier Blanchard, the former chief economist at the International Monetary Fund, tweeted on Monday. He went on to point out that, during the Second World War, the federal deficit as a percentage of the G.D.P. rose to twenty-six per cent, as the Roosevelt Administration spent heavily on armaments and other programs. “Let’s not be squeamish,” Blanchard added.
Shepherdson agrees. “This is not a normal economic event in any way, shape, or form,” he said. “You have to be willing to think what previously would have been unthinkable.” If necessary, he said, the Federal Reserve could buy the bonds that the U.S. Treasury issues to finance a massive economic support package—a tactic known as “monetization,” which also was employed after the Second World War.
“Why do we worry about monetization?” Shepherdson said. “Because we are concerned about hyperinflation, but that isn’t an issue now, and we have a much bigger problem in our faces.” If the economy slumps in the way he thinks it is about to, a lack of adequate financial support for people who are adversely affected could lead to social unrest. “The first job of the government is to prevent social breakdown,” Shepherdson said. “If ever there was a case when quick government action could do that, then this is it.”
Jan.10 — Former U.S. Treasury Secretary Lawrence H. Summers and Roger Ferguson, TIAA president and chief executive officer, discuss the emergence of secular stagnation and the challenges that central bankers will face in a new decade. They speak with David Westin on “Bloomberg Wall Street Week.”
The latest liberal spin is that the economy is on a “sugar high” from deficit-financed tax cuts and spending hikes. When the rush wears off, they warn, watch out for a crash landing. It’s true that in fiscal 2018 the budget deficit swelled to nearly $800 billion, or about 4.2% of gross domestic product. But the Bureau of Economic Analysis estimates that the economic “contribution” from extra government spending added only 0.23 percentage point to growth in 2018. So even without all the budget bloat, the economy would still be growing well above 3%... The same BEA data confirm that this year’s growth comes predominantly from a boom in production and investing—particularly in construction, manufacturing, and oil and gas development. While the housing market is weak, consumers are spending more as their wages rise... The real contradiction in the “sugar high” argument is that it ignores the slow growth of the Obama years, which featured an avalanche of debt spending. Deficits as a share of GDP were 9.8% in 2009, 8.6% in 2010, 8.3% in 2011 and 6.7% in 2012. Where was the sugar high then? Instead of the expected burst in output coming out of the 2008-09 recession, borrowing more than $1 trillion a year for four years yielded the worst recovery since the Great Depression. Even excluding 2009, Mr. Obama’s deficits averaged more than 5% of GDP throughout the rest of his presidency but produced less growth than Mr. Trump has with lower deficits.
This wasn’t what Keynesians expected. Mr. Obama’s economic team predicted 4% growth every year coming out of the recession. Instead the “sugar high” from record peacetime deficits produced measly 2% growth. By 2016 GDP was running about $2 trillion below the trend line of a normal recovery.
The fastest growth rate over the past three decades was recorded in Bill Clinton’s second term, when federal government spending fell from 21.5% to 18% of GDP and deficits disappeared into surpluses. So much for the idea that deficit spending is a stimulant.
Mr. Trump’s fiscal policies have produced more growth than Mr. Obama’s because they were designed to incentivize businesses to invest, hire and produce more here at home. The Obama “stimulus,” by contrast, went for food stamps, unemployment benefits, ObamaCare subsidies, “cash for clunkers” and failed green energy handouts.
.. Massive government spending blitzes don’t produce “sugar highs” or anything like them. Even some conservatives erroneously argue that military spending stimulates the economy. But as Milton Friedman said, the government can only put money into the economy that it first takes out.
.. Those pushing the “sugar high” fallacy also don’t realize that the Trump tax cuts aren’t going away soon. The 2017 business tax cuts can’t cause a recession in 2019 or 2020 because they don’t expire until 2025. They aren’t sugar pills.
The biggest threats to the economic boom and financial markets today are a deflationary Federal Reserve and the specter of a global trade war. Solve those problems and the American economy can keep flying high on its own power. And Mr. Trump’s critics will be proved wrong again.
But in a cult of personality, truth is replaced by belief, and we believe what the leader wishes us to believe. The face replaces the mind.
.. The transition from democracy to personality cult begins with a leader who is willing to lie all the time, in order to discredit the truth as such. The transition is complete when people can no longer distinguish between truth and feeling.
.. Cults of personality make us feel rather than think. In particular, they make us feel that the first question of politics is “Who are we, and who are they?” rather than “What is the world like, and what can we do about it?” Once we accept that politics is about “us and them,” we feel like we know who “we” are, since we feel that we know who “they” are. In fact, we know nothing, since we have accepted fear and anxiety — animal emotions — as the basis of politics. We have been played.
.. The authoritarians of today tell medium-size lies. These refer only superficially to experiences; they draw us deep into a cave of emotion. If we believe that Barack Obama is a Muslim born in Africa (an American lie with Russian support), or that Hillary Clinton is a pedophile pimp (a Russian lie with American support), we are not actually thinking; we are giving way to sexual and physical fear.
.. These medium-size lies are not quite the big lies of the totalitarians, although Mr. Orban’s attacks on George Soros as the leader of a Jewish conspiracy come rather close. They are, however, big enough that they help to disable the factual world. Once we accept these lies, we open ourselves up to believing a whole raft of other untruths, or at least suspect that there are other, vaster conspiracies.
.. We imagine that we make choices as we sit in front of our computers, but the choices are, in fact, framed for us by algorithms that learn what will keep us online. Our online activity teaches machines that the most effective stimuli are negative: fear and anxiety.
.. As social media becomes political instruction, we prime ourselves for politicians who reproduce the same binary: What makes us afraid and what makes us feel secure? Who are they and who are we?
.. The empty heterosexual posturing, the shirtless photo ops, the misogyny and indifference to the female experience, the anti-gay campaigns, are designed to hide one basic fact: A cult of personality is sterile. It cannot reproduce itself. The cult of personality is the worship of something temporary. It is thus confusion and, at bottom, cowardice: The leader cannot contemplate the fact that he will die and be replaced, and citizens abet the illusion by forgetting that they share responsibility for the future.
The cult of personality blunts the ability to keep a country going. When we accept a cult of personality, we are not only yielding our right to choose leaders but also dulling the skills and weakening the institutions that would allow us to do so in the future. As we move away from democracy, we forget its purpose: to give us all a future. A cult of personality says that one person is always right; so after his death comes chaos.
Democracy says that we all make mistakes, but that we get a chance, every so often, to correct ourselves. Democracy is the courageous way to have a country. A cult of personality is a cowardly way of destroying one.
The response to the 2008 economic crisis has relied far too much on monetary stimulus, in the form of quantitative easing and near-zero (or even negative) interest rates, and included far too little structural reform. This means that the next crisis could come soon – and pave the way for a large-scale military conflict.
BEIJING – The next economic crisis is closer than you think. But what you should really worry about is what comes after: in the current social, political, and technological landscape, a prolonged economic crisis, combined with rising income inequality, could well escalate into a major global military conflict.
The 2008-09 global financial crisis almost bankrupted governments and caused systemic collapse. Policymakers managed to pull the global economy back from the brink, using massive monetary stimulus, including quantitative easing and near-zero (or even negative) interest rates.
But monetary stimulus is like an adrenaline shot to jump-start an arrested heart; it can revive the patient, but it does nothing to cure the disease. Treating a sick economy requires structural reforms, which can cover everything from financial and labor markets to tax systems, fertility patterns, and education policies.1
Policymakers have utterly failed to pursue such reforms, despite promising to do so. Instead, they have remained preoccupied with politics. From Italy to Germany, forming and sustaining governments now seems to take more time than actual governing. And Greece, for example, has relied on money from international creditors to keep its head (barely) above water, rather than genuinely reforming its pension system or improving its business environment.
The lack of structural reform has meant that the unprecedented excess liquidity that central banks injected into their economies was not allocated to its most efficient uses. Instead, it raised global asset prices to levels even higher than those prevailing before 2008.
In the United States, housing prices are now 8% higher than they were at the peak of the property bubble in 2006, according to the property website Zillow. The price-to-earnings (CAPE) ratio, which measures whether stock-market prices are within a reasonable range, is now higher than it was both in 2008 and at the start of the Great Depression in 1929.
As monetary tightening reveals the vulnerabilities in the real economy, the collapse of asset-price bubbles will trigger another economic crisis – one that could be even more severe than the last, because we have built up a tolerance to our strongest macroeconomic medications. A decade of regular adrenaline shots, in the form of ultra-low interest rates and unconventional monetary policies, has severely depleted their power to stabilize and stimulate the economy.
If history is any guide, the consequences of this mistake could extend far beyond the economy. According to Harvard’s Benjamin Friedman, prolonged periods of economic distress have been characterized also by public antipathy toward minority groups or foreign countries – attitudes that can help to fuel unrest, terrorism, or even war.
For example, during the Great Depression, US President Herbert Hoover signed the 1930 Smoot-Hawley Tariff Act, intended to protect American workers and farmers from foreign competition. In the subsequent five years, global trade shrank by two-thirds. Within a decade, World War II had begun.
To be sure, WWII, like World War I, was caused by a multitude of factors; there is no standard path to war. But there is reason to believe that high levels of inequality can play a significant role in stoking conflict.
According to research by the economist Thomas Piketty, a spike in income inequality is often followed by a great crisis. Income inequality then declines for a while, before rising again, until a new peak – and a new disaster.
This is all the more worrying in view of the numerous other factors stoking social unrest and diplomatic tension, including
- technological disruption, a
- record-breaking migration crisis,
- anxiety over globalization,
- political polarization, and
- rising nationalism.
All are symptoms of failed policies that could turn out to be trigger points for a future crisis.
.. Voters have good reason to be frustrated, but the emotionally appealing populists to whom they are increasingly giving their support are offering ill-advised solutions that will only make matters worse. For example, despite the world’s unprecedented interconnectedness, multilateralism is increasingly being eschewed, as countries – most notably, Donald Trump’s US – pursue unilateral, isolationist policies. Meanwhile, proxy wars are raging in Syria and Yemen.
Against this background, we must take seriously the possibility that the next economic crisis could lead to a large-scale military confrontation. By the logicof the political scientist Samuel Huntington , considering such a scenario could help us avoid it, because it would force us to take action. In this case, the key will be for policymakers to pursue the structural reforms that they have long promised, while replacing finger-pointing and antagonism with a sensible and respectful global dialogue. The alternative may well be global conflagration.
In handicapping the US-China conflict, Keynesian demand management is a better guide than comparative advantage. In principle, China can avoid any damage at all from US tariffs simply by responding with a full-scale Keynesian stimulus.
The United States cannot win its tariff war with China, regardless of what President Donald Trump says or does in the coming months. Trump believes that he has the upper hand in this conflict because the US economy is so strong, and also because politicians of both parties support the strategic objective of thwarting China’s rise and preserving US global dominance.
But, ironically, this apparent strength is Trump’s fatal weakness. By applying the martial arts principle of turning an opponent’s strength against him, China should easily win the tariff contest, or at least fight Trump to a draw.
.. Comparative advantage certainly influences long-term economic welfare, but demand conditions will determine whether China or America feels more pressure to sue for trade peace in the next few months. And a focus on demand management clearly reveals that the US will suffer from Trump’s tariffs, while China can avoid any adverse effects.
From a Keynesian perspective, the outcome of a trade war depends mainly on whether the combatants are experiencing recession or excess demand. In a recession, tariffs can boost economic activity and employment, albeit at the cost of long-term efficiency. But when an economy is operating at or near its maximum capacity, tariffs will merely raise prices and add to the upward pressure on US interest rates. This clearly applies to the US economy today.
.. US businesses could not, in aggregate, find extra low-wage workers to replace Chinese imports, and even the few US businesses motivated by tariffs to undercut Chinese imports would need to raise wages and build new factories, adding to the upward pressure on inflation and interest rates.
.. With little spare capacity available, the new investment and hiring required to replace Chinese goods would be at the cost of other business decisions that were more profitable before the tariff war with China. So, unless US businesses are sure the tariffs will continue for many years, they will neither invest nor hire new workers to compete with China... Assuming that well-informed Chinese businesses know this, they will not cut their export prices to absorb the cost of US tariffs. That will leave US importers to pay the tariffs and pass on the cost to US consumers (further fueling inflation).. Thus, the tariffs will not be “punitive” for China, as Trump seems to believe. Instead, the main effect will be to hurt US consumers and businesses, just like an increase in sales tax.
.. Where will the competitively priced imports that undercut China come from?
In most cases, the answer will be other emerging economies. Some low-end goods such as shoes and toys will be sourced from Vietnam or India. Final assembly of some electronic and industrial machinery may relocate to South Korea or Mexico.
.. But this should have no effect on Chinese growth, employment, or corporate profits if demand management is used to offset the loss of exports. The Chinese government has already started to boost domestic consumption and investment by easing monetary policy and cutting taxes.
.. In principle, China can avoid any damage at all from US tariffs simply by responding with a full-scale Keynesian stimulus. But would the Chinese government be willing do this?1
This is where bipartisan US support for a “containment policy” toward China paradoxically works against Trump. China’s rulers have so far been reluctant to use overt demand stimulus as a weapon in the trade war because of strong commitments made by President Xi Jinping to limit the growth of China’s debt and to reform the banking sector.
.. But such financial policy arguments against Keynesian policy are surely irrelevant now that the US has presented the battle over Trump’s tariffs as the opening skirmish in a geopolitical Cold War. It is simply inconceivable that Xi would attach higher priority to credit management than to winning the tariff war and thereby demonstrating the futility of a US containment strategy against China.
.. This raises the question of how Trump will react when his tariffs start to hurt US businesses and voters, while China and the rest of the world shrug them off. The probable answer is that Trump will follow the precedent of his conflicts with North Korea, the European Union, and Mexico. He will “make a deal” that fails to achieve his stated objectives but allows him to boast of a “win” and justify the verbal belligerence that inspires his supporters.
Trump’s surprisingly successful rhetorical technique of “shout loudly and carry a white flag” helps to explain the consistent inconsistency of his foreign policy. The US-China trade war is likely to provide the next example.
What the crisis called for, then, were policies to boost spending, to offset the effects of the housing bust. But the normal response, cutting interest rates, wasn’t available, because rates were already near zero. What we needed, instead, was fiscal stimulus: increased government outlays and tax cuts for lower- and middle-income families, who would be likely to spend them.
And we did indeed get substantial stimulus. But it wasn’t big enough, and even more important, it faded out much too fast. By 2013, with unemployment still above 7 percent, government at all levels was providing barely more economic support than it had in 2007, when the housing boom was still running strong... But the most important reason the great slump went on so long was scorched-earth Republican opposition to anything and everything that might have helped offset the fallout from the housing bust.
When I say “scorched earth,” I’m not being hyperbolic. Let’s not forget that in the summer of 2011 Republicans in Congress threatened to provoke a new financial crisis by refusing to raise the debt limit. Their goal was to blackmail President Barack Obama into cutting spending at a time when unemployment was still 9 percent and U.S. real borrowing costs were close to zero.
.. The very same politicians who piously declared that America couldn’t afford to spend money supporting jobs in the face of a deep, prolonged slump just rammed through a huge, deficit-explodingtax cut for corporations and the wealthy even though the economy is currently near full employment. No, they haven’t abandoned their commitment to fiscal responsibility; they never cared about deficits in the first place.
.. So if you want to understand why the great slump that began in 2008 went on so long, blighting so many American lives, the answer is politics. Specifically, policy failed because cynical, bad-faith Republicans were willing to sacrifice millions of jobs rather than let anything good happen to the economy while a Democrat sat in the White House.