Corona Virus Chronicle (IX) - This could be a very long and painful recession.
The coronavirus pandemic has the potential to cause ‘one of the biggest economic shocks ever experienced, eclipsing the shocks of 1929 and even 9/11’.
The coronavirus pandemic has the potential to cause ‘one of the biggest economic shocks ever experienced, eclipsing the shocks of 1929 and even 9/11’. That is the view of Gabriel Mathy, an economist at American University in Washington, DC, and a specialist in macroeconomics and the Great Depression.
In an essay published on Monday, Mathy argued that the disproportionate toll the looming downturn is set to take on services means it ‘will be different’.He noted that in previous recessions ‘services [have been] basically acylical’, as they cannot be stored and so must be consumed.‘You can drive that old car a little longer, but your hair keeps growing in a recession,’ he wrote ‘There are furloughs of auto-manufacturing workers during every recession, but barbers have not been furloughed – until now.’He pointed out that in the 1981 to 1982 recession services actually rose in real terms. And while the Great Depression did see a decline of approximately 20% in services in the years up to 1932, this was much lower than the more than 70% drop in domestic investment over the same period.
But given that ‘services, by their very nature, largely involve human interaction’ a pandemic will mean that ‘sales in the service sector will collapse due to social distancing.’
‘While people’s hair will continue to grow, we may see many bankruptcies among barbershops and hairdressers as people cut their own hair to avoid infection. If people cut their hair at home, there won’t be much effect of pent-up demand to cause demand to surge once the pandemic recedes. ‘This is very different to what we see in basically any recession in modern experience.’
With 130 million workers in the US’s service sector, making up 86% of non-farm employees, a recession which starts with a shock to the services sector is likely to have a ‘devastating’ impact on employment. This in turn will lead to people cutting back on purchases of goods, while firms will dial back on investment due to being left with excess capacity and air plane manufacturers such as Boeing will be hit as demand for air travel dives. Mathy argued the response to this vicious circle ‘should not be to stop GDP from contracting’, as this is a necessary consequence of social distancing, but helping businesses to continue ‘without massive layoffs’ and a payment to individuals to support demand. He concluded: ‘Once the epidemic recedes then the standard stimulus measures can be applied.
‘Monetary policy is constrained by being close to the effective lower bound to interest rates at or near zero. Federal debt levels are perceived to be high, limiting the fiscal response, which was already disappointing in the last recession.
‘This could be a very long and painful recession.’
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About the Author
Peter Smart, Head of Investments
Peter has been involved in investment markets since 1985, working within the private client areas of two global banks and for 22 years as the fixed income specialist for the UK Wealth manager, Brewin Dolphin. More recently Peter formed part of the investment team at bridport in Jersey specialising in the provision of specialist, income focussed portfolio’s.