U.S. Economic Outlook — A Slow March Back to "Normal"
Summary:
Coronavirus abruptly ended the longest expansion in U.S. history and things are going to get worse before they get better. This week it was reported that real GDP for the U.S. economy was -4.8 percent, the deepest contraction since 2008. Calls for a V-shaped economic recovery are getting fainter. Despite the rolling out of the CARES Act and another $484 billion in Covid-19 relief funds as well as the Federal Reserve’s raft of liquidity facilities, the recovery is going to be more painful and take longer than most Americans want. That will be seen in gruesome data releases of unemployment claims, manufacturing production and home sales. The Congressional Budget Office is calling for a 40 percent contraction in the economy in Q2, with unemployment hitting 16.0 percent. The return to “normal” is going to be slow and will mean less globalization, reconfigured supply chains, more digitalization, a bigger challenge in managing fiscal deficits and an ocean of debt — and possibly greater political risk. We have our view of where we expect the economy to head, but admit that we are humble in our forecasting. It is a challenge to get one’s arms around the enormous nature of what is happening.
First quarter U.S. economic activity was worse than many forecasters had expected.
Considering the critical nature of the consumer to the economy, the Department of Commerce’s 7.6 percent decline in consumer spending from January through March provided a hint that things were going to be bad. Reflecting the dire nature of the contraction, healthcare accounts for 40 percent of the fall in consumption, with transportation, recreation, and food services and accommodation experiencing sharp declines. The current 4.8 percent contraction will likely be updated, showing a larger contraction as more data is added.
The U.S. economy is likely to see a substantial contraction in economic activity in the second quarter of 2020, but will see recovery begin in Q3 and, barring another round of the virus, gain momentum. Estimates for the year vary, with the IMF calling for a 5.9 percent contraction; Standard & Poor’s looking to -5.2 percent, Bank of America at -10.4 percent, and Wells Fargo at -2.3 percent. Smith’s is forecasting a 5.5 percent contraction for 2020, with a 4-5 percent rebound in 2021. We would add to this that different parts of the country are going to bounce back faster than others.
The problem is that the U.S. economy is being hit by a shutdown in both supply and demand.
The problem is that the U.S. economy is being hit by a shutdown in both supply and demand. Although parts of the economy are actually experiencing growth, most of the economy has gone dormant. The world of retail has been largely closed down; many manufacturing plants are down to skeleton and maintenance crews, and demand has died – for now. There is considerable speculation that when the U.S. economy re-emerges from the recession, the consumer will be more cautious (which hurts entertainment and hospitality sectors) and more geared to saving than spending. The expected spike in unemployment has signaled for many Americans that they need to build up a cushion in their finances.
At the same time, the U.S. economy is undergoing a number of important structural changes. While the Great Recession (2008-2009) led to a critical reassessment of globalization, it was not until the Trump administration that the process of de-globalization became a core element of U.S. policy1. This was pursued by pulling out of the Trans-Pacific Partnership, using tariffs against both friends and foes on a number of products, forcing Canada and Mexico to renegotiate the North American Free Trade Agreement (now called USMCA), launching a bruising trade war with China and consistently threating a major trade war with Europe. At the same time, the aggressive stance of the Trump administration on the risks of global supply chains, many of which stretched out to China, demonstrated the problematic nature of relying too much on the outsourcing of important products, such as hospital equipment and pharmaceuticals. Part of the emerging new normal will entail the movement of production facilities closer to home, either in the U.S. or Mexico or perhaps Central America and the Caribbean. Over the long term this could help reduce the unemployment number in the U.S.
While many U.S. companies are coming to terms with the probable end of China as a global manufacturing hub, the advance of digitalization has greatly accelerated with coronavirus. This will most likely be a net gain, but there remains a considerable amount of work to be done in many sectors. This includes agriculture.
Although there are rising concerns about food security in the U.S., it is expected that some of the mismatches that occurred between production and distribution (between farms and large customer restaurants and schools or between farms and grocery stores and food banks) will be worked out. Digitalization can go a great distance to reduce the current imbalances in the food sector, though the disruption currently taking place in the agri-business and food sectors has sent a chill in American society long accustomed to access to different types of cheap food. The images are almost contradictory, U.S. milk suppliers dumping milk, while food banks are turning away people. The reality is that one part of the demand side for agri-goods has collapsed (restaurants and hospitality) and in another part (home food making) demand is up. This is a major adjustment and a greater use of technology can make a difference in getting food from the farm to the consumer more smoothly.
Digitalization of the American economy is only going to accelerate. We have witnessed a rapid increase in the use of telemedicine, tele-banking and e-commerce, distance learning as well as an advancement of usage in the 55 years and above age group. The penetration of that demographic is probably permanent and broadens market possibilities.
The other major factor hanging over the U.S. economy is the growing mountain of debt (see table below). According to the Federal Reserve Bank of St. Louis, as of year-end 2019 total U.S. federal public debt stood at $23.1 trillion (up from $19.97 trillion at year-end 2016). It is set to rise considerably following the recent stimulus packages passed by Congress. The money is needed to soften the blows from shutdowns of businesses and to reach out to millions of Americans suddenly set adrift economically. That includes many state and local governments working hard to maintain public services in the face of greater demand and lower revenue inflows.
Related to this is the widening of the U.S. fiscal deficit. According to a new projection by Moody’s, the addition of new stimulus spending on the part of the U.S. government “along with materially weaker revenues and growth” will propel the fiscal deficit from 4.6 percent of GDP in 2019 to over 15 percent this year. That means more Treasury bonds will be issued to cover the difference (one estimate put the amount at $3 trillion). It also puts more pressure on policymakers to do what they can to jack up economic growth.
Adding to the mix of things to be considered is whether the federal government, if the need arises, will be in a financial position to help bail out state governments, which of course has political implications? The political side could become more manifest if future administrations opt to raise taxes, both corporate and personal, to return public finances to a more prudent path. The other option would be to let U.S. state and local governments go bankrupt, which would raise both legal and political questions.
Along the same track of debt management, what happens to sovereign ratings? Moody’s rates the U.S. sovereign at Aaa, S&P at AA+ and Fitch at AAA. How long will it take the U.S. to bring its debt back down below 100 percent of GDP and fiscal deficit to a more manageable number? Thus far the rating agencies have been cautious, but if the recovery becomes more W-shaped or L-shaped, pressure for a downward revision could be in the cards.
Another factor that must be considered in how the economy is managed and performs is the potential for greater political risk. 2020 is an election year, which usually elevates political differences. Although the passage of large stimulus packages through the U.S. Congress reflected a high degree of bipartisan behavior, there remain very strong differences, especially around the person of the president, who is a controversial and divisive figure. There has been some discussion that in the case of a second round of coronavirus in the fall elections might be postponed. Considering that elections were held in the middle of the U.S. Civil War and both World Wars, it would be difficult to make the case; postponement could also set off social unrest. Any such unrest would certainly complicate the economic policymaking environment.
The U.S. economy is undergoing one of its worst recessions since records have been kept. Unemployment is set to skyrocket and the ranks of small and medium-sized businesses are set to be thinned. What comes out at the other end of the crisis will be different; the challenge will be to take hold of more positive trends and deepen their impact on the nation’s productivity. The U.S. will need any positive developments from the crisis to deal with the massive debt burden that has been created. Failure to find a sustainable path out of the debt could well set any recovery on unstable ground, setting the stage for another stumble, leaving the 2020s to look more like the rollercoaster-like 1930s than the roaring 1920s.
- For many critics of globalization free trade, outsourcing, and high CEO pay led to wage stagnation, underemployment, economic precariousness and record inequality in advanced economies. For the U.S. it came at the cost of losing 5 million jobs.
