The U.S. economy is in free-fall, perhaps headed for its deepest recession of the post-war era. Typically, recessions are necessary to corrects that build up during an expansion—for example, restoring liquidity, improving savings, purging bad debt, and realigning exorbitant risks. In the economic recovery that just ended, however, there were very few excesses or problems that needed to be addressed. After more than a decade of quantitative easing, liquidity was everywhere; job creation, income growth, and profitability were solid, household savings rates had been the strongest of several recoveries, there was never a major lending or borrowing cycle, banks were not in trouble, debt service was not onerous, no housing bubble or excessive capital-spending surge occurred, and there was not an extreme run by the public into high-risk equity assets.
Essentially, today’s contraction is a “Recession Without A Purpose!” It was not needed to restore a solid foundation for a new economic expansion. Rather, this recession (and probably a very deep one at that!) is simply the inadvertent casualty-of-war from a nasty health bug. To be sure, it will create considerable hardship, and if it goes on long enough it may produce significant economic damage that will be challenging to reverse. However, because of its unique health heading into this recession, should the virus-curve bend in the next couple of months, and if at least a partial restart of the economy is achieved, economic activity could snap-back much quicker than many now fear.
Although U.S. capitalism is effectively shut down, the conditions of the economy just a few weeks ago may still prove important in determining how fast, and how vibrantly, economic activity will eventually be revived. For this reason, it is worth comparing the last couple of expansions to the economic character of the contemporary experience. The economic stoppage at present could have come at a much worse time when vulnerabilities were evident and plentiful. Rather, it is worth recognizing that the latest economic expansion ended in a healthy position, which could meaningfully increase the odds of a more successful revival.
Earlier this year, the unemployment rate had declined to one of its lowest readings of the entire post-war era, consumer confidence measures were near record highs, and job creation and income growth were solid. Moreover, the financial position of the household sector was remarkably robust.
Not only have households built a buffer by accumulating savings during the expansion, but they were also extraordinarily conservative with debt. The household debt-service burden is at a record low of 9.7%, compared to a 12.4% debt burden at the start of the 2001 recession, and 13.2% in 2008. Furthermore, today’s debt burden has been on the decline for three years, while it accelerated before each of the last two recessions.
Admittedly, not all households were in a strong position entering this recession. However, overall, the U.S. household sector appears better prepared for a crisis than it has been in decades (to the extent one can really be prepared for a crisis). Many households have kept debt accumulation particularly low while also building considerable staying power (savings) for the present-day thunderstorm!
While it will not help reduce the current surge in unemployment, the fact that the U.S. job market was extremely tight at the onset of this crisis could speed a “return to work” trend when the spread of the virus eases.
Heading into this recession, job openings exceeded the number of people looking for work by almost 20%! Of course, this is changing quickly as layoffs have surged in the past few weeks and will likely continue climbing in the coming weeks. However, in sharp contrast with the last two expansions, the fact that companies were having trouble finding appropriately skilled workers before this temporary economic shutdown implies, they may be inclined to quickly add to staff once an all-clear signal is delivered.
Certainly, some companies are facing, or will encounter, significant financial challenges during this crisis; but, headed into this recession, U.S. corporations appeared to be in solid financial shape, overall. U.S. companies remained unusually liquid and solvent at the end of the expansion, despite the longest recovery in history.
Heading into today’s recession, U.S. corporations had a shortage of laborers relative to what they needed, had not yet embarked on any major capital spending sprees, were surprisingly liquid, and were using debt at a pace less than one-third to one-half as much as they did in the previous two expansions. Like U.S. households, recent years’ hyper-conservative behavior of U.S. companies may allow for much greater staying power during the present-day crisis.
U.S. corporations and households were in far better shape heading into this crisis than they typically were in the past, and U.S. policy officials have responded quicker and much more aggressively than they have historically. Normally, the likelihood of a recession is widely debated, which often delays and diminishes the implementation of helpful economic policies. As economic reports begin to disappoint, Fed officials and others usually debate whether the evidence suggests a mere slowdown or a recession and what, if any, policy response is appropriate. These debates take time and slow the pace and magnitude of policy support.
That has not been the case in the contemporary crisis. Because this recession is the result of an “announced” economic shutdown, there was no debate about the chance of a recession. Instantly, everyone accepted it was imminent. Consequently, the size and speed of today’s recessionary policy response have been second to none!
The fed funds rate was taken to zero and the 10-year bond yield declined to about 0.5% even before the recession began. By comparison, when the 2008-09 recession started, the funds rate was about 4% and it was not lowered to zero until the end of 2008.
Similarly, the Federal Reserve has quickly and massively boosted quantitative easing in recent weeks, and real money supply growth has exploded to one of its fastest rates in 40 years. The annual growth of M2 money supply is now about 8% versus only 3.5% and 1.5% at the start of the 2001 and 2008 recessions, respectively.
Finally, although there is evidence that growth has weakened of late, U.S. authorities have already passed, and are implementing, a fiscal bomb! With the $2 trillion stimulus package, the U.S. federal deficit as a percent of nominal GDP is poised to reach about 13%—making it the largest in post-war history. This is going to be an awfully deep recession. The only “announced economic shutdown” in U.S. history will lead to a collapse like never before seen. The question is, how long will it last? If the virus curve cannot be bent for several months, then the economy and the stock market are likely to experience an extended period of liquidation and a slow recovery. A prolonged recession will compromise even healthy companies, likely producing damage only time can heal.
However, should the virus curve show a bend in the next couple of months, the recovery in both the economy and the stock market could prove much sharper and faster than many appreciate. Unlike any other recession in U.S. history, households, businesses, and the job market are exceptionally healthy entering this recession; with an unprecedented “policy bridge” in terms of size and speed, the economy could respond much more favorably regardless of the extent to which economic activity temporarily contracts. Consequently, although risk remains high and nobody knows where this is headed, the risk is not one-sided. From here, both bears and bulls alike face great uncertainty.