PRAIRIE VIEW, Texas (March 17, 2020) – The novel Coronavirus (COVID – 19), which emerged from China just months ago, has now engulfed the planet earth. Like a category five hurricane, the virus made landfall in the United States somewhat late but packs a powerful punch. The country is now dealing with a full-blown crisis, perhaps much worse than a category five hurricane or another natural disaster.
What is happening in the global business market?
The stock market has unceremoniously crashed, losing nearly a third of its value over a short span of a few trading days. It has been a bloodbath for investors, with equities in all sectors of the economy in steep decline. Those who follow stocks closely will agree that very few sectors were spared in the March Madness on Wall Street. The energy sector took an extra punch from the price war that suddenly broke out between Saudi Arabia and Russia, between the two largest oil exporters in the world. The timing of the price war seems freakish, but the intent seems to be predatory – bankrupt the “new kid on the block” – the shale oil producers in America, mostly in Texas.
Even if miraculously the virus dissipates quickly, something that is unlikely to happen, the damage to business and the economy will be considerable. A slowing in the GDP growth, and very likely a recession (a contraction in the GDP), are likely outcomes. The widespread losses cannot be easily or quickly recouped. Unless the government is able to work with Congress to roll out a package of comprehensive relief, we may be looking at a long economic winter. The Coronavirus crisis is destined to leave its mark on America and the world.
How should we conceptually measure the economic impact of a disaster such as the Coronavirus crisis, which has now mutated into a significant global crisis, officially declared a pandemic by the World Health Organization?
There are a number of aspects one can look at.
- First, one can look at the negative impact on the financial markets. Since the Dow Jones has lost nearly 9,000 points (as of March 12, 2020), one can make the case that we have lost more than $5 trillion in assets [On February 25, a 6.3% loss was estimated to be equivalent to $1.73 trillion]. Some may say this is only a “paper” loss. In other words, you had assets (a small share in a company), which has lost value, and if you don’t sell it, the loss is not real.
- On the other hand, for many investors and savers, waiting is not an option. Many investors and traders use borrowed money [margin] to purchase stocks. They will be getting “margin calls,” and some would be forced to sell their holdings at a much lower price.
- Broadly speaking, for the firms and new startups, raising capital in the money market has just become more difficult. Even though interest rates are at historically low levels, and we are not yet seeing banks in distress, the stunning decline in the value of stocks could trigger major consequences for the “real” economy.
- Indeed, the “Wall Street” and the “Main Street” are interconnected. When one stumbles, the other often finds itself in distress. No wonder the Fed has made a few aggressive precautionary moves, more recently pumping nearly $1.5 trillion into the bond markets to ensure adequate liquidity.
In the long run, the negative impact will percolate through the economy causing bankruptcies, reduced investments, reduced spending, and, in turn, impacting employment and incomes. The economy could very well contract and end up going into a recession. Economists measure recessions in terms of trends in GDP growth. Two consecutive quarters of negative GDP growth officially herald a recession.
The economists and the government agencies measure the GDP (total output) using a concept known as Aggregate Demand, which equals the sum of total spending, including net spending by foreigners (exports minus imports). The major components of this spending are the consumers (roughly 60% -65%), followed by businesses (roughly 15%) and government (roughly 20%) and net exports (roughly 1%, but can be negative). The crisis will certainly reduce consumer spending as they practice social distancing and stay away from travel and major events. The negative wealth effect from declines in stocks may also put a damper on consumer spending. The business investments are also likely to suffer, given major disruptions in the global supply chain, and impending fears of a slowdown. The net exports will likely decline since massive disruptions to global commerce. The government can step in to offset these declines by massive spending, but that depends on how well the President works with Congress.
Using the supply-demand tool, much beloved by the economists, if one can envision the production side of the economy captured by the aggregate supply curve, and the consumption side of the economy by the aggregate demand curve, we can further this analysis. Normally, the aggregate supply and aggregate demand in the economy are at an “equilibrium,” where the two curves intersect, indicating a point of stability where the level of output and the price (at which each unit is bought or sold), have come to rest. In an infectious disease created crisis, like the one we find battling today, the initial impact is on the supply side, given the disruption in the global “supply chain.” This was caused by forced freezing of economic activities in Wuhan, China, considered by some to be the epicenter of global manufacturing. As a result, the cost of producing goods suddenly went up as factories were idled – given the sudden and unexpected nature of this event, this is appropriately called a “supply shock.”
If this were a natural disaster, the supply shock would be the major shock to the economy. After the storm passes, gradually as economic activities resume – humans are remarkably resilient species – the impact of the shock dissipates overtime. Unfortunately, in the current crisis, we have to also account for the demand side of the economy. Given the enormous loss of wealth from declining stocks – perhaps in many trillion dollars – those who own stocks, whether directly or indirectly through 401K accounts and pension funds, will suddenly feel less well off. This “negative wealth effect” will cause many to shore up their savings by cutting back on their spending.
What caused the meltdown in the global stock markets? The great fear of an economic meltdown – not just the financial markets, but the real economy – possibly triggered panic among investors, many of whom were over-leveraged and somewhat complacent as happens at this stage of a long and historic bull market. As a result, everyone rushed for exits at the same time. The effect of a generalized panic among investors is much akin to a “run on the bank,” which can destabilize or bankrupt even the healthiest banks. Once investors panic, the decline becomes self-filling. But then again, we should not blame the traders. Perhaps much of rapid sell-off is algorithm-engineered-selling.
Munir Quddus, Ph.D.
To sum, the decline in GDP as measured by Aggregate Demand will eventually depend on the length and depth of the Coronavirus crisis. It also depends on how quickly government is able to move to offset the expected contraction in private sector demand. This is the time for the government – the executive as well as the legislature – to act in unison. A combined strategy will not only help offset reductions in the private economy, but also provide a much-needed confidence boost for all citizens.
The 2020 Coronavirus crisis once again demonstrates the fragility and interdependence of the global economy and humanity. The lesson of this most recent social and economic upheaval is that we must build bridges and strengthen our alliances in good times, so that in times of crisis as we face today, we can act in unison to battle the common enemy.
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Munir Quddus, Ph.D., is a dean and professor of economics at Prairie View A & M University.