These fevered times bring back memories. We have not seen such sudden wrenching change in the economy from an external shock since the 1970s / early 1980s. Since then, slowdowns and market disruptions have been financial: the S&L crisis, the European exchange rate mechanism collapse, the Mexican devaluation, the Asia crisis and Russian default, the tech wreck, and, finally, the global financial crisis. We had been spared supply shocks and their sudden disruptions until now.
Along with the oil shocks of that era, this reminds me of another, little remembered, shock, the imposition of credit controls by Jimmy Carter. Those controls, while mild in and of themselves, had a disproportionately negative effect on the economy. Here we have a twofer, the coronavirus is affecting both manufacturing via supply chains and services through announcement effects and fear.
Manufacturing is usually the swing factor in an economic cycle. It is far more volatile than services, many of which are central to our everyday lives. We simply cannot or will not live without them. Diminished demand typically drags down manufacturing. Not this time. The coronavirus or COVID-19 has been affecting manufacturing by disrupting supply chains. iPhone components are not being manufactured and vessels are not sailing.
Manufacturing is more volatile than services. Source: Bureau of Economic Analysis
The virus is affecting and will further affect services, which account for seventy percent of activity in the United States. Services typically undergird the economy even through downturns, are far less cyclical than manufacturing and are less prone to turning negative. The times they did go negative were in the 1970s and 1980s and again in the wake of the Global Financial Crisis (GFC). The earlier period featured two oil shocks, the high interest rates of the Volcker era and the Carter credit controls. Those credit controls consisted of a “voluntary” cap on loan expansion combined with a fifteen percent deposit against certain types of credit. They hit credit card spending hard, less through their direct effects than from the announcement of the program. Consumer spending plunged. People sent cut up credit cards to the White House and berated issuers who still solicited credit card accounts as unpatriotic.
COVID-19, while a real and present danger to our health, is similar to Carter’s credit controls; the dissemination of information about the virus has led to profound effects on travel and other consumer services. It is bringing a series of sudden stops to areas of the economy that are not used to this kind of disruption. Yes, we saw sharp declines in travel after 9/11, but not the unwillingness to assemble or to venture out locally. Some of these strictures are involuntary. A doctor friend has been told by his employer not to be in a group larger than five and my wife’s company is conducting meetings for people who are on premises via Skype.
While COVID-19 is having a real effect on the world economy and on our personal lives, don’t despair. This could be over relatively quickly if the authorities react appropriately and are able to contain it. If the health emergency continues for an extended period, I see a potential risk to highly indebted firms whose cash flow suffers. Such firms will need guaranteed access to bridge financing, rather than the cut in rates the Fed provided. I hope that does not come to pass, but there it is, forbearance, not price, is what I expect will matter.
As for me, I am involuntarily quarantined, having broken my ankle in a mountain biking accident. A blessing in disguise? Who knows?
In the words of Sgt. Phil Esterhaus: “Let’s be careful out there.”
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