The coronavirus pandemic may cast a longer economic shadow on the US than policymakers think

Mass vaccination does not provide immunity against longer-term economic damage. And research on major pandemics dating back to the 14th century suggests that Covid-19’s impact on the US economy is likely to be far-reaching and profound

Stephen Roach

Published: 1:30am, 23 Dec 2020

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The outlook for economic and financial markets hinges on the interplay between two cycles – the Covid-19 cycle and the business cycle. Notwithstanding the true miracles of modern science that we are now witnessing, the post-pandemic economy is in need of more than just a vaccine.

Extraordinary damage was done by last spring’s lockdown. Now, a second and more horrific wave of the coronavirus is at hand – not dissimilar to the course of the 1918-20 influenza outbreak.

In the United States, the adverse economic repercussions are evident in mounting jobless claims in early December and a sharp decline in retail sales in November. With partial lockdowns now in place in about three-quarters of US states, a decline in economic activity in early 2021 seems likely.

The history of the US business cycle warned us of the possibility of a double dip. Eight of the last 11 recessions featured just such a pattern. Yet financial markets still made a big bet on a V-shaped recovery. Investors were lulled into a false sense of complacency by the dead-cat bounce of a 33 per cent annualised surge in real GDP in the third quarter.

But reopening after a sudden stop hardly qualifies as a self-sustaining economic recovery. It is more like a fatigued swimmer gasping for air after a deep dive.

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The source of the coming economic relapse is hardly a surprise. It is the echo effect of the first wave of Covid-19. Despite extraordinary breakthroughs in vaccines, therapeutics and treatment protocols, the second wave is far worse than the first in terms of infection, hospitalisation and death rates.

While the new restrictions on economic activity are not as tight as those last April, they are already having an adverse impact on aggregate economic activity.

The longer-term consequences of the Covid-19 cycle are likely to be more severe. While mass vaccination points to an end to the pandemic itself, it does not provide immunity against lasting economic damage. Recent research on the impact of 19 major pandemics dating back to the 14th century – each with death counts in excess of 100,000 – highlights the long shadow of the economic carnage.

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Real rates of return on “safe” European assets were found to be depressed for several decades following these earlier horrific outbreaks.

The long shadow of the Covid-19 cycle looms as well. In the US, employment is still 9.8 million jobs below its pre-pandemic peak, and consumer expenditure on services has recouped only 66 per cent of the plunge that occurred during the March-April lockdown.

A banner against renters’ eviction is displayed on a controlled-rent building in Washington on August 9. Photo: AFP

A second wave of partial lockdowns will only reinforce dislocations that are now painfully evident in most major US cities, including excess office and public-transit capacity, along with the devastation of hospitality, entertainment and retail businesses.

The permanent destruction to aggregate supply and demand, in conjunction with fundamental shifts in behavioural norms, aligns the long-shadow contour of the Covid-19 cycle with comparable patterns in the aftermath of earlier major pandemics.

The interplay between the short-term dynamics of the US business cycle and the longer-term pattern of the Covid-19 cycle bears critically on the current policy debate. Yet hope is widespread that this time is different – that creative new policy strategies can offer new solutions to old economic problems.

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So-called Modern Monetary Theory supposedly gives the fiscal authorities an open-ended licence to binge on debt. But MMT is neither modern nor a theory. What is new is something far more basic: the supposed death of inflation.

As long as inflation remains subdued, goes the argument, then both monetary and fiscal authorities can ignore the risks of higher borrowing costs and work in tandem in providing relief for a pandemic-stricken real economy. But nothing in economics is forever – not even the death of inflation.

US inflation is hardly immune to further dollar depreciation, given a sharp deterioration in the US current-account deficit, the strengthening of the euro, and the weak-dollar bias of a Federal Reserve that remains wedded to zero-interest rates.

Supply-chain disruptions – reversing the powerful disinflationary forces of globalisation – should also boost underlying inflation. And, of course, there are painful memories of policy mistakes made in the late 1960s and early 1970s, when overly accommodative monetary policy set the stage for a wrenching and lasting acceleration of inflation.

How different is today’s seemingly enlightened penchant for open-ended quantitative easing?

The confluence of the second wave of Covid-19 and a double-dip in the US economy has left US policymakers with little choice but to approve another relief package, this time for US$900 billion. Never mind, argues MMT, if that puts US federal debt on the cusp of exceeding the previous record of 108 per cent of gross domestic product, reached in 1946, in the aftermath of World War II.

Yet back then, the mounting debt overhang was finessed by a reflationary surge in GDP, which caused the debt-to-GDP ratio to plummet to 47 per cent by 1957. “All” it took was a 6.4 per cent average consumer inflation rate from 1946 to 1951. Maybe that is all it will take this time as well. But what might that spell for interest rates, debt service and incredibly frothy financial markets? Don’t look to MMT for an easy answer.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The co-dependency of America and China. Copyright: Project Syndicate