The historic economic data reported on Thursday confirmed the enormity of the second-quarter blow suffered by the global economy and the challenging road ahead. It comes when Congress in particular remains divided about how to support relief and reform policies.
The longer lawmakers delay, the greater the risk that the stalled economic recovery will lead to a significant spike in unemployment and more business closings that would spread contractionary ripples to the rest of the global economy.
According to the data released on Thursday morning, U.S. gross domestic product contracted by an astounding 32.9% when annualized in the second quarter. This far exceeds both the worst quarter of the 2007-09 recession (an 8.4% fall) and the previous record set in 1958 (a drop of 10%) for this data series. Once again, economists and Wall Street analysts are rushing to recalibrate the Y-axis for the country’s historical growth data. And the U.S. numbers are not the only reason — data coming out of Europe earlier Thursday are also having the same effect.
The initial hope had been that the brutal March collapse in U.S. economic activity would be followed by a sharp recovery in the second and third quarters that would minimize the risk of short-term dislocations becoming deeply embedded problems that would be harder to solve in the long term. This hope for a quick V-shaped recovery has been increasingly called into question in recent weeks by high-frequency indicators that measure economic engagement. It is now being undermined even more strongly by the weekly jobless claims number released Thursday, which showed a deterioration in both initial claims (an increase to 1.43 million) and continuing claims (an increase to 17 million).
All this sends a clear message to Congress — and one that, judging from the extremely dovish tone Federal Reserve officials took on Wednesday, the central bank has fully incorporated: As deteriorating health conditions have forced more states either to halt or reverse their economic reopening plans, the balance of risks to the U.S. economy has shifted in a markedly unfavorable way in the past couple of weeks.
If Congress fails to act, a number of economic forces would risk combining in a negative self-reinforcing loop. For example:
- Consumption would take another hit, especially as the expanded unemployment benefits end.
- Business investment would fall in response to poorer demand prospects.
- A growing number of companies would face higher bankruptcy risk.
- State and local governments would experience even less revenue coming into their coffers, forcing them to cut spending even more and lay off workers.
In turn, such a combination would erode the effectiveness of the Fed’s continued exceptional liquidity support for markets, making valuations more vulnerable to sharp and sudden declines. If all this materializes — and it is still an “if” given the ability of policies to counter the mounting risks — the U.S. would face a considerable triple threat to the high, sustainable and inclusive growth needed for longer-term prosperity: that is, a mix of increasing household economic insecurity, lower productivity and more episodes of pronounced financial instability.
The hit to the rest of the world would extend beyond losing an important engine of global growth for a longer period. Protectionist pressures would increase, fueling an already tense set of bilateral trade and investment relations, particularly between China and the U.S. Global policy coordination would become even less likely. The debt service challenges facing developing countries would increase, with some defaulting. And all this would risk increased fragmentation of an already structurally vulnerable economy.
After protracted negotiations, the members of the European Union found a way last week to agree on a potentially transformational fiscal action. In doing so, they strengthened not only their short-term crisis response but also put in a place an important foundation for fiscal harmonization that, unlike the monetary union they achieved, has long eluded them despite being critical to the EU’s joint objective of ever closer integration.
U.S. lawmakers need to react appropriately and urgently to the challenges facing this country, and not only by approving soon a bill that maintains relief efforts and reinforces the potentially self-reinforcing relationship between lower health risks and greater economic activity during this period of “living with Covid.” They also need to materially strengthen over time the other two policy responses I detailed in my previous Bloomberg Opinion article — countering long-term downward pressures on productivity and limiting the rise in household economic insecurity — which are needed to ensure that we end up both winning the war against a depression and securing a peace of longer-term, inclusive socioeconomic prosperity and genuine financial stability.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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