The National Bureau of Economic Research (NBER) said recently that the COVID-19 pandemic pushed the American economy into recession in February, ending the nation’s longest-running economic expansion in history – one which had lasted ten years and eight months.
According to a June 8 World Bank forecast, economic growth in the US will slow down to -6.1% in 2020 – down 7.9 percentage points from the previous January forecast – due to COVID-19. After the global financial crisis of 2008, the US embarked on a decade of economic expansion fueled by massive fiscal borrowing and unconventional monetary easing, but it did not emerge from low growth. Lawrence Summers, a Harvard professor and former World Bank chief economist, said in 2013 that America may go into secular stagnation. IMF data showed that after the global financial crisis, growth in the developed West, including the US, was much lower than it had been in the same period after 1929.
At the end of 2017, the US Congress passed the Tax Cuts and Jobs Act which led to massive tax cuts. Yet short-term stimulus failed to boost sustained economic growth. The US economy grew by 2.3% in 2019 (down from 2.9% in 2018), falling short of Donald Trump's 3% growth target for the second year in a row. It was also the lowest growth since 2016. In the midst of destructive trade tensions with other countries, corporate investments fell further. The COVID-19 pandemic applied a sudden brake to the long boom. To overcome the crisis, the US Federal Reserve has bought US$2.1 trillion in treasury and mortgage bonds to pump liquidity into the financial markets and launched a US$2 trillion fiscal stimulus package to prevent the economy from plunging into a deep recession.
Impact of COVID-19 will be felt across the board in the second quarter
The latest figures showed the pandemic’s impact on the job market. The unemployment rate rose to 14.7% in April, the highest since the end of World War II. Since March, 33 million Americans have for the first time applied for unemployment benefits. Due to statistical delay, the April unemployment rate was assessed on the basis of data up to mid-April and perhaps did not reflect the full extent of the job crisis. The unemployment rate is expected to peak at 19% by the end of the second quarter, according to Bank of America. However, broader unemployment measures suggest that the real unemployment rate is probably already above 20%, well above the published figures.
Meanwhile, US exports fell a record 20.5% in April while imports and exports both fell to their lowest levels in a decade. US imports fell a record 13.7% in April, the lowest since July 2010. Trade deficits increased by 16.7% in the month. Many of the economic indicators will visibly rebound with restart of the economy and accelerated production resumption. However, the rebound is not expected to last or lead a V-shaped recovery. The Congressional Budget Office forecasted an annualized GDP decrease of 38% in the second quarter. In other words, the COVID-19 pandemic has almost wiped out all the GDP growth in the past four years. The real GDP is expected to fall back to the end-of-2017 level.
Balance sheet deterioration and tail risk surge
As the pandemic continues, the US$2 trillion US government bailout will be quickly exhausted. Without a new recovery plan, many American households and businesses will be at risk of bankruptcy. The fiscal stimulus package has been expected to basically keep households and businesses alive for only three months. With its expiry approaching and a new bill possibly blocked in the Senate, implementation of additional stimulus may well be delayed, which will further slowdown the economic recovery process and incur new tail risks.
First, the corporate sector's balance sheet is deteriorating at an accelerated pace. US non-financial corporate debt soared in the first quarter to its highest level since 1952, data showed. In the COVID-19 pandemic, many companies have been struggling for liquidity, leading to a surge of bank lending and corporate bond issuance. Data suggests that the number of zombie businesses is at an all-time high due to low interest rates and a massive liquidity injection. According to the Institute of International Finance, defaults on non-financial corporate bonds jumped to US$70 billion dollars in the second quarter – the highest level on record– with US companies accounting for two-thirds of it.
Second, the Fed's balance sheet and government debt are at all-time highs. UBS forecasts that the Fed's balance sheet, at US$7.2 trillion, will continue to climb and could top US$8 trillion this year. The fiscal position is even worse, with recession and fiscal measures leading to a huge build-up of deficits. The federal budget deficit hit US$399 billion in May, up 92% year-on-year, as the result of a combination of significantly lower tax revenues and huge overspending. The US fiscal deficit is expected to reach US$3.7 trillion in fiscal year 2020, 276% higher than the previous year and well above the record US$1.41 trillion of fiscal 2009. Systemic financial and debt risks are thus accumulating at an accelerated pace, with higher interest rate increase risk and US dollar risk. Debt risk transfer will also become a policy option.
Third, local governments may pass on the burden to enterprises through tax increases. According to a new report from Arizona State University, tax revenues will fall by more than 30% in at least 10 states as a result of the COVID-19 pandemic. State tax revenues are expected to fall by an average of 20% and New York State by up to 40%. To help address the shortfall, California is imposing higher taxes on businesses. Budget shortfalls are forcing state and municipal governments to cut jobs and spending. Congress, on the other hand, is deadlocked over providing more aid to states to fill the funding gap. Competition between the government and businesses for sources of revenue could, therefore, become the ‘new normal’.