COVID-19 To Cause Significant Contraction In Q2 Economic Activity – Here’s Why

Lorimer Wilson March 2, 2020 1 Comment 1,282 Views

…A significant contraction in U.S. economic activity in the second quarter of 2020 is highly likely. Furthermore, a bear market in US equities, associated with this U.S. contraction and a broader global recession, is highly likely…

An Economic Contraction is Virtually Certain in 2Q 2020

Various areas around the U.S. are currently on the verge of major outbreaks, and these actual and potential outbreaks already are having serious economic impacts. These impacts will only grow in the next few months.

…[Below are] the factors that will drive a U.S. economic contraction in 2Q 2020.

1. Global economic recession

…A global economic recession driven by severe recession in China is now a certainty…[and it] will have major direct and indirect spill-over impacts on the U.S. economy, via supply, demand and impacts on the financial system.

2. Investment freeze

As a result of disruptions in both supply and demand, producers and entrepreneurs will cancel or otherwise postpone planned investments:

A collapse in non-residential investment expenditure will likely subtract 1.0% to 1.5% from GDP in 2Q 2020. The only real question is: How severe or for how long?

3. Manufacturing contraction

Major global supply chain disruptions, particularly out of China, will induce a major contraction in activity in the U.S. manufacturing sector – and all of the economic activity which is associated with U.S. manufacturing production. This will have several impacts:

…[It] will severely lower sales of manufactured goods in the U.S..
…there will be substantial layoffs in the manufacturing sector associated with idled production.

…It only takes one missing part to grind the entire mass production line of a manufacturer to a halt [and] this, in turn, impacts both the upstream and the downstream businesses that depend on U.S. manufacturing:

The direct and indirect impact of U.S. manufacturing on the U.S. economy amounts to about 30% of GDP.
In a relatively benign scenario, I estimate that the (non-investment) supply-based and demand-based shock emanating from the manufacturing sector will not subtract less than 2.0% of GDP in the second quarter. This would be a best-case scenario.

4. Service sector contraction

“Social distancing” will be the new catch-phrase for 2020. Conventions, business gatherings, concerts and sporting events will be cancelled:

companies and individuals will drastically reduce travel and all associated consumption in the hospitality industry.

The magnitude of the hit to U.S. consumption activity depends on the extent and breadth of the spread of COVID-19 in the US. However, in a best-case scenario,

I estimate that overall service sector final expenditure will contract by at least 3%, implying roughly a 2% hit to GDP.

5. Imports and exports

U.S. exports will collapse in the third quarter of 2020 due to the decline in global demand and due to the disruption of global supply chains.
imports also will collapse due to supply chain issues [and, as such,] the net “accounting” impact on GDP from net exports is difficult to estimate…

6. Relative price distortions

The prices of many goods will decline due to the collapse in global demand.
However, due to supply chain disruptions, the prices of many goods will increase – in some cases, very substantially.
The resulting relative price disruptions will cause serious economic problems for businesses.
Price distortions also will have deleterious effects on both business and consumer confidence…

It should be noted that I fully expect:

aggressive fiscal and monetary policies…by the Fed (rate cuts and QE) and
massive expenditure bills to be passed by Congress and signed by the executive…
[and] that these measures will somewhat offset the contractions in investment and consumption caused by COVID-19 supply and demand shocks…
[but that] they will certainly not prevent a contraction in economic activity in the second quarter. For example, no amount of fiscal or monetary stimulus is going to persuade consumers to go to cinemas, restaurants and shopping malls in areas impacted by COVID-19. These measures also will not alleviate supply chain disruptions.

Thus, although the depth of the contraction in 2Q economic activity depends on how severe and widespread the COVID-19 becomes, a significant contraction in 2Q is virtually assured. (Please note that I’m explicitly not applying the “R” word. A recession generally implies a contraction in economic activity that’s more widespread, severe and prolonged than that which we can confidently estimate going forward based on our limited estimations related to 2Q 2020.)

Editor’s Note: The original article by James A. Kostohryz has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

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