With Californians sheltering in place due to coronavirus, Cal State Fullerton economists Anil Puri, director of the Woods Center for Economic Analysis and Forecasting, and Mira Farka, co-director of the Woods Center and associate professor of economics, presented an April 22 virtual spring forecast.
Looking at the impact of coronavirus and related disruptions on the national and local economies, the two economists anticipated unprecedented declines in gross domestic product (GDP), employment and consumer spending during the second quarter of 2020, but a recovery that will erase much of the damage by the end of 2021, assuming the virus follows the anticipated trajectory and no massive flare-ups occur.
“Making a prediction is both an art and a science,” said Puri. “It is a difficult task under the best of circumstances. In a time like this, one thinks of Yogi Berra, and his famous quotes: ‘It’s tough to make predictions, especially about the future,’ and ‘The future ain’t what it used to be.’ So it’s not only a tough task but the future may be quite different from the recent past. The virus has been like a ticking bomb or wildfire that has gone throughout the world.”
What comes next will largely depend on the rapidity of the recovery – and how the crisis will be treated by businesses. Farka used the example of Hurricane Katrina in 2005, which, to date, is modern America’s costliest and deadliest natural disaster, as a local prototype of what may occur nationally with coronavirus.
“If businesses treat this as a natural disaster, then the effects will most likely be temporary and disappear quickly. But there are cases when bigger natural disasters reveal bigger cracks in the systems, such as Hurricane Katrina, when employment took three years to get back to the pre-Katrina level in Louisiana,” recalled Farka. “We think the COVID-19 shock will follow a Katrina-like pattern and not only reveal cracks in the systems that have been there for a while – such as high levels of corporate debt – but more importantly, we don’t know the duration of this disaster.”
Coronavirus Upends the Global Economy
While the Woods Center’s forecast of a 1.8% rise in U.S. GDP for 2020 as presented in the last economic forecast in October 2019 seemed reasonable during the first month and a half of the new decade, conditions began to change in mid-February, when stock markets reacted to the novel coronavirus’ spread in Italy, South Korea and other industrialized nations, creating a crisis without precedent in recent memory.
“Coronavirus has caused such devastation in terms of human toll and economy that the whole world has come to a standstill, like a medically induced coma, and there is no precedent for that,” said the forecasters.
Though much remains unknown about the disease’s course and its related economic impact, the economists relied on what is known: The virus has a much higher fatality rate than ordinary influenza and limitations on testing in the U.S. and globally create challenges in understanding the true extent of its impact. In cases and deaths, the U.S. has followed a trajectory similar to hard-hit European nations, such as Italy, though the totals in absolute terms have been much higher in the U.S., due to the larger population.
New York state has been worst hit, with other hot spots in Louisiana, Michigan and New Jersey, while California’s curve has been much lower, likely due to earlier aggressive action to stem the virus’ spread.
Locally in Southern California, Orange County appears to have weathered the storm better than nearby counties.
“Orange County has been able to do better, with the curve bending faster and quicker, so the number of cases is smaller and smaller every day. The number of deaths, too, is smaller,” said Puri.
Looking at the demographics worst impacted by coronavirus, Puri noted that men seem to be at higher risk than women, and that cases and deaths are highest among older adults.
Examining the S&P 500 index – widely considered one of the best barometers of the economy – the economists noted that the declines thus far are not as large as the 85% drop during the Great Depression of the 1930s, the 57% decline during the Great Recession of the late 2000s, or the 55% setback in the mid-1970s, but the rapidity of the drop, reaching a tentative bottom on March 23 with the passage of the CARES Act recovery package, is among the most severe on record.
Oil prices have also been in free fall as demand has dried up amidst coronavirus. On April 20, U.S. crude prices even fell into negative territory for the first time.
The Great Disruption
In keeping with the terminology of the Great Depression and Great Recession, Farka dubbed the current crisis the Great Disruption.
She noted that unlike previous downturns, the cause is largely outside of economics, and thus the solution will be as well.
“If there is a small measure of solace, a smidgen of silver lining, it is that for once, this crisis cannot be blamed on economists. This is not something we missed or failed to foresee. This is a public health crisis, not an economic crisis. Unfortunately, the longer it goes on, it will be an economic crisis,” she said.
While initially a supply shock, as governments took drastic action against the virus, including shutdowns in all but five U.S. states, the situation has expanded into a demand shock as well, as unemployment claims have shot up from the relatively low levels of 230,000 to 240,000 weekly during the first 10 weeks of 2020 to nearly 7 million in the past three to four weeks.
Grimly, Farka reported that it has taken four weeks to lose the 22 million jobs gained over the past decade since the Great Recession, though it is likely that many of these workers are furloughed, and many – but not all – will be rehired when coronavirus restrictions ease.
In divining the scale of the drops in both GDP and employment, Farka examined the size of the sectors deemed non-essential by authorities in which work cannot be done remotely, and deduced that a loss of 32% of GDP is occurring, or about $580 billion per month, and about 45 million American jobs are at risk, including 1.13 million in Los Angeles County, 420,000 in Orange County and 520,000 in the Inland Empire, more than twice the totals during the Great Recession.
Farka said maximum U.S. unemployment will likely reach 17.4% in May 2020, which would be the highest number nationally since the 1930s. But by the end of 2021, the jobless rate will likely be about 6.2%.
The Woods Center’s quarterly Orange County Business Expectations Survey – polling local business leaders on their expectations for the Orange County economy – revealed a decline of 75% in sentiment on the index from the beginning of 2020, with half anticipating staff cuts.
The Cal State Fullerton economists are following a baseline scenario in which a slow reopening begins in the late May to June timeframe, with therapeutic drugs available by late summer, a vaccine for coronavirus sometime in 2021 and a possible second wave during the colder months of 2020-2021.
“We assume the grand reopening will be fitful, partial, fragile and non-synchronous, with different places opening at different times, and reopening under strict conditions, such as more testing, social distancing and restrictions on large gatherings,” said Farka.
The Policy Response and the Deepening Crisis
Looking at federal policymakers’ response to the coronavirus crisis, Puri noted a more rapid adoption of measures than in the wake of the Great Recession.
“The response has been swift, broad and substantial,” he said. “Unlike during the Great Recession, when fiscal stimulus took months to pass, Congress passed three acts in rapid succession.”
Thus far, there have been three waves of measures: First, an $8.3 billion bill focused on public health and testing; secondly, a $172 billion measure focused on workers and families, including measures such as paid family and medical leave and expansion of unemployment and Medicaid programs; and the third, a $2.3 trillion package and the largest stimulus bill since World War II, providing relief to large corporations, small businesses, stimulus checks to individuals and businesses, and a further unemployment benefits expansion.
While stimulus measures in 2008-2009 amounted to 5.9% of GDP, the current measures reach 10.5%, and have been coupled with strong action by the Federal Reserve.
“The Fed has also gone all in, springing in to aggressive action, not only adopting policies used during the financial crisis, but expanding and extending programs in a way we have never seen before,” said Puri.
Interest rates have been slashed to nearly zero, quantitative easing established after the Great Recession has resumed and forward guidance has been issued for near-zero interest rates until the economy recovers.
While the Fed’s actions are helping to unclog funding, small businesses and at-risk workers still need more support, which makes a phase-four fiscal policy package likely, focused on extensions of small business payroll protection, unemployment benefits, and relief to state and local governments.
“It is incorrect to call these stimulus packages, these are more like support packages, for immediate needs. Much more will be necessary down the road,” he said.
One area where a bounce back might not occur immediately is consumer spending, which Farka and Puri forecast to decline 29.2% in the second quarter, dwarfing the previous record decline of 11.5% in 1950. However, pent-up demand will likely create the strongest increase in record during the third quarter, though consumption probably won’t reach pre-COVID-19 levels until the end of 2021.
This could be devastating to small businesses. According to a survey from the National Federation of Independent Businesses, 50% of such enterprises can only operate for two months or less without revenue, with a further 31% surviving from three to six months.
“Even if we reopen, the fact that we are reopening with six-foot social distancing, rebooting many businesses will be very difficult, since they may have to operate at 50% capacity,” said Farka.
Making matters worse, corporate debt is about 75% of GDP, the highest level historically, which Farka described as a “brewing crisis” even before coronavirus made its entrance, as corporations have doubled their rate of new bond issuance since the Great Recession compared to before 2008, taking advantage of low interest rates.
On the positive side, banks are well capitalized, with a $1.9 trillion buffer and a $2.7 trillion liquidity buffer.
“The banking system is in a much better place than in the financial crisis of 2008-2009, so the banking system could be part of a solution rather than part of the problem,” said Farka.
The Impact on Real Estate
Unlike the Great Recession that was strongly focused on a residential real estate collapse, Puri and Farka predicted that the commercial market would be hardest hit this time around, as businesses close and many establishments turn increasingly to remote work.
“This is a tough time for real estate, especially for the commercial market,” Puri said. “In the last three weeks, mortgage applications have sunk in California, New York and Washington state, where lockdown procedures were implemented before anyone else did.”
Though a total of $125 billion worth of mortgage and rent payments come due every month in the U.S., creating a dire situation in light of uncertain incomes, the federal government’s provided mortgage forbearance, combined with rent collection freezes in many cities, offer hope of avoiding a housing crisis.
Still, Puri and Farka expect that housing prices will be negatively impacted through 2021 before heading up slowly, while commercial real estate prices experience a more severe decline.
This housing market downturn follows a strong showing during much of the first quarter, at least in Southern California.
“This virus will take the steam out of the engine, and we expect prices to decline for the year as a whole, before a slight upward movement next year,” said Puri.
Better Times Ahead
Despite the current turmoil, Puri and Farka are hopeful that the U.S. economy will eventually recover and return to economic growth, with the current decline following the pattern of previous depressions and recessions in American history that gave way to an overall pattern of growth, rather than a state of protracted collapse.
“America being what it is, we have strong belief that we will come back, and come back stronger,” said Puri.