Will the US face a depression?

Will the U.S. face an economic downturn, maybe even a depression, brought on by the Wuhan virus?  Optimists say no.  They contend that pent up demand will explode and the economy will come roaring back once the government imposed lock-downs are lifted.  The Treasury and the Fed will do their part to make this so.  The country can expect multiple stimulus projects and abnormally low interest rates for the foreseeable future.  Certainly, this is how President Trump and his economic advisers like Larry Kudlow and Steven Mnuchin see things,

But is it realistic?  The skeptic in me says no.

Take small businesses as one example.  In spite of the bravado, a significant number of them will not recover from epidemic.  Prior to the Chinese virus, many small businesses were operating on the edge.  This is borne out by pre-Wuhan statistics.  For small businesses, 20% fold in their first year, 30% in the second year, and 50% fail after five years.  Finally, 70% of small businesses typically go under in their tenth year in business.  And these numbers are before the draconian lockdowns.  To expect small businesses to come bouncing back is wishful thinking.

Then there's consumer spending.  It typically accounts for some 70% of U.S. growth.  But consumer spending and confidence will not come back to their idyllic pre-pandemic days.  Why?  For two reasons.  First, people's wallets will have been walloped by the Wuhan virus shutdowns.  In addition to the effects of unemployment, consider what the drop in the stock market and low interest rates have done to retirees depending on their savings and 401(k) plans. 

Secondly, people will also realize how vulnerable their jobs can be.  Accordingly, many people will be haunted by a feeling of financial insecurity.  This will cause them to pull in their horns on spending and try to save more. 

Cutting back on spending might be easier to do than commonly realized.  That's because much of what consumers spend money on is superfluous.  To get a handle on the amount, the New York Post estimated that the average American "wastes $18K in "non-essential" expenses each year."  This includes things like entertainment, travel, and a whole host of other goods and services.

Given these numbers, two things are clear.  One, superfluous consumer spending is critical for the economy.  Second, such spending is likely be cut back, given that people will have less money, at the same time fearing for their financial security.  For many households, spending will fall.

The net result will be a noticeable lowering of overall demand.  And when demand softens, so will employment and wages.  This will lead to over-capacity and falling prices.  The Fed's fairy dust can't do much in such an environment.  This is captured in the economic metaphor of "pushing on a string."  That is, loose monetary policies can't stimulate demand if people want to save their money instead of spending it.  And that's assuming that people even have as much money to spend as before.

And then there's the enormous debt that's hanging over the economy.  Nobody seems worried about it.  Everyone should be, as it can't help but be a drag on the economic performance .

It is hard to see the economy getting back to the way it was before the Chinese virus ended the party.  The greatest danger here is that the drop in demand will go through the superfluous and bite into what consumers actually need.  That would result in a political and social upheaval.  Hopefully, that will not be the case.  In any event, the transition to a new paradigm will be painful.  But in at least one way, it might be healthy.  Much of the economic boom the U.S. was experiencing was due to, shall we call it, imprudent consumer spending.  This was fueled by abnormally cheap credit and massive amounts of debt at the government, corporate, and individual levels.  This was not sustainable.  Sooner or later, a change had to be made, and it looks as though the Wuhan virus shutdowns could be the change agent.

Will the U.S. face an economic downturn, maybe even a depression, brought on by the Wuhan virus?  Optimists say no.  They contend that pent up demand will explode and the economy will come roaring back once the government imposed lock-downs are lifted.  The Treasury and the Fed will do their part to make this so.  The country can expect multiple stimulus projects and abnormally low interest rates for the foreseeable future.  Certainly, this is how President Trump and his economic advisers like Larry Kudlow and Steven Mnuchin see things,

But is it realistic?  The skeptic in me says no.

Take small businesses as one example.  In spite of the bravado, a significant number of them will not recover from epidemic.  Prior to the Chinese virus, many small businesses were operating on the edge.  This is borne out by pre-Wuhan statistics.  For small businesses, 20% fold in their first year, 30% in the second year, and 50% fail after five years.  Finally, 70% of small businesses typically go under in their tenth year in business.  And these numbers are before the draconian lockdowns.  To expect small businesses to come bouncing back is wishful thinking.

Then there's consumer spending.  It typically accounts for some 70% of U.S. growth.  But consumer spending and confidence will not come back to their idyllic pre-pandemic days.  Why?  For two reasons.  First, people's wallets will have been walloped by the Wuhan virus shutdowns.  In addition to the effects of unemployment, consider what the drop in the stock market and low interest rates have done to retirees depending on their savings and 401(k) plans. 

Secondly, people will also realize how vulnerable their jobs can be.  Accordingly, many people will be haunted by a feeling of financial insecurity.  This will cause them to pull in their horns on spending and try to save more. 

Cutting back on spending might be easier to do than commonly realized.  That's because much of what consumers spend money on is superfluous.  To get a handle on the amount, the New York Post estimated that the average American "wastes $18K in "non-essential" expenses each year."  This includes things like entertainment, travel, and a whole host of other goods and services.

Given these numbers, two things are clear.  One, superfluous consumer spending is critical for the economy.  Second, such spending is likely be cut back, given that people will have less money, at the same time fearing for their financial security.  For many households, spending will fall.

The net result will be a noticeable lowering of overall demand.  And when demand softens, so will employment and wages.  This will lead to over-capacity and falling prices.  The Fed's fairy dust can't do much in such an environment.  This is captured in the economic metaphor of "pushing on a string."  That is, loose monetary policies can't stimulate demand if people want to save their money instead of spending it.  And that's assuming that people even have as much money to spend as before.

And then there's the enormous debt that's hanging over the economy.  Nobody seems worried about it.  Everyone should be, as it can't help but be a drag on the economic performance .

It is hard to see the economy getting back to the way it was before the Chinese virus ended the party.  The greatest danger here is that the drop in demand will go through the superfluous and bite into what consumers actually need.  That would result in a political and social upheaval.  Hopefully, that will not be the case.  In any event, the transition to a new paradigm will be painful.  But in at least one way, it might be healthy.  Much of the economic boom the U.S. was experiencing was due to, shall we call it, imprudent consumer spending.  This was fueled by abnormally cheap credit and massive amounts of debt at the government, corporate, and individual levels.  This was not sustainable.  Sooner or later, a change had to be made, and it looks as though the Wuhan virus shutdowns could be the change agent.