A dark economic winter

As winter approaches, health experts are warning that the United States faces a dark COVID-19 winter. They should also be warning of a long and painful U.S. economic winter. 

It is not simply that the economic recovery is at risk of faltering if the earlier easing of  COVID-19-related lockdowns is at least partially reversed and if a second  fiscal stimulus package is delayed until after January 20. It is also that the world’s overvalued equity and credit markets could be seriously unsettled by a double-dip European economic recession and by a serious emerging market debt crisis.

One need not be an epidemiologist to recognize that the U.S. is on the cusp of a second and more vicious wave in the health crisis. Even before the winter, the number of new daily infections in many states well exceeded its earlier summer peak. Worse yet, those infections are now increasing at an alarming fortnightly rate of around 40 percent, with little prospect of a comprehensive national plan to put a brake on the virus’s rapid spread and with little prospect of a widely distributed vaccine until the second half of next year. 

To be sure, even if there were to be a major resurgence in infections, it is highly improbable that the U.S. would again go into a full economic lockdown of the sort that last spring plunged the country into its deepest economic recession in the past 90 years. 

But one must expect that should new cases soar and hospitals become overburdened, we will at least have a partial economic shut down on a state-by-state and city-by-city basis. One must also expect that even in the absence of officially mandated restrictions, individuals are bound to become more cautious about undertaking economic activities that might unnecessarily expose them to the virus. That, in turn, will likely accelerate the wave of bankruptcies and defaults that are already evident in the retail, hospitality, entertainment and commercial real estate sectors of the economy.  

Any rollback in the earlier easing of COVID-19 restrictions runs the real risk of precipitating a double-dip economic recession. Even before the virus’s recent resurgence, Federal Reserve Chairman Jerome Powell was warning that the economic recovery was showing troubling signs of running out of steam. Another round of COVID- related economic restrictions might be all that it takes to snuff out the economic recovery. This would seem to be particularly the case at a time when supplemental unemployment benefits have run out for many and as small businesses are desperately in need of financial support to stay afloat.

Compounding the domestic risks to the economic recovery is the likely souring in the international economic environment. In response to a second wave in the European pandemic, major European countries, including France, Italy, Spain and the United Kingdom, have already substantially rolled back their earlier easing of their lockdowns. This will likely throw Europe into a double-dip recession and give rise next year to another round of the European sovereign debt crisis, especially in systemically important and highly indebted countries such as Italy and Spain.

Meanwhile, real trouble is brewing in the emerging market economies. Indeed, the World Bank is warning that in the wake of the pandemic, we should brace ourselves for a wave of emerging market defaults and debt rescheduling that will likely be more severe than that which occurred after the September 2008 Lehman Brothers bankruptcy. Coming on top of likely defaults in many other parts of the global economy, a wave of emerging market debt defaults will pose a real challenge to the global financial system.

With all of these domestic and international risks to the U.S. economic recovery, and with around 11 million U.S. workers still unemployed, we can ill afford to delay a second fiscal stimulus package until after Congress’s lame-duck session. Rather, we must hope that with the elections behind us, Congress and the White House will soon find a compromise on a major fiscal stimulus package that the U.S. economy desperately needs.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.