Submitted by Joseph Carson, former Chief Economist at Alliance Bernstein
As difficult it was to decide to shut down large segments of the economy in order to contain coronavirus it will be even trickier to decide when to end the lockdown. News that the coronavirus curve (i.e., the number of cases) may be flattening will only intensify the pressure on government leaders to relax restrictions on work-life and travel, as well as social and recreational gatherings.
There is a risk in removing government restrictions too early in a war against a virus. History shows it is essential that the “the chain of transmission” of the virus is severed as a second wave could prove to be even more damaging.
In 1980, government-imposed credit restrictions to kill the “inflation” virus. At that time, “inflation” was labeled as public enemy number one much like coronavirus is viewed today.
The decision to impose credit controls to attack the “inflation” virus literally “scared people away from the stores” (The Wall Street Journal, May 5, 1980) triggering the sharpest one-quarter decline in consumer spending in the post-war period.
The National Bureau of Economic Research (NBER), the official arbiter of dating economic cycles peaks and trough, viewed the sudden drop in business activity to be so severe it announced that the economy was in recession even before the official GDP data showed an actual contraction. That surprising announcement by NBER compelled the federal government and the Federal Reserve to abruptly end the credit-control program, only 90 days after it was first implemented.
Investors will be pleased to learn the removal of government restrictions on credit sparked a quick and powerful rebound in the economy. Real GDP posted back-to-back quarterly gains of nearly 8% annualized in Q4 1980 and Q1 1981. The entire decline in consumer spending and output loss of the short 6-month recession was recaptured.
However, investors should be alarmed to learn the chain of transmission of the “inflation” virus was not severed. Instead it was alive and well, ready to resurface once the economy rebounded.
The second wave of the “inflation” virus proved to be more damaging as it forced the Federal Reserve to implement broader and more stringent monetary constraints. A deeper and more protracted recession followed, lasting 18 months from the middle of 1981 to the end of 1982.
Looking back on the 1980 experience economic and policy experts voiced concern that not enough was done early on to break the chain of transmission for the “inflation” virus.
Federal Reserve Board Vice Chairman Frederick Schultz in testimony before Congress in late 1980 stated, “Now, with the benefit of 20/20 hindsight… I think there is a considerable risk that the underlying problems of the economy will be found to be even more intense once the period of credit controls has been ended…the quick-fix or the band-aid policy always looks attractive, but that is a cruel deception”. Mr. Schultz was right.
2020 recession like that of the 1980 recession is similar in that both are government-made, linked to a “contagious” virus, and involve a sudden stop in the economy. The difference is that the 1980 recession involved an economic virus versus today’s medical one.
As such, investors must realize the timing, scale and sustainability of any business rebound are not forecastable. Recovery depends on the coronavirus curve that has no economic properties and the success of medical science.
At this point, it would be best for the government officials to follow science and let the data determine the timing of the “on” switch for the economy. The last thing anyone wants if to have a medical expert testify before Congress in 6 months (like that of Mr. Schultz in 1980) and say “wish we’d done something more in the spring” to break the transmission chain.