The Dow Jones Industrial Average dropped another 357.28 points on Friday, bringing its losses over the past six trading days to more than three thousand seven hundred points, or about thirteen per cent. That’s a big move, to be sure, but it needs to be placed in perspective. The market is now trading at roughly the level it was at a year ago. Many of the gains since then have been based on wishful thinking and speculation, rather than rising corporate earnings. As I pointed out a few days ago, the market’s dive was an accident waiting to happen.
Where will things go from here for the markets, the broader economy, and the U.S. polity? Anybody who makes firm predictions now is a fool or a knave. With the worldwide spread of the coronavirus, we have entered a zone of chronic uncertainty—or what economists sometimes refer to as Knightian uncertainty, after Frank Knight, the noted Chicago economist of the early twentieth century. In his book “Risk, Uncertainty and Profit,” from 1921, Knight distinguished between risks that can be calculated, such as the chances of rolling two sixes or winning the lottery, and risks that are so complex and hard to decipher that they “are not susceptible to measurement.” That’s where we are now. We still don’t have enough reliable information to form sensible judgments about where this thing is ultimately heading.
On Friday, the World Health Organization again stopped short of declaring a global pandemic. “What we see at the moment are linked epidemics of COVID-19 in several countries, but most cases can still be traced to known contacts or clusters of cases,” Tedros Adhanom, the director general of the W.H.O., said at his daily briefing. “We do not see evidence as yet that the virus is spreading freely in communities. As long as that’s the case, we still have a chance of containing this virus, if robust action is taken to detect cases early, isolate and care for patients, and trace contacts.”
In the United States, the number of confirmed cases is still small, but it’s not clear whether that’s simply because there hasn’t been much testing. In California, the authorities are monitoring more than eight thousand people who recently travelled abroad, but, according to the governor, Gavin Newsom, the state has only two hundred testing kits. On Friday, Mick Mulvaney, the White House chief of staff, acknowledged that the spread of the virus may lead to school closures and disruptions to public transportation, but he also accused the media of exaggerating the crisis in an attempt to bring down Donald Trump. Larry Kudlow, Trump’s top economic adviser, spoke with reporters and insisted that the U.S. economy would be fine. “I just don’t think this short-term stock-market correction is going to have any effect,” he said.
Statements like these are counterproductive: they just further undermine the White House’s already tattered credibility. (Earlier this week, Kudlow said, of the coronavirus, “We have contained this. . . . It’s pretty close to airtight.”) A wiser Administration would be honest about the uncertainties, avoid Panglossian predictions, and concentrate on public-health measures, such as supplying more testing kits and expanding health facilities in case there is a mass outbreak. Regarding the economy, the White House should merely say that it will work with Congress and the Federal Reserve to maintain stability, and it should stop trying to talk up the stock market—a tactic that treats investors as idiots.
When people encounter Knightian uncertainty, they tend to hunker down and adopt an attitude of safety first—a perfectly rational reaction. In the financial markets, this translates into selling risky assets such as stocks, raising cash, and buying safer assets, particularly government bonds. On Friday, the interest yields on long-term U.S. Treasury bonds hit all-time lows—with thirty-year Treasury bonds dipping below 1.9 per cent—a textbook case of a flight to safety.
The hunkering down isn’t confined to the financial markets, of course. Much of the vast Chinese economy, a key source of goods and components for other countries around the world, is still on enforced hiatus. In many places, restrictions on travel and group events are being introduced, and not just by governments. On Thursday, Facebook cancelled its annual developer conference, which was due to take place in early May; on Friday, Amazon ordered its employees to defer all nonessential travel, including trips within the United States. There is even talk of postponing this summer’s Olympic Games, which are scheduled to take place in Tokyo.
In assessing the economic impact of the virus, some analysts have interpreted the market slide as a temporary shock to production—a “supply shock.” Thinking along these lines, a number of Wall Street forecasters have bravely predicted that economic growth, after taking a hit in the first part of this year, will rebound sharply. This matches what happened after the shock of 9/11, and it could happen again. But there is another, darker narrative in which rising infection rates, falling stock prices, and the widespread adoption of emergency restrictions on international travel and internal movements combine to produce a substantial fall in spending by consumers and businesses—a “demand shock,” which then interacts with the supply shock to produce a deeper and more lasting downturn.
On Friday, the economics team at Goldman Sachs published a study that outlined three different scenarios, with economic outcomes that ranged from a rapid rebound to a global recession. The analysts said that, for now, they were sticking with their intermediate, baseline view that there would be “a short-lived global contraction that stops short of an outright recession.” However, they added that they would be monitoring “a wide range of indicators, including the monthly hard economic data, higher-frequency indicators on economic activity, financial conditions, medical statistics, and more anecdotal reports.” At this stage, that is about all anybody can do.