Major Economies Face a ‘Sudden Stop’

The global economy was already reeling from the impacts of the coronavirus outbreak, with countries in lockdown and fear of contagion freezing travel, spending, and investment. But U.S. President Donald Trump’s decision to ban all travel from Europe for at least a month, announced late Wednesday in a halting Oval Office address, has only added to the market panic and will increase the economic pain for airlines, hotels, restaurants, and such big manufacturers as Boeing and Airbus.

The Dow Jones Industrial Average plummeted 10 percent Thursday with a 2350.60 point drop, the worst trading day since the October 1987 “Black Monday” crash, just a day after another huge drop formally ended the 11-year bull market that Trump inherited. Asian and European stock markets also tanked Thursday with double-digit percentage losses in the wake of Trump’s speech, while crude oil prices plunged again on expectations that travel bans will only further diminish demand for oil.

The economic impacts of the virus, initially expected to be modest and dismissed by Trump as alarmist fantasies invented to hurt his presidency, have now become painfully clear. A year that was expected to see a healthy rebound in global growth after two years of trade wars has turned into a market bloodbath, with growing fears of recession in Asia, Europe, and the United States. As in the financial crisis of 2008-09, capital flows threaten to dry up, with potentially catastrophic consequences for a world awash in debt as never before.

“We typically use the term ‘sudden stop’ in the context of emerging markets, where capital flows can come to a sudden halt or reverse and force countries into recession,” said Robin Brooks, chief economist at the Institute of International Finance. “What is happening now in the United States is similar, just that it isn’t driven by external capital flows but by a sharp rise in risk aversion due to COVID-19.”

The Federal Reserve announced a massive, trillion-plus dollar program to inject liquidity into the financial system and help stem the market routs, its third intervention this week; the Dow ignored it and kept falling.

One critical issue for whether recession looms is how long the outbreak and its attendant disruption will last. China, which was in near-total lockdown at the beginning of the year, is showing signs of returning to activity. Europe, meanwhile, is just feeling the brunt of the outbreak, with Italy in near-paralysis and other countries preparing similar measures.

And hopes that the virus would be a one-quarter wonder are quickly fading. Brooks last week downgraded U.S. growth expectations to 1.3 percent for the year, on the assumption that the worst of the virus would pass soon and that a second-half recovery would kick in.

“That V-shaped recovery assumption is now looking more and more problematic, as the sharp drop in oil prices is increasing credit issues in the United States and raising recession risk,” he said.

Globally, he expects growth to drop to just 1 percent this year—the lowest level since the depths of the great financial crisis.

Thursday’s market panic came after Trump’s brief but error-filled speech Wednesday night. Facing severe criticism for his administration’s mishandling of the coronavirus outbreak, Trump sought to pin the blame for the rise of cases in the United States on Europe, where the outbreak is currently growing the fastest. He slapped a 30-day ban on travel from all 26 countries in the Schengen free-movement zone in Europe—though, oddly, not from the United Kingdom, where the outbreak is spreading rapidly.

“The European Union failed to take the same precautions and restrict travel from China and other hotspots,” Trump said. “As a result, a large number of new clusters in the United States were seeded by travelers from Europe.” (In reality, the virus has been spreading for weeks undetected in the United States, in part because the Trump administration actively discouraged health professionals’ efforts to combat the virus.)

The travel ban, which in some ways is a fulfillment of Trump’s policy to isolate the United States from the rest of the world, only adds to the global economic decoupling that began with his tariffs and trade wars and continued with the outbreak’s shattering of delicate, cross-border supply chains. As the magnitude of the economic impacts have become clearer—in terms of lost wages, rising health care costs, and shuttered factories—global stock and bond markets and central bankers have made plain their fear of an impending recession.

And while the severe market correction is already bad enough for the economic outlook—analysts late last year forecast that such a move would halve U.S. growth—there is another kind of “sudden stop” that can poleax economies: when businesses stop getting revenue and have trouble paying their employees, who then stop making purchases.

“This kind of crisis—a sudden stop crisis—is common in developing countries,” said Richard Baldwin, a professor of international economics at the Graduate Institute in Geneva. “This sudden stop of cash flow is now happening within G-7 countries, especially in services. That could lead to lots of bankruptcies, and there could be real, permanent damage.”

That is becoming especially evident in the travel and tourism sector—especially now that Trump has decided to ban travel from Europe. The huge hospitality industry was already wobbly from the effects of the virus, particularly airlines, which were cutting capacity to deal with a sudden drop in demand for travel, especially overseas. (Don’t even start on cruise lines, which are being bludgeoned by the crisis.) Trump himself cheered the collapse in international travel, celebrating that Americans would spend more money at home, even as domestic airlines hemorrhaged cash. The World Tourism Organization just slashed its outlook for global tourism from healthy growth to contraction, which will cost the industry between $30 billion and $50 billion this year.

Airline executives have been bemoaning that the collapse in air travel is even worse than in the aftermath of the Sept. 11, 2001, terror attacks. But they have been chalking that up to the “fear factor” associated with the virus, hoping that after a few months of empty planes, business will pick up. Now, with his ban on travel from Europe, even as the outbreak continues to spread, Trump seems to be guaranteeing a prolonged slump.

“We knew that the impact of Sept. 11 was circumscribed in a way, and airlines had more certainty about their recovery,” said Loizos Heracleous, an expert on the aviation industry at the University of Warwick in Britain. “That was an event, whereas the coronavirus is a live process.”

Trump’s travel ban may be symbolic in a way, since international travel had already cratered. But the knock-on effects of formally prohibiting travel from Europe are potentially huge—and will only deepen the demand shock unleashed by the outbreak so far. The United States is one of the world’s leading tourism destinations and by far the country that earns the most money—$214 billion a year—from tourism. About one-fifth of the 80 million people who visit the United States each year are from Europe, but they won’t be visiting anytime soon.

“In the short term, there will be a lot of pain, not only for aviation, but also for other sectors, including tourism, retail, restaurants, transportation, everything that people who travel would use,” Heracleous said. Aviation, directly and indirectly, supports about 65 million jobs worldwide and underpins about $2.7 trillion in economic activity, he noted.

U.S. and European airline stocks plunged even more than the broader market on Thursday, with stocks in international carriers, which typically make about 15 percent of their sales on trans-Atlantic travel, posting losses of 10 percent or more. Airlines are freezing hiring, talking about unpaid furloughs, and deferring capital expenditures, like buying new aircraft—which in turn is bad news for big manufacturers like Boeing and Airbus.

And while Trump’s travel ban won’t, as he initially said in his speech, directly affect cargo and trade between the United States and Europe, it could indirectly. A big part of airlines’ business is carrying high-value cargo in the belly of aircraft. With no passenger flights crossing the Atlantic, suppliers will have to find new freight routes for that cargo or face further disruptions to supply chains already rattled by shutdowns in China, South Korea, and elsewhere.

Trump’s latest travel ban will also sour trade talks with the European Union, which were already problematic thanks to the president’s specious use of tariffs to block European imports and threats of more to come. Investors and analysts were hoping that the United States and Europe could reach some sort of limited trade accord this year in order to remove the specter of truly damaging tariffs on autos. Instead, Trump has opted to further alienate what was once among Washington’s closest allies.

“The European Union disapproves of the fact that the U.S. decision to impose a travel ban was taken unilaterally and without consultation,” the EU’s leaders said in a joint statement.

Mar. 12:  This article was updated to include the Fed intervention.