There’s a difference between crisis and collapse
MICHAEL J BOYLE
Updated April 08, 2020
The U.S. economy’s size makes it resilient. It is highly unlikely that even the most dire events would lead to a collapse. If the U.S. economy were to collapse, it would happen quickly, because the surprise factor is a one of the likely causes of a potential collapse. The signs of imminent failure are difficult for most people to see.
Most recently, the U.S. economy almost collapsed on September 16, 2008. That’s the day the Reserve Primary Fund “broke the buck”—the value of the fund’s holdings dropped below $1 per share.1 Panicked investors withdrew billions from money market accounts where businesses keep cash to fund day-to-day operations.2 If withdrawals had gone on for even a week, and if the Fed and the U.S. government had not stepped in to shore up the financial sector, the entire economy would likely have ground to a halt.
Trucks would have stopped rolling, grocery stores would have run out of food, and businesses would have been forced to shut down. That’s how close the U.S. economy came to a real collapse—and how vulnerable it is to another one.
Will the U.S Economy Collapse?
A U.S. economy collapse is unlikely. When necessary, the government can act quickly to avoid a total collapse.
For example, the Federal Reserve can use its contractionary monetary tools to tame hyperinflation, or it can work with the Treasury to provide liquidity, as during the 2008 financial crisis. The Federal Deposit Insurance Corporation insures banks, so there is little chance of a banking collapse similar to that in the 1930s.
The president can release Strategic Oil Reserves to offset an oil embargo. Homeland Security can address a cyber threat. The U.S. military can respond to a terrorist attack, transportation stoppage, or rioting and civic unrest. In other words, the federal government has many tools and resources to prevent an economic collapse.
These strategies may not protect against the widespread and pervasive crises that may be caused by climate change. One study estimates that a global average temperature increase of 4 degrees celsius would cost the U.S. economy 2% of GDP annually by 2080. (For reference, 5% of GDP is about $1 trillion.) The more the temperature rises, the higher the costs climb.
What Would Happen If the U.S. Economy Collapses?
If the U.S. economy collapses, you would likely lose access to credit. Banks would close. Demand would outstrip supply of food, gas, and other necessities. If the collapse affected local governments and utilities, then water and electricity might no longer be available.
A U.S. economic collapse would create global panic. Demand for the dollar and U.S. Treasurys would plummet. Interest rates would skyrocket. Investors would rush to other currencies, such as the yuan, euro, or even gold. It would create not just inflation, but hyperinflation, as the dollar lost value to other currencies.
If you want to understand what life is like during a collapse, think back to the Great Depression. The stock market crashed on Black Thursday.3 By the following Tuesday, it was down 25%. Many investors lost their life savings that weekend.
By 1932, one out of four people was unemployed.4 Wages for those who still had jobs fell precipitously—manufacturing wages dropped 32% from 1929 to 1932.5 U.S. gross domestic product was cut nearly in half. Thousands of farmers and other unemployed workers moved to California and elsewhere in search of work. Two-and-a-half million people left the Midwestern Dust Bowl states.6 The Dow Jones Industrial Average didn’t rebound to its pre-Crash level until 1954.
Collapse Versus Crisis
An economic crisis is not the same as an economic collapse. As painful as it was, the 2008 financial crisis was not a collapse. Millions of people lost jobs and homes, but basic services were still provided.
Other past financial crises seemed like a collapse at the time, but are barely remembered now.
The OPEC oil embargo and President Richard Nixon’s abolishment of the gold standard triggered double-digit inflation. The government responded to this economic downturn by freezing wages and labor rates to curb inflation.7 The result was a high unemployment rate. Businesses, hampered by low prices, could not afford to keep workers at unprofitable wage rates.8
The Fed raised interest rates in a bid to end double-digit inflation.9 That created the worst recession since the Great Depression. President Ronald Reagan cut taxes and increased government spending to end it.10
1989 Savings and Loan Crisis
One thousand banks closed after improper real estate investments turned sour. Charles Keating and other Savings & Loan bankers had mis-used bank depositor’s funds.11 The consequent recession triggered an unemployment rate as high as 7.5%.12 The government was forced to bail out some banks to the tune of $124 billion.13
The terrorist attacks on September 11, 2001 sowed nationwide apprehension and prolonged the 2001 recession—and unemployment of greater than 10%—through 2003.14 The United States’ response, the War on Terror, has cost the nation $6.4 trillion, and counting.15
2008 Financial Crisis
The early warning signs of the 2008 Financial Crisis were rapidly falling housing prices and increasing mortgage defaults in 2006.16 Left untended, the resulting subprime mortgage crisis, which panicked investors and led to massive bank withdrawals, spread like wildfire across the financial community.17 The U.S. government had no choice but to bail out “too big to fail” banks and insurance companies, like Bear Stearns and AIG, or face both national and global financial catastrophes.18
2020 Coronavirus Crisis
It is too soon to tally up the total costs of the 2020 Coronavirus pandemic—the crisis is still ongoing. Already we have seen worldwide supply-chain interruptions, heightened volatility and steep losses in financial markets, and sharp slowdowns in the travel and hospitality industries.
Given the pandemic’s rapid spread and persistence, we should expect more disruption, and more economic cost. How much? According to the United Nations’ Conference on Trade and Development, the global economic hit could reduce global growth rates to 0.5% and cost the global economy as much as $2 trillion for 2020.
Source: The Balance