Coronavirus: the spiraling economic impact

We’ve all seen the speculation about the coronavirus recently discovered (or should that be unleashed?) in China.  The health issues are well-known, and are being very urgently addressed all over the world.  What many people haven’t thought about (or, at least, not enough) is the economic impact.

China is now the world’s largest or second-largest manufacturing economy, depending on whose figures you believe.  The majority of consumer goods bought and sold around the world come from there – but their production has been almost completely disrupted as quarantines prevent people from coming to work, keep factory doors closed, and generally shut down production in China.  More than half of the country is on shutdown, and won’t begin to resume normal activity until at least February 10 – perhaps longer than that.  That includes every factory in those areas.  Those factories supply parts and components to other factories around the world;  and if the latter can’t get their supplies, they’ll be forced to stop production as well.  This is already having a worldwide impact.  Literally millions of workers in scores of countries may be forced to stay at home until parts can be obtained to resume operations.  What’s more, firms such as Apple that rely on Chinese production facilities may find themselves with nothing to sell, which is going to affect their bottom line in a very drastic way.  It may also affect Apple’s launch of new products.

This applies particularly to the automotive industry.  As Bloomberg points out, “Hubei [province] — known for its car factories and bustling capital Wuhan — is paying the price, with the mortality rate for coronavirus patients there 3.1%, versus 0.16% for the rest of China”.  The epicenter of the coronavirus is also the epicenter of Chinese vehicle manufacturing – and the production of cars and parts for export (including to the USA).  Expect this to have an increasing impact as existing parts and supplies are used up.  To name just one example, Bosch – supplier to many vehicle manufacturers – is already warning about this.  No vehicle manufacturer will be exempt from it, including in the USA.

The impact on Chinese industrial production may be far longer-term than implied by the current quarantines and shutdowns.  Charles Hugh Smith points out that many Chinese factories operate on razor-thin profit margins, and any interruption to normal business might cause some of them to close their doors.

The reality is that much of the supply chain is at risk of financial collapse … a consequential percentage of the supply chain companies in China are only viable due to expanding debt and speculation. Any disruption of this fragile balance between losing money manufacturing/assembling but covering the losses with risky speculative gains will sink the companies: the doors are locked and the owners disappear rather than face the music.

. . .

U.S. corporations that assume their supply chains will return to normal in a week or two are in for a big surprise: consequential chunks of their supply chains, likely chunks they never paid much attention to, will dry up and blow away. The factories will not re-open, and the workers won’t return.

. . .

Once the supply chain breakdown comes home to roost in Corporate America, the mass delusion that the U.S. economy is invulnerable will collapse in a heap. Was it ever plausible that China’s economy could grind to a halt and there wouldn’t be a domino-like collapse of all the weak links in its supply chains? No. Companies living on debt and speculation only needed the slightest push to careen off the cliff into insolvency. The coronavirus is that push.

Was it ever plausible that China’s economy could grind to a halt and there wouldn’t be any consequences for the U.S. economy? No. Alas, mass delusions always end badly.

There’s more at the link.

Frankly, I don’t think investors or businessmen have yet made sufficient allowance for this potential disruption.  I think it’s rather more likely to happen than not.  It’s already affecting demand for oil and natural gas around the world, because China’s demand for those products has plummeted.  If you’re an oil or gas producer, and a big chunk of your market goes away, can you afford to keep your doors open on a much reduced volume of sales?  The same applies to many other areas of economic activity – minerals, agricultural products, etc.  Countries like Australia, who depend on Chinese demand for a very large proportion of their export earnings from mining and agriculture, are likely to be hard hit by this.  That, in turn, will affect their trade with other countries.  For that matter, the ships and aircraft carrying those goods are already feeling the pinch, as shipments to and from China slow down.  They can’t be ramped up or down overnight.  It takes time to schedule shipping, air or sea, and provide the transportation needed.  Shipping companies are facing a crisis in demand (or the lack thereof), and some may not survive.

Another threat to normal production is that China is going to need a whole lot more consumer and medical goods to rebuild its internal stocks, and it’s going to have to repurpose many of its factories to produce them – whether the factories like it or not.  To name just one example, toilet paper supplies are alleged to be running low there, resulting in panic buying.  That’s a pretty basic, existential need!  I think many paper product producers are going to be run off their feet rebuilding domestic supplies.  Until they’ve done so, they won’t be producing much for export.  What will that do to overseas supplies of such a basic necessity?  Another example is surgical masks.  Supplies are so short that one Chinese city is alleged to have “stolen” masks en route to another city, and distributed them to its residents.  When the destination city complained, they were met with a metaphorical shrug of the shoulders.  If you need to make sufficient disposable face masks for a nation of over a billion people, each needing one or two masks every day . . . that’s an awful lot of masks, and won’t leave many over for export to other countries.

This is how the coronavirus will affect normal medical supplies in many parts of the world.  For example, the USA obtains almost all its medication and basic health care gear supplies from China – and their production is currently disrupted.  The same goes for medical examination gloves, face masks, isolation garments, and what have you – even the simplest of bandages.  China is going to be reorienting production to meet its own needs, and/or seizing goods destined for other countries until it’s refilled its own supplies.  There’s no point complaining about it – it’s a fact of life – but if you rely on prescription medication coming from there, you may be in trouble.  No-one knows yet, and it’s too early to make predictions, but I’ve heard from two friends in the pharmaceutical industry that they’re already rationing what they sell to distributors, pharmacies and hospitals, in the expectation of future shortages.  (If you haven’t built up a reserve of your prescription medications in the past, this may be a very good time to do so, if possible.)

There’s also the threat of Chinese action against drug manufacturers who produce medications they think they might need.  A Chinese laboratory has already applied for a use patent for an American-sourced experimental drug, without so much as a “by your leave” to the US company.  What if they get it?  What if the government of China decides to produce the drug, again without permission, on the grounds of national emergency?  So much for intellectual property rights.  Who pays?  And how much?  And what if the US company goes bankrupt because its expected income, to pay for the hugely expensive costs of developing such a drug, vanishes like water in the desert?  I don’t think China will care about that.

On the basis of current trends, I don’t think the coronavirus outbreak will be an uncontrollable health disaster.  It may turn out to be something like a particularly bad form of influenza.  However, in the process of getting a handle on the problem and controlling its spread, the economic damage is likely to prove significant, and perhaps long-term.  This might turn out to be a “black swan” event that triggers a global depression.  We’ll have to wait and see – but in the meantime, let’s make what preparations we can, as private individuals and businessmen.  How secure is your job if that happens?  How stable is our economy?  And how much medication do you need, and do you have reserve supplies?

Peter