The Dow Jones Industrial Average suffered its worst week in over a decade as investors who spent most of the winter shrugging off coronavirus-related concerns shifted into panic mode, rapidly wiping out a year’s worth of steady gains.
With Covid-19 not yet impacting Americans’ daily lives — few people are confirmed to be sick, no Americans have died, no schools are closed, no cities are operating under broad quarantine measures, and few if any events have been canceled — the daily carnage in financial markets is the most concrete manifestation of the epidemic.
It’s the financial panic, rather than briefings from the CDC or anything else related to the substance of the matter, that’s weighed on the mind of President Donald Trump and prompted a mini shake-up of the federal response with smoking-denialist Mike Pence officially designated as in charge of coordination. More consequentially, the White House has moved to lock down the flow of information from government agencies to the public — requiring all public communications to be cleared through Pence’s office, apparently out of concern that career officials are being insufficiently mindful of the market’s response to their words.
This might make sense if you were worried that the weak stock market could cause a recession. But that’s mostly backward.
Nothing particularly bad has happened in the United States. Markets are down because events abroad imply bad business conditions are coming in the near future. The trajectory of the financial markets in the weeks and months to come is mostly going to be driven by actual reports about revenue and profits, not by what government officials say on television.
The economic, political, and substantive aspects of the epidemic are all fundamentally interrelated, and the best thing for the markets — just like for the general public — would simply be good, credible news about the course of the disease itself.
A pandemic is bad for business
Trump, at his February 26 press conference, was at pains to distinguish the lethality of Covid-19 from some other emergent diseases that have been in the news in recent years.
“This is a much different problem than Ebola,” Trump said. “With Ebola — we were talking about it before — you disintegrated. If you got Ebola, that was it. This one is different. Much different. This is a flu. This is like a flu. And this is a much different situation than Ebola.”
It is true that Covid-19 is significantly less lethal than Ebola. However, the fact that a very large share of infected people don’t become all that sick actually makes it harder to halt the spread of the disease. People with mild cases can spend days walking around shedding virus and going about their business. And the case fatality rate from Covid-19, while well below Ebola’s, is currently thought to be something like 10-20 times higher than for influenza. So while you should feel reassured that we’re not talking about The Stand here, it is in fact a much more serious problem than a flu outbreak.
More to the point, from a financial market perspective, the outbreak doesn’t need to be apocalyptic to be bad for business. Best practices for pandemic containment involve a lot of “social distancing” — canceling large events and broadly encouraging people to minimize both the quantity, duration, and closeness of their interpersonal interactions.
That’s fine for public health, but a well-implemented program of social distancing is necessarily going to mean huge amounts of lost revenue for movie theaters, restaurants, airlines, hotels, concert venues, and other places where groups of people gather for recreational purposes. It will also inevitably mean less foot traffic to malls, fewer people visiting leisure destinations, and lots of companies having their internal efficiency undermined by unusually large numbers of workers taking sick leave or needing to work semi-distractedly while caring at home for children due to school closures.
This is not end-of-the-world stuff, but it’s really bad for business. And while some kinds of businesses might simply weather a downturn and then bounce back later (if nobody buys dishwashers during the height of a pandemic, pent-up sales will spike afterward), a lot of businesses are structured in a way that makes that impossible. If restaurants suffer multiple weeks of unusually low sales or airlines need to fly half-empty aircraft, those sales are never coming back. The technology world, which seems more attuned to social distancing practices than most of American society, is already canceling lots of conferences, which means reduced sales for all kinds of businesses that would count on conference-goers. If the illness keeps spreading and cancellations hit broader sectors of the economy, there will be lots of short-term hits.
This is a particularly intense problem since many businesses have fixed costs — rent and perhaps debt service payments — that need to be made whether or not any money is coming in. Consequently, even a temporary disruption could, if severe enough, push businesses into bankruptcy and cost permanent jobs.
There are big questions about the “supply chain”
Dating back to before the apparent failure of containment in Hubei province, China, some sectors of the economy were beginning to worry about disruptions to the global supply chain.
The main factory for assembling iPhones in China, for example, has been shut down all month rather than reopening as expected at the end of the Lunar New Year celebrations. Apple can’t sell iPhones they can’t manufacture, so their share price has been especially hard hit. The new problem for companies like Apple is that their supply chains are so sprawling and complex that they have multiple points of failure and are at risk of needing to repeatedly shut down even if the pandemic is successfully controlled in particular places.
Apple’s official list of suppliers includes locations in China, Korea, Japan, Taiwan, Malaysia, the Philippines, Austria, Singapore, Belgium, Mexico, India, Indonesia, the UK, Germany, the Netherlands, Tennessee, Brazil, Vietnam, Israel, Ireland, Norway, France, Czechia, Malta, and sixteen different US states. To an extent, this is redundancy. Corning, for example, which makes the special glass for iPhones, has four different locations listed as Apple suppliers, so a quarantine order in one city wouldn’t shut down all Gorilla Glass supplies. But by the same token, if any of the four cities features a situation where people can’t come to work or where shipping routes are disrupted, that will make it difficult to keep iPhone production at full capacity.
The evolution of these elaborate global supply chains has been one of the major changes in the way the world does business during the past generation. International trade used to mostly mean products in one country being shipped to customers in another country. But modern trade often involves components from many countries being shipped to an assembly facility somewhere and then shipped out to customers globally. Innovation in this sphere has led to a lot of new efficiencies in manufacturing, but people have been fretting for a long time that it also makes the global economy more fragile — and we’re now witnessing that fragility in action.
Disruptions to the electronics supply chain are bad for business, of course, but other kinds of supply chain problems — like the inability to secure the Chinese-made precursor chemicals that pharmaceutical companies count on for manufacturing drugs — could have more dire consequences.
The feedback between economics and the epidemic also works in the other direction. Many people getting sick would be economically costly, but genuine efforts to seal the borders in order to prevent infection would also be extremely costly since even really large countries like the United States are not set up for self-sufficiency. Cars that are “made in America” incorporate foreign parts, and you’d need to shut down domestic industry to avoid dependence on foreign trade. And of course no matter what we do at home, export sectors will be hurt by bad news from abroad.
There could be a looming developing world crisis
At the moment, infections have mostly occurred in China — a middle-income country with strong state institutions — or else in high-income countries like South Korea, Japan, and Singapore.
And the experience of Singapore, in particular, suggests that a country with a competent government, a high level of social trust, and a strong economy can manage an outbreak without chaos or large-scale loss of life.
Unlike China, Singapore is not locking down its whole citizenry; but it is conducting tight surveillance, sophisticated contact tracing, and vigorously enforced quarantine measures at individual level. Applying an incredibly disciplined approach. https://t.co/wG9zS3GQQA— Jeremy Konyndyk (@JeremyKonyndyk) February 28, 2020
The big exception to this trend, however, is Iran — a country whose economy was in weak shape before the virus hit and whose government has long shown minimal competency in domestic service provision and enjoys relatively little trust from the mass public.
In Iran, not coincidentally, the virus seems to have spread widely and is killing a lot of people — second only to the deaths counted up among the much-larger Chinese population.
.@DrMikeRyan says high number of deaths in Iran — second to China — likely attributed to virus spreading much more broadly than authorities realized. So the death number looks high next to cases discovered -- but likely more to come soon, as @BogochIsaac and other predicted.— Julia Belluz (@juliaoftoronto) February 27, 2020
Iran is no Singapore, but for all its problems it is very far from being the poorest country in the world or having the weakest public health infrastructure and basic state institutions. The prospect of large-scale epidemics in places like India, sub-Saharan Africa, or Central America is terrifying because the relatively low death rate currently observed among Covid-19 cases is contingent on the availability of respirators and other medical devices to treat acute cases. The disease could be significantly more lethal in countries that are less generously endowed with hospital infrastructure, and in the context of a global outbreak, rich countries are unlikely to offer much help.
Poor countries, by definition, are not as economically significant as rich countries. But the fact that Covid-19 could become not just more widespread but significantly more lethal in some parts of the world is further weighing on world markets. Much of the prosperity of the American agricultural sector in recent years has come from the fact that as poor countries have gotten less poor they’ve started eating way more meat, raising demand for American agricultural staples. The situation facing the developing world is primarily scary in terms of the potential loss of life, not any impact on global commodity prices, but the impact there is clearly visible in financial markets as well.
The market decline is not important per se to most people
One thing that’s important to say is that while global financial markets are useful sources of information, their ups and downs are not actually important to the vast majority of people.
Eighty percent of the value of the stock market is owned by about 10 percent of the population, for starters, so the fluctuations of the markets mostly matter to rich people.
But more broadly, even if you do have a 401(k) or a 529 account that you care about, it’s at least not obvious that the stock market being down is bad for you. If you are making regular contributions to your retirement account, for example, a stock market crash simply means that your dollar stretches further and you’re able to buy more shares. If you’re 45 or under, what matters is the market’s value decades in the future, not today. And while the coronavirus situation is fairly alarming, it doesn’t have any particular implications for the economy over a long time horizon.
That’s not to say information from stock prices should simply be ignored. Share prices are going down because investors believe companies’ short-term revenue and profit outlook has gotten much worse. If that comes to pass, companies are going to end up laying off workers, and it’s at least possible that layoffs and lost household income will then lead to secondary and tertiary economic problems.
Since inflation expectations were already low and falling before the market started collapsing, the case for rapid action from the Federal Reserve to cut interest rates seems strong. The Fed doesn’t normally act except during regularly scheduled meetings, but the chair has the statutory authority to convene an emergency meeting (or indeed even a conference call) and make changes between meetings. So far there is no sign of that happening, at least in part out of concern that it could exacerbate a sense of panic. Nonetheless, the prospect of nobody doing anything is also somewhat panic-inducing.
It is worth emphasizing, however, that interest rates are already very low so there is a limited amount that interest rate cuts can realistically accomplish. For years, experts have been putting forward various ideas for ways Congress could act to create automatic fiscal backstops to prevent recession (see my interviews with Claudia Sahm and Indi Dutta-Gupta on the Weeds podcast about two proposals) but no action has been taken, so the US economy is to an extent flying without a net.
This might all be an overreaction
One of the strengths of financial markets is that they are forward-looking.
In other words, stocks fall not because bad things have happened to companies but because there is good reason to believe that bad things will happen in the future. That makes them useful sources of information, but they’re not oracles. Markets often exhibit herding behavior and excessive volatility, and even at best they are judging probabilities in an uncertain world, not issuing prophecies about the future.
There is a strong chance that coronavirus will become a global pandemic and good reason to believe a pandemic will be very destructive to business conditions.
It is also possible that the virus will continue to spread only very slowly. And while Trump’s proclamation that warm weather will stop coronavirus is wildly premature, it’s at least plausible. There is unquestionably a happy scenario in which we pass through several scary weeks but infections don’t get out of control, the virus starts to recede in April, and a vaccine is available next winter. The crashing market says that investors are increasingly unwilling to bet on that happening, and scientifically speaking that appears to be the right bet. But nothing is foreordained, and with good organization and a little luck, it’s unquestionably possible that the kind of dire economic situation currently forecast by markets will be avoided.
Hope, however, is not much of a plan. And Congress and the administration should be thinking harder about what they can do to backstop the economy in a real way rather than trying to “reassure markets” on television.