Don't believe anyone who tries to tell you that "demand destruction" resulting from the impact of the novel coronavirus across U.S. and world economies isn't going to result in a global recession. They don't know the facts.
By way of just one example, China, the first country hit and hit hard by COVID-19, which originated in Wuhan, Hubei province, announced its February manufacturing PMI (purchasing managers index) dropped to 35.7 from January's 50 level.
Fifty is the index's dividing line - above 50 implies expansion, and below 50 spells contraction.
That drop is both a record drop for one month and a record low for China.
Worse, China's non-manufacturing PMI (think services) fell from 54.1 in January to 28.9 in February.
At the height of the financial crisis, China's manufacturing PMI only fell to 38.7. Its non-manufacturing PMI never even broke 50.
With 11 million people locked down in Wuhan and at least 46 million people across China quarantined, of course demand declined, and so did production.
Now, all of Italy's locked down.
And President Trump declared a state of emergency in the U.S.
As the virus spreads to all 50 states in America and infection rates around the world increase, demand in the U.S. and globally isn't just going to decline; it's going to be destroyed.
Recessions happen when consumer spending weakens, leaving companies with lower revenue and kicking off a dangerous cycle of job cuts, slowed purchase activity, and economic contraction.
If the negative feedback loop that fosters recession gains momentum, the result is a depression.
If the coronavirus isn't corralled and eradicated in the next three months, the U.S. and world economies are headed for recession, according to economists.
If the virus isn't contained and killed off and infection rates haven't leveled off in six months, depression becomes a possibility.
There are two separate demand effects to consider...
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How Demand Destruction Plays Out
First, people will buy less of some goods and services because they are afraid of potential exposure to the virus.
They're already less willing to travel or go out to eat. The result is airlines, cruise lines, hotels, and restaurants are suffering staggering demand declines.
The U.S. Travel Association predicts that international travel to the United States will fall by 6% over the next three months.
"There is a lot of uncertainty around coronavirus, and it's pretty clear that it's having an effect on travel demand - not just from China, and not just internationally, but for domestic business and leisure travel as well," the association's president, Roger Dow, said in a recent statement.
The stocks of cruise operators, which have lost more than 60% since the first reported coronavirus cases outside of China around Jan. 20, continued to spiral on Thursday, when the major market indexes fell just shy of 10%.
Carnival Corp. (NYSE: CCL) said it would voluntarily cease operations on its Princess Cruises line - which has had two ships quarantined due to the coronavirus outbreak - for 60 days.
Airline stocks are down between 35% and 55% year to date, worse than the drops of the Dow Jones Industrial Average and the S&P 500 over the same span.
Now sporting events, conferences, and gatherings of a few hundred people are being impacted.
As Americans feel increasingly uneasy about the spread of the virus, they will cut back on some goods and services and increase their emergency savings instead.
Many households have inadequate health insurance, which could leave them with large doctors' bills when they get sick. Most Americans don't have paid sick leave. If they get sick from the virus and need to stay home, they will not get paid.
Given those kinds of risks, many people will avoid activities that increase exposure to others. On an economy-wide scale, that means less spending and less growth.
Second, lots of firms impacted by sliding sales will be forced to close and lay off workers.
Obviously, those workers will have less to spend, again cutting overall demand.
Unknown risks and uncertainties have a large and paralyzing effect on consumers and consumption habits.
The U.S. economy - even with its strong labor market and consumption levels - already exhibits a heightened sense of uncertainty.
Both a global and U.S. economic uncertainty index, developed by economists from Northwestern, Stanford, and the University of Chicago, note an all-time high in August 2019.
As supply chain disruptions, demand contractions, and global economic uncertainty impacts consumption and production, firms and households are straining under large amounts of debt.
Debts must be repaid even if the economy slows. Continued debt service then leaves less money for businesses and households to spend when their incomes drop.
High debt levels will exacerbate the economic fallout from the virus, especially if central banks can do little to ease that burden by cutting interest rates.
Banks and other financial institutions may restrict and reprice credit because they can't properly assess short-term risks to borrowers, sectors, or countries.
Less credit availability could make it harder for businesses, especially smaller ones, to invest and grow. Credit market uncertainty could then exacerbate the demand fallout from the coronavirus.
The impact of demand destruction on the economy can't be overexaggerated.
Unless the impact of the coronavirus on demand reverses in the next few months, the U.S. and global economies are headed for recession.
Beyond that is almost unthinkable.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
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