Market of Ideas Blog

Special Contributor: Mark Schug, Ph.D.

The Economics of the Coronavirus: Is a Recession Around the Corner?

The coronavirus pandemic dominates the news. The coronavirus was first detected in Wuhan City, Hubei Province, China and has now been detected in over 100 locations internationally, including cases in the United States. The Centers for Disease Control expects more cases to be identified in the United States in the coming days, including more instances of community spread.

What about the economic impact of all of this? Analysis such as the one that follows can seem heartless. Individual deaths, while being just part of a statistic, change the course of real families and futures. I don’t think money and wealth are the most important things in life. But we do need to know what might happen to the economy.

We are looking at two scenarios. The first is that the virus is contained through public health efforts in Asia, Europe, Middle East, and the U.S. China may have already run its course. This will mean economic disruptions for a few months. While the economy may slump, it might also make a quick recovery.

The second scenario is that despite all public health efforts to contain it, coronavirus spreads and runs its full course in places like Europe and the United States. This could knock points off global and domestic Gross Domestic Product and cause a hike in the unemployment rate.

Let’s look at the big picture and then see about Wisconsin.

Are we headed for a recession? The good news is that we enter this with a strong economy. Unemployment is at historic lows. Inflation is low. Labor force participation is solid. Consumer confidence was high coming into this. Wisconsin begins with an unemployment rate of 3.3%, slightly below the national average of 3.5%

The key statistic to watch is Gross Domestic Product (GDP). When it contracts for two consecutive quarters, most economists say we are in a recession. The Dow Jones Industrial Average tracks closely to GDP. When the economy contracts, stock markets tank.

GDP consists of four parts 1) Consumption (consumer spending) 2) Investment (business spending 3) Government (government spending on goods and services) and 4) Net Exports (the value of exports minus imports, usually a negative number).

Consumer spending, which is two thirds of GDP, is taking a big hit. Things are shutting down to slow the spread of the coronavirus. Hardest hit sectors include entertainment, airlines, travel industry, restaurants, and professional sports. The oil sector is also taking a big blow, largely due to the actions of Russia and Saudi Arabia as they respond to the decline in demand for oil in China. Investment spending has not been strong walking up to this. No doubt it will decline in response to all of the uncertainty. Government spending, depending on what stimulus program the federal government chooses, will likely increase. Exports are almost certain to decline also due to reduced demand.

GDP was growing at 2.3% in the fourth quarter. It is almost certain to decline. The question is by how much? Even if our first scenario is the one that plays out, it appears that we are looking at a year of no growth or perhaps a recession, meaning negative growth.

What about Wisconsin? Wisconsin’s economy is largely driven by manufacturing which is certainly going to be hurt due, in part, to supply chain and demand problems in China and elsewhere. U.S. car manufacturers, for example, are suspending production which sure takes a bite out of Wisconsin. China is Wisconsin’s third most important trade partner.

At the national level, there is talk about rescuing the airlines, other affected other businesses as well as loans to small businesses. In Wisconsin, small manufacturers make up 70% of Wisconsin manufacturing employment.

Direct funds from the federal government for businesses comes with uncertainty, political (not market) incentives, and inevitable strings attached. Rather than rescues, there is a more efficient path. The most important thing now is for the government, including the Federal Reserve System, to keep liquidity in the system so that businesses large and small that were solvent before the arrival of the coronavirus have a fighting chance to get through this. This means loans in exchange for collateral of solid asset to be paid back when the crisis passes, which it will.

Finally, what might the savvy investor do in such a situation? Back in 2008, investors who stayed with a “buy and hold” approach were eventually rewarded. That might work well again in 2020 depending on your time horizon. I suggest:

Consult with your financial advisor.

Stay diversified.

Consider buying when the market is down