Illustration: Craig Stephens
by Andy Xie
by Andy Xie

Luck may be the only thing standing between the coronavirus and a US stock market crash

  • The slowdown in Chinese manufacturing and ripple effect on global supply chains will hit the global economy hard, even if a recession can be avoided
  • If the outbreak cannot be contained by summer, a crash worse than the 2008 crisis awaits America’s inflated asset markets
China’s manufacturing sector will take quite some time to get back to normal. The global supply chain is being disrupted, triggering production stoppages in other industrial centres. China will at least struggle through this month. The odds are high, and rising, that the coronavirus crisis will last through March, which may be enough to push the global economy into recession.

There is a significant chance that the crisis will last until summer. The economic disruption may pack enough of a punch to pop the biggest global bubble – centred around the US stock market – in modern history. 

The coronavirus outbreak appears much more serious and more likely to persist than appeared to be the case just two weeks ago. In addition to disrupting the services sector at an estimated cost of over 0.5 per cent of gross domestic product per week, the manufacturing sector may not be able to get back to normal before at least the end of February.

Disruption in March looks increasingly likely. The longer the crisis lasts, the more likely is a global recession.

Over the past two decades, global supply chains have come to rely on China for cheap components. From automobile and electronics to shoes and garments, sourcing materials and components from China is vital to keeping the global economy humming. If China cannot get back to normal soon, the disruption may push the global economy into recession.

Many migrant workers, the main labour force for the factory sector, returned to major production centres like Shanghai and Shenzhen last week. This is already one week beyond the normal Lunar New Year holiday.

Normal precautions require these workers to be quarantined for two weeks. If everything works out perfectly, China’s manufacturing could get back to normal by the end of February.

Under the above best-case scenario, the global economy may avoid a recession. But a significant hit is unavoidable. China’s economy is obviously contracting, even though official statistics won’t show it.

The financial ramifications will be a significant drag for many quarters to come. China’s local governments and businesses have been struggling against high leverage amid slowing growth. A big hit like this will force many to retrench.
China is the largest industrial economy and second largest overall. If its economy slows so much, commodity prices will suffer greatly. The recent fall in oil and iron ore prices are cases in point. That would lead to declining purchasing power for emerging economies.

A slowdown in China alone could trigger a global recession. While the current level of commodity prices doesn’t yet imply a global recession, it is quite close. If the prices of oil and iron ore decline by another 20 per cent, a global recession would be upon us.

If the manufacturing disruption lasts through March, production in other industrial economies like Japan and South Korea would be affected. Emerging economies that make shoes and garments will have trouble sustaining production.

The migration of downstream manufacturing to Southeast and South Asia is backed by supplies of materials and parts from China. In this scenario, a global recession becomes highly likely.

Could the coronavirus trigger a China-led global recession?

Even if Beijing orders all factories to restart, events beyond its control may stop production anyway. If one virus carrier is found in one factory, part of its workforce would need to be quarantined. The factories down the supply chain will be affected. China’s manufacturing sector will have to depend on luck to operate normally.

In the worst-case scenario, all human efforts won’t be enough to contain the outbreak. The world must wait for the real saviour – summer time – to break the crisis. The prolonged disruption to global supply chains would lead to bad earnings for multinational companies for two quarters.

The bad news may trigger the US stock market bubble to burst, which is likely to be more devastating than the crash in 2008. The global ramifications are easy to imagine.

The US Federal Reserve appears determined to prolong the bubble. Despite the record low US unemployment rate, it introduced another round of quantitative easing last autumn – about US$400 billion since September – to protect the bubble. While the Fed may come up with wild theories to justify its actions, it is clearly in the pocket of those who benefit from the bubble.

Since the 2008 global financial crisis, no major economy has cut their debt leverage. The biggest two – China and the US – have increased it. All these debts have not weighed the world down, because asset prices have risen faster than debt, making businesses and households feel secure.

China’s fear of job losses looms large as coronavirus takes toll on economy

This global Ponzi scheme has been built on the renminbi’s peg to the dollar. As the Fed introduced massive quantitative easing after 2008, it allowed China to triple money supply and quadruple credit, in the 10 years since 2008, by importing the US central bank’s loose monetary policy. This turbo effect led to rising asset prices everywhere.

In the past two years, however, the Chinese government has begun to worry about a debt crisis. In contrast, the Fed has relied on the one-pony show of propping up the US stock market to keep it going.
Liquidity is a necessary condition for a bubble, but not sufficient. It also takes mass hysteria. Right now, this centres around the big tech companies. When speculators realise that bad earnings will stick around for a long time, they may run. The resulting global recession would validate the panic. The coronavirus may just be the “ black swan” to end the mania.

Andy Xie is an independent economist

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