Coronavirus fears hit the markets

On Monday, U.S. stock markets plunged, apparently reflecting new fears that the coronavirus would be more disruptive to the economy than previously realized. On Tuesday, stocks were slightly positive.

How scared should we be?

Most investors and economists saw the virus as a temporary hit to China’s economy, one that would ripple through other economies as well, but would cause only temporary disruption. Disquieting news such as the shutdown of Apple production facilities in China and halts in tourism to and from China suggested that impacts could be significant but probably not very long-lived.

The spread of the virus to places as far-flung as Italy, Iran and South Korea now raises somewhat greater concerns. The specter of a longer, less controlled spread, even a global pandemic, cannot be completely dismissed.

An economist is poorly placed to assess the dangers of a pandemic. I will keep to the assumption that the virus will spread further but will be contained with a few weeks or months in the countries where it shows up. What might be the economic effects?

For many U.S. companies, the virus has already affected supply chains that include China. On top of the U.S.-China tariff war, the outbreak has further disrupted production. More importantly, it adds another argument in favor of reconsidering supply chain arrangements. It is costly to replace production now located in China, however. Finding or building new production capacity takes time and money. In this way, the outbreak builds up the trade war’s negative effects, intensifying uncertainty, raising costs and delaying investment decisions.

Additionally, the spread of the virus to Italy could affect that country’s already weak economy, deepening the economic funk in the European Union. Italy’s real GDP shrank 0.3 percent in the last quarter of 2019; the outbreak in Italy’s industrial heartland near Milan could help extend that downturn. And Italy has China-based supply chains: Fiat is reportedly shutting a factory in Serbia due to problems with parts made in China.

Germany, too, could be affected. So far, the number of virus cases is small in Germany. But the country sells capital goods to China, and relies on Chinese supply chains too. Not good news for a country that experienced no growth in the last quarter of 2019.

European markets are, of course, quite important to U.S. companies. The headwinds from slowing growth in Europe have contributed to moderating U.S. growth. Also, weak European economies could further strengthen the political standing of far-right parties eager to charge mainstream Governments with incompetence and worse.

Finally, slumping Chinese tourism has the potential to impact the U.S. hospitality industry. Losses to airlines and shipping companies could be keenly felt as well.

In and of themselves, these issues are likely to depress U.S. growth for the next quarter, and possibly spill over into the following quarter. The impacts are more likely to be noticed in European countries like Italy and Germany that were already on the cusp of recession. The U.S. economy has been in much better health.

Still, U.S. authorities will definitely be looking at how to respond. The Federal Reserve lowered interest rates last year in response to slowing growth and below-target inflation. The Fed’s moves tend to be most quickly seen in “interest-sensitive” sectors of the economy such as the housing market. So many homebuyers need mortgage loans, and so many construction companies rely on credit for themselves or implicitly for their customers that construction and the housing sector usually respond strongly to rate cuts. That seems to have been the case this time, as well.

Unfortunately, the areas of the economy needing help are not so interest-sensitive, and their problems mainly do not have to do with the cost of credit. Lower federal funds rates will not reopen Chinese factories, nor will they fill flights to New York with Chinese tourists.

Monday’s sell-off on Wall Street was a dramatic sign that coronavirus may be a bigger deal than we thought. But, in the U.S. at least, it does not seem that the sky is falling — yet.

Evan Kraft is the economist in residence for the economics department at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.