Could this virus trigger recession?

Fears are growing that the new coronavirus will infect the U.S. economy.

A major U.S. stock market index posted its biggest twoday drop on record, erasing all the gains from the previous two months; companies including Apple and Walmart have been warning of potential sales losses from COVID-19 and the Centers for Disease Control and Prevention told Americans to prepare for the outbreak to spread to the United States, with unknown but potentially “bad” consequences.

Lately, many people have asked me, as an economist, a question I haven’t heard in years: Could a virus really send the global and U.S. economies into recession – or worse? Put more pertinently, will COVID-19 trigger an economic meltdown?

The worry is understandable; viruses are scary things. I’ve read my share of medical thrillers based on some new virus spreading throughout the globe killing millions, destroying businesses and almost ending civilization until heroes — super or not — contain it at the last minute.

While these are works of fiction, we only have to look back 100 years to find a real example of what an unchecked virus can do.

The 1918-1919 influenza pandemic, also known as the Spanish flu, killed at least 50 million people worldwide, with some estimates putting the number as high as 100 million. In the U.S., almost 1 of every 3 people became infected, and 500,000 died.

Fortunately, the adverse economic impacts were shortlived. With today’s more mobile and interconnected world, however, some suggest any large-scale pandemic would be much more severe, with costs in the trillions.

Even if the death rates are relatively low, the economy can still suffer. These economic impacts would likely come in four forms: shortages of products from China, reduced sales to China, a drop in consumer spending based on fears about the virus and falling stock prices.

The U.S. imports over $500 billion of products each year from China, everything from smartphones and televisions to clothing and machine parts. Sick people in China can’t work, which means they can’t make products. Closing off parts of the country from other areas also curtails production.

The reduced availability of Chinese products could slow some segments of the U.S. economy, with the computer and electronics industries being the most vulnerable.

It’s too early to say how severe it will get, but the dependency of U.S. supply chains on China is a major concern. It shows how something like the coronavirus could become a huge problem in the modern economy.

On the flip side, U.S. companies sell well over $100 billion of products to China annually, with the most important being technology like computer chips and agricultural products such as soybeans.

These sectors have already taken a hit from the tariffs imposed by China during the U.S.-China trade war of the last two years. The recent thaw in the conflict – and a limited deal with China — had created optimism for U.S. factories and farms that increased sales were around the corner.

That corner may be harder to reach as a result of the coronavirus outbreak and its significant impact on the Chinese economy. More U.S. companies are now worrying about their sales to China as a result.

Ultimately, more than anything, the spending of consumers drives the U.S. economy, accounting for roughly 70% of growth. Economists, policymakers and traders will be closely watching measures of this to help them understand how worried they should be.

Significant declines in spending are usually the most direct cause of a recession and often signal falling incomes and higher unemployment. But consumers also reduce spending as a result of fear – such as when they see traders panicking on Wall Street. That is, nothing actually bad has to happen to reduce spending, and this fear-induced penny pinching can have real-world consequences and even trigger a recession.

Also, there could be two positive offsets from the virus that will boost consumers. One is a reduction in interest rates that has already occurred and will be welcome news for people borrowing money for a home or vehicle. Second is a drop in oil — and, ultimately, gas — prices that will mean less money to be paid at the pump.

Lastly, let’s look at the impact on stocks.

One thing traders and investors absolutely do not like is uncertainty. And that’s what we have right now.

Until we have a good idea of how much the virus will spread and whether containment efforts will be successful, markets could remain wobbly.

A falling stock market could affect the real economy in a number of ways, including by sapping consumer confidence and reducing their spending.

But just as a bout of bad news can send markets into a tailspin, a reason for optimism could cause a rebound just as fast.

For now, we’ll all — traders, companies, consumers — have to just live with uncertainty, not knowing just how bad it will get.

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