January 27, 2020

The potential for a consequential disruption in China's supply chains appears to be vastly under-appreciated.

Despite the current drop in stocks (less than 1.5% as this is written), there's a tremendous reservoir of complacency about the economic and financial impact of the coronavirus epidemic. The zeitgeist reflects an implicit confidence that the coronavirus will blow over like the SARS scare a few years ago and the impact on the global economy will be essentially zero.

Have all the risks already been fully discounted? Here are some of the reasons why the assumption that this will have little effect on the U.S. economy and stock market may be misguided:

1. Patient One (the first reported case of 2019-ncov) on 31 December was unlikely to be the person in which the mutation enabling person-to-person contagion occurred. The latest genetic analysis suggests the virus first mutated into its present form sometime between late October and late November.

It's thus highly likely the virus had already been spreading for at least a month before 31 December. The symptoms of this new virus are not that different from typical flu strains, so why would authorities spend the time and money searching for a novel flu in a patient? The only reason authorities become involved would be a cluster of flu/ pneumonia patients dying.

Hundreds of thousands of people die of the flu every year, between 12,000 and 50,000 in the U.S. alone, so the death of a patient with flu-like symptoms is not uncommon enough to trigger an official investigation.

This line of reasoning suggests there was already an expanding pool of virus carriers long before officials discovered the new virus and began acting to limit its spread.

If this is the case, then the virus may have spread outside Wuhan before officials reacted.

2. This virus is a new type, and this makes it especially dangerous as humanity may have limited immunity to viruses that are sufficiently different from existing variations.

There are several bits of evidence that this novel flu is both contagious and dangerous. One is that health workers have caught the flu from patients despite all precautions and anecdotal evidence that the disease has spread from one family member to everyone else in the household.

The other is the relatively high death rate. Based on data from Chinese authorities (likely incomplete) , about 3% of the patients have died. The great flu pandemic of 1918-19 killed about 2.5% of its victims, and since it was highly contagious, it's estimated 50 to 60 million people died in that pandemic--often young healthy people.

3. The incubation period for this flu may be up to 14 days, and someone who has it may be asymptomatic (display no symptoms) for 5 or 6 days. This means screening passengers for fever is essentially useless.

Even more alarming, the new virus doesn't always cause a fever, making screening for fever even less effective.

Despite these data points, the American populace is being assured that screening is effective and so it's perfectly safe to travel as usual. This complacent confidence appears to be unfounded.

4. The Chinese populace is highly mobile within China and the world. Hundreds of thousands of Chinese work in other nations, and a significant percentage of these offshore workers returned home for Lunar New Year and will be returning to their jobs in the U.S., Europe, Africa, Southeast Asia, the Mideast, etc. next week.

To assume that none of these returning workers are asymptomatic carriers of the flu is a stretch.

5. Researchers are busy developing a flu shot to offer some immunity, but if this virus is virulently contagious, the question becomes: can authorities outrace the spread of the virus? Realistic estimates of how long it will take to develop and test a vaccine are 6 to 7 months, and that's if everything works perfectly, i.e. the virus doesn't mutate, etc. Producing hundreds of millions of doses and administering the vaccine to hundreds of millions of people will take additional time.

6. The implicit model for this coronavirus in the mainstream is SARS, which was isolated and contained. But this new virus may be much more contagious and so the relatively rapid and successful isolation of SARS may be a misleading model.

7. Authorities seem to prioritize "don't panic" messages, as if fear of this flu is irrational. But fear of a risk that cannot be assessed with any confidence is entirely rational. The smart strategy is to lay low and wait for more evidence on the nature of the risk.

8. The potential economic impact of this virus is grossly underestimated. The Chinese economy is particularly vulnerable now for a number of reasons. In essence, all the low-hanging fruit of rapid development have been picked, and adding more debt to boost building and consumption is no longer as effective now that debt has soared.

The world has depended on China's skyrocketing consumption for growth for the past 30 years. Should China's economy actually contract due to the knock-on effects of the virus, the global economy will soon follow.

How fear triggers a domino-like effect in an economy is poorly understood. In an economy that's already teetering on recession, quarantines, disruption of travel and commerce and a generalized "circle the wagons" response to uncertainty will push the precarious economy over the cliff.

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