What the coronavirus is doing and will do to China

The coronavirus is an epidemic in China and seems to be morphing into a worldwide pandemic.  In its current form, the virus does not appear to be extremely deadly, but the fear is that it could mutate into something far worse.  Maybe it will; maybe it won't.

In any event, much of China is now on lockdown.  Travel is restricted, and people are being prevented from going to work to curtail the spread of the virus.  This is until February 10 at the least.  And it's happening not just in Wuhan, the viral epicenter, but in many other provinces, including modernistic Shanghai.  As Peter Zeihan reports, "[t]he most dynamic portion of the Chinese economy — the Yangtze Basin — is at least for now closed for business."  He estimates that this could knock off a full GDP percentage point from China's already sagging economy.

From there, things get worse.  There has already been a three-year exodus of manufacturing out of China due to uncertainties over the trade war, rising labor costs, environmental concerns, access to raw materials, and China's increasing authoritarian nature.  This coronavirus outbreak  can only accelerate the trend of companies to relocate out of China proper.  Commerce secretary Wilbur Ross touched on this in an interview with NBC News.  He said:

Well, first of all, every American's heart has to go out to the victims of the coronavirus.  So, I don't want to talk about a victory lap over a very unfortunate, very malignant disease," Ross told Fox Business Network on Thursday.  "But the fact is, it does give businesses yet another thing to consider when they go through their review of their supply chain."

"On top of all the other things, you had SARS, you had the African swine virus there, now you have this," Ross continued.  "It's another risk factor that people need to take into account.  So, I think it will help to accelerate the return of jobs to North America.  Some to U.S., probably some to Mexico, as well."

Ross mentioned supply chains, but what are they?  Here's a short definition

A supply chain is a connected system of organizations, activities, information and resources designed to source, produce and move goods from origination to a final destination — typically from a supplier to an end customer.  Modern supply chains are often very complex, spanning multiple countries and involving many steps.

Another feature of modern supply chains is that they apply Just-In-Time (JIT) inventory policies.  At its best, links in the chain get the parts and raw material they need only when they are ready to use them.  Computers make this all possible.  JIT is done to minimize inventory holding costs.  The axiom of JIT is that inventory is bad; it is a needless cost.  While JIT is highly efficient from an accounting point of view, it makes the supply chain highly vulnerable to disruptions, for, like any other chain, a supply chain is only as strong as its weakest link.  Basically, if parts or raw material don't make it to one of the links in the supply chain, the whole process stops.  There is no slack inventory to buffer the disruption. 

This is what China is now doing to the global supply chain.  It is hindering a significant part of product flow.  Non-Chinese businesses and economies will be adversely affected to the degree they are dependent on China.  Many business leaders outside  China have been sitting on the fence, trying to decide on whether or not to move their operations out of China.  The coronavirus could be the last straw.  With it, the scales could drop from the eyes of business executives, allowing them to see China for the risk it truly is.

Adding to this assessment is a fact that has been conveniently ignored up to now: coronavirus is not the first Chinese virus epidemic.  China is the world's premier incubator of new flu strains. Experts blame it for the 1918-19 "Spanish' flu," 1957's Asian flu, the Hong Kong flu of 1968, and the Russian flu of 1977, and the more recent SARS outbreak of 2003.

Businesses cannot withstand risks like that.  The coronavirus could be the final grain added to the Chinese sand pile that causes it to collapse.  The perception of China as a place to do business and where to get fat profits is quickly changing.

The coronavirus is an epidemic in China and seems to be morphing into a worldwide pandemic.  In its current form, the virus does not appear to be extremely deadly, but the fear is that it could mutate into something far worse.  Maybe it will; maybe it won't.

In any event, much of China is now on lockdown.  Travel is restricted, and people are being prevented from going to work to curtail the spread of the virus.  This is until February 10 at the least.  And it's happening not just in Wuhan, the viral epicenter, but in many other provinces, including modernistic Shanghai.  As Peter Zeihan reports, "[t]he most dynamic portion of the Chinese economy — the Yangtze Basin — is at least for now closed for business."  He estimates that this could knock off a full GDP percentage point from China's already sagging economy.

From there, things get worse.  There has already been a three-year exodus of manufacturing out of China due to uncertainties over the trade war, rising labor costs, environmental concerns, access to raw materials, and China's increasing authoritarian nature.  This coronavirus outbreak  can only accelerate the trend of companies to relocate out of China proper.  Commerce secretary Wilbur Ross touched on this in an interview with NBC News.  He said:

Well, first of all, every American's heart has to go out to the victims of the coronavirus.  So, I don't want to talk about a victory lap over a very unfortunate, very malignant disease," Ross told Fox Business Network on Thursday.  "But the fact is, it does give businesses yet another thing to consider when they go through their review of their supply chain."

"On top of all the other things, you had SARS, you had the African swine virus there, now you have this," Ross continued.  "It's another risk factor that people need to take into account.  So, I think it will help to accelerate the return of jobs to North America.  Some to U.S., probably some to Mexico, as well."

Ross mentioned supply chains, but what are they?  Here's a short definition

A supply chain is a connected system of organizations, activities, information and resources designed to source, produce and move goods from origination to a final destination — typically from a supplier to an end customer.  Modern supply chains are often very complex, spanning multiple countries and involving many steps.

Another feature of modern supply chains is that they apply Just-In-Time (JIT) inventory policies.  At its best, links in the chain get the parts and raw material they need only when they are ready to use them.  Computers make this all possible.  JIT is done to minimize inventory holding costs.  The axiom of JIT is that inventory is bad; it is a needless cost.  While JIT is highly efficient from an accounting point of view, it makes the supply chain highly vulnerable to disruptions, for, like any other chain, a supply chain is only as strong as its weakest link.  Basically, if parts or raw material don't make it to one of the links in the supply chain, the whole process stops.  There is no slack inventory to buffer the disruption. 

This is what China is now doing to the global supply chain.  It is hindering a significant part of product flow.  Non-Chinese businesses and economies will be adversely affected to the degree they are dependent on China.  Many business leaders outside  China have been sitting on the fence, trying to decide on whether or not to move their operations out of China.  The coronavirus could be the last straw.  With it, the scales could drop from the eyes of business executives, allowing them to see China for the risk it truly is.

Adding to this assessment is a fact that has been conveniently ignored up to now: coronavirus is not the first Chinese virus epidemic.  China is the world's premier incubator of new flu strains. Experts blame it for the 1918-19 "Spanish' flu," 1957's Asian flu, the Hong Kong flu of 1968, and the Russian flu of 1977, and the more recent SARS outbreak of 2003.

Businesses cannot withstand risks like that.  The coronavirus could be the final grain added to the Chinese sand pile that causes it to collapse.  The perception of China as a place to do business and where to get fat profits is quickly changing.