Long-Term Impact: An idea that explains why the economy is in danger

That relationship, between spending and income, consumption and production, is at the core of how a capitalist economy works. It is the basis of a perpetual motion machine. We buy the things we want and need, and in exchange give money to the people who produced those things, who in turn use that money to buy the things they want and need, and so on, forever.

What is so deeply worrying about the potential economic ripple effects of the virus is that it requires this perpetual motion machine to come to a near-complete stop across large chunks of the economy, for an indeterminate period of time.

No modern economy has experienced anything quite like this. We simply don’t know how the economic machine will respond to the damage that is starting to occur, nor how hard or easy it will be to turn it back on again. Thanks to government statistical tables, we can understand the sheer size of the economic sectors that appear to be entering a near shutdown. The US and much of the world are on the verge of a shrinkage in consumption spending, which in turn will mean less economic output and lower incomes among the people who provide those services.

The Bureau of Economic Analysis tables of personal consumption expenditures include three categories likely to see very sharp declines in the weeks ahead. Americans spent $478 bn on transportation services in 2019 (which includes things like airfare and train fare but not the purchase of personal automobiles).

They spent $586 bn on recreation services (think tickets to sports events). And they spent $1.02 trillion on food services and accommodation. That adds up to $2.1 trillion a year, 14% of total consumption spending — which appears likely to dry up for at least a few weeks and maybe longer.

So what might such a collapse in spending in those major categories mean for the other side of the ledger, incomes?

That revenue from those sectors goes a lot of places. It pays employees for their labor directly. It goes to suppliers. It pays taxes that finance the police and schoolteachers, rent that rewards property owners, and profits that accrue to investors. All of those flows of cash are in danger as consumption spending plunges.

What happens if widespread bankruptcies were to cause losses in the banking system and cause a tightening of credit across the economy? Companies with perfectly sound finances today — which should be able to ride out the crisis — could find themselves unable to carry on simply because of a cash crunch.

For weeks, as the novel coronavirus spread, a common line among economists was that it would cause a “supply shock,” limiting the availability of certain manufactured goods made in China. But huge swaths of the economy are starting to experience the biggest demand shock any of us have ever seen. And we’ll soon find out what happens once a mighty economic machine gets a microscopic, yet potent, virus in its gears.