Taking a closer look

6 Comments

 

The COVID-19 pandemic is starting to ease, but the economic and financial fall out has just begun. It is not as if the world economy was in good shape before economic activity was slashed and entire industries were shut down. Those fault lines are only going to worsen, and the consequences might be very dark.

Reserve Bank of Australia (Getty images/ Mark Metcalfe)

The first and most pressing problem is debt. This was already running at 320 per cent of global GDP, which is unsustainable. The only way to keep the ball rolling was to reduce interest rates to close to zero, effectively making it debt in name only.

The pandemic will greatly worsen the situation. Aggregate debt will increase as governments borrow more to maintain a semblance of economic activity. Meanwhile, the ability of borrowers to pay will be reduced because they will have lower incomes, probably for years.

In Australia, Federal government debt is comparatively low, so the increase in budget deficits will not lead to unsustainable debt levels, especially with global interest rates being so low. Australia’s debt is instead disproportionately skewed towards households: mainly big mortgages because of asustained property bubble. The residential property market is especially vulnerable. About two fifths of purchases are investors taking advantage of negative gearing: a strategy of losing money in the short term in the hope ofmaking a windfall in the long term. Many of those investors are now under financial pressure because of the pandemic and they will be unsentimental about selling.

If there is a sharp fall in property prices it may in turnpose problems for the banks, whose business is almost entirely dependent on lending for property. The banks’ stress tests, taken last year, in theory indicate that they would survive, although their profitability would plunge. But that is just a hypothetical. The reality may prove very different.

What may happen in Australia is an extension of quantitative easing, whereby the Reserve Bank buys back government debt and leaves it on its balance sheet. As Percy Allan, professor of economics at the Institute of Public Policy and Management, UTS, has argued, instead of on-selling the government debt to commercial players, the central bank could leave it on its balance sheet as a type of social investment — in effect a form of debt forgiveness, or debt shelving.

 

'A further lesson is that, before believing "we are all in this together", it very much pays to take a closer look.'

 

Elsewhere in the world economy, debt forgiveness is becoming ever more likely, especially in China. The most obvious flash point is Hong Kong, which, according to analyst Kyle Bass, has the most levered (indebted) economy in the world, with bank debt standing at a dizzying 850 per cent of GDP and assets. The situation is little better in mainland China where half the banks are technically insolvent and domestic money supply (M2) is $US29 trillion in an economy only worth $US13.6 trillion. That is one of the most ridiculous money printing exercises ever.

If the United States sues China for spreading the virus and confiscates Chinese assets in America as reparation, it would deprive China of the foreign exchange it desperately needs to buy resources and food (China has not allowed foreign corporations to take funds out of China since late 2016 it is so desperate to retain foreign exchange). The country will then be forced to withdraw and the era of Chinese economic interconnection with the West will come to an ugly end. Japan is another candidate for debt cancellation and are set. Its debt bubble burst spectacularly in 1990 and in the ensuing 30 years the Japanese economy has never recovered.

America’s economy is teetering on the edge; unemployment may reach as high as 30 per cent, worse than the Great Depression. America does have a special advantage, the world’s reserve currency. About $US5 trillion of American dollars spins around the world daily in the global capital markets. That is how it was possible for the US Federal Reserve to ‘invent’ more than $US10 trillion out of thin air, money it mostly threw at banks, big corporations and Wall Street rather than workers and small businesses.

The result of such inequity will likely be a hollowing out of the American economy that will dwarf what happened with globalisation. This would be an economic upheaval that could easily spin out of control. At the very least, expect massive class actions from people whose businesses have been destroyed by panicking governments (more than 40 per cent of American small businesses are now not operating and many will not return).

One lesson from the crisis is to never listen to modellers; they have been wrong, as modellers nearly always are, by orders of magnitude about the virus’ lethality. Another lesson is not to let financiers, especially bankers, do what they like. A further lesson is that, before believing ‘we are all in this together’, it very much pays to take a closer look.

 

 

David JamesDavid James is the managing editor of businessadvantagepng.com. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Main image: Reserve Bank of Australia (Getty images/ Mark Metcalfe)

Topic tags: David James, COVID-19, economics

 

 

submit a comment

Existing comments

Those fault lines are only going to worsen, and the consequences might be very dark? https://en.wikipedia.org/wiki/Hooverville#/media/File:Huts_and_unemployed,_West_Houston_and_Mercer_St.,_Manhattan_(NYPL_b13668355-482853).jpg Peter Gutwein, Premier of Tasmania is showing the health, safety and well being of the homeless currently doing it tougher than ever, and tougher than all of us, is of highest priority. Nobly endeavouring to eliminate the accentuating of social and psychological isolation of the homeless on the streets of Tasmania. Leadership is an action, not a position. I now look forward to hearing from other Australia premiers of Australia, take suit.
AO | 29 April 2020


David, I suspect you are correct about the outcomes of the COVID-19 pandemic, a scary scenario indeed. I did Economics 101 in First year Uni but was so disillusioned by the fancy graphs that I returned to my main area of Geography. On graduation I became a school teacher and climatologist (now retired) . Back to the world of models which deal with Climate Change where I am immersed almost daily. The warnings are out, but with a scientific degree of uncertainty which the "denialists" love to quote back at us. Climate models use observed data, thus do not have to deal directly with human actions, unlike economic models, therefore they are more useful forecasting tools pointing to future climate change if we don't reduce CO2 emissions. My advice; don't throw all models out with the bathwater, some are more useful than others. Gavin A.O'Brien FRMetS
Gavin O'Brien | 29 April 2020


“Never listen to modellers” is good advice. Just as climate models vastly overstated global warming, so too the predictive models for the coronavirus pandemic got it very wrong. Modelling can be a useful source of information, but to shut down a society on the basis of a model is extremely dangerous. Additionally, there are numerous disagreements among those who are advising governments. Britain’s “Guardian” got it right when they accused Boris Johnson’s government of using the refrain “following the science” to “abdicate responsibility for political decisions”. Ministers were “abdicating political duty to a narrow field of opaque expertise.” You can’t divorce public health from the economy. Bankrupt countries don’t have first class health care.
Ross Howard | 30 April 2020


“At the very least, expect massive class actions from people whose businesses have been destroyed by panicking governments (more than 40 per cent of American small businesses are now not operating and many will not return).” Those who delight in economic doomsaying (a sub-category of soothsaying and a close cousin, if charts are illusions (as the Austrian school would probably agree) of modelling) should make up their mind where they want to stand. Either ‘lockdown’ was necessary and governments weren’t ‘panicking’ or the Tea Party/ liberationist types were correct and governments were. Anyway, there’s a difference between an economy dissipated of energy because people are too poor to buy and one straining at the leash with pent-up energy because businesses are banned from selling. Despite the poverty of the population, post-WW2 (West) Germany was actually an interesting case of the latter, war locking down businesses much like our virus. The Australian basics today are in much better shape than West Germany in 1945. This country can feed itself many times over without imports. There are raw materials galore underground. Petrol is cheap thanks to Putin. All we need is for Frydenberg to turn into Ludwig Erhard.
roy chen yee | 30 April 2020


“If the United States sues China for spreading the virus and confiscates Chinese assets in America as reparation, it would deprive China of the foreign exchange it desperately needs to buy resources and food (China has not allowed foreign corporations to take funds out of China since late 2016 it is so desperate to retain foreign exchange).” So, every cloud does have a silver lining.
roy chen yee | 30 April 2020


David, A gentle but prescient reminder by you of things to come. Sure; reality has to be faced and no one on this masthead would want you to forsake your fine reputation for speaking to the truth as well as your commitment to interrogate and critique those who 'run' the economy...even those among ourselves who imagine we don't but who inevitably play a role within it that we invariably take no responsibility for. Given that two avid respondents here have equally graciously already flagged their muted objections, indicting their commendable preference for alternative foci and better priorities as we stumble our way out of the juddering stop that COVID-19 had brought to the global economy, do you think you could speculate on an alternative economic way of our living and 'transacting' together in modalities that at last acknowledge that now is the chance to lay the intellectual and practical groundwork for a new future (which is Gavin's point) and that such a future ought to be one that puts the human person first (which I take to be AO's point)? Surely there's an essay in that to start us thinking along these lines as house prices collapse and unemployment grows?
Michael Furtado | 01 May 2020


x

Subscribe for more stories like this.

Free sign-up