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.
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 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)