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Taking a closer look

  • 29 April 2020
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.'  

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