Five weeks ago, I warned you about it: Australia’s vulnerability to another COVID-19 outbreak, and the risks of more lockdowns as a result.
Well, this time it’s Adelaide.
Bloomberg describes it as one of the toughest lockdowns in the world. You can’t walk your dog. State borders are closed. Some of those who quarantined in hotels for two weeks have had their stay extended.
South Australia’s Chief Health Officer is warning it’s a particularly dangerous strain this time.
Do you think the lockdown will last just six days? I doubt it. Estimates for how long the virus can incubate are up to 14 days…
Of course, after the lockdown ends, we’ll be back to where we started. Back to where we were before the lockdown. Back to waiting for the next outbreak. And then another lockdown.
Does this seem like progress to you?
The basic premise of a lockdown, as the World Health Organisation acknowledged, is to buy time for other solutions. It is not a way of dealing with the virus. Because lockdowns are simply too dangerous. To our health, the economy and future compliance with government policy.
And yet, Australia has decided it is going to attempt to delay COVID-19 at the expense of all these.
Delay because the virus is not simply going away. If Australia wants to have tourism and trade, it’ll be at risk of another outbreak for a long time to come.
But it seems we don’t want either tourism or trade. We prefer to have the spectre of lockdowns, or actual lockdowns, hanging over us indefinitely.
So, let’s count the costs.
How many people will start businesses when the prospect of a lockdown looms?
How many businesses will hire new workers?
How many multinational corporations will invest in Australia when the government can impose lockdowns?
And, most important of all, what happens to those of us in debt?
Back to that in a moment. First, consider that markets just don’t seem to care anymore.
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COVID-19 has become a known unknown
Aussie stocks are levitating. And the Aussie dollar is surging past where it started 2020.
I remember February, when the virus didn’t seem to matter. Then it spectacularly sunk markets.
Now, with global virus cases and deaths at record levels, and cases accelerating exponentially, you’d think markets would worry once more.
But not yet. I think that’s a big mistake. Not just because we haven’t had the pandemic in Australia yet. But because the true economic consequences of COVID-19 haven’t even hit yet.
Do you remember when subprime was a containable problem in a faraway place?
That problem took years to really emerge. Because foreclosures and defaults take time.
Well, this time we have a far larger shock. So what do you think the consequences might be?
A coming debt crisis?
The Financial Times reported on the extraordinary figures:
‘Global debt rose at an unprecedented pace in the first nine months of the year as governments and companies embarked on a “debt tsunami” in the face of the coronavirus crisis, according to new research.
‘The pace of debt accumulation will leave the global economy struggling to reduce borrowing in the future without “significant adverse implications for economic activity”, the Institute of International Finance warned on Wednesday.
‘The total level of global indebtedness has increased by $15tn this year, leaving it on track to exceed $277tn in 2020’.
The current wave of bankruptcies in the US is set to leave more of a mark than usual according to a Bloomberg article titled ‘Bond Defaults Deliver 99% Losses in New Era of U.S. Bankruptcies’:
‘Bankruptcy filings are surging due to the economic fallout of Covid-19, and many lenders are coming to the realization that their claims are almost completely worthless.
‘Instead of recouping, say, 40 cents for every dollar owed, as has been the norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies — if that.’
How do we know this is likely to happen? The prices of credit default swaps, which are a bit like insurance you can buy on a bond going bust, suggest that defaulting bonds will pay out even lower amounts than in 2009 — when the financial crisis’ fallout played out in debt markets.
In other words, companies that are going bust, or expected to do so, are in far worse shape than before. It’s a more severe crisis for those companies in too much debt. The rest are adding more debt to survive in the short run…
The problem is, of course, that many lenders to companies are also in debt. Can they weather such losses — bigger than in 2009? I’m not so sure.
This chain reaction is what makes debt so dangerous. It’s why a debt crisis is contagious and the word contagion is used to describe it. One default can trigger many more.
But that’s in the US. We began our story there because US financial markets are developed enough to have a lot of bonds and credit default swaps, which reveal the distress to come in their market prices. They reveal what the market expects is coming for investors.
In Europe, banks and bank lending are a bigger topic when it comes to debt. Which means we know less about what’s going on. The banks don’t have market prices on their loans like US bonds do.
In Australia, we’ve had huge debt deferral programs to protect borrowers. That’s not going well according to The Australian:
‘One in ten households with a mortgage said they had experienced trouble meeting repayments over the four weeks to mid-October, more than twice the proportion in June during the peak of the coronavirus recession.
‘The latest Australian Bureau of Statistics’ COVID-19 household impacts survey revealed the proportion of mortgage holders struggling to pay the loan on their home or investment property had more than doubled from 5 per cent in June to 11 per cent four months later.’
But if periodic lockdowns continue, what’ll this mean for those who are now in more debt than before their deferrals?
SoftBank’s Masayoshi Son is warning about another debt crash. He referred to the Lehman Brothers and warned about the next few months. His fund has shifted to huge amounts of cash.
It’s not just the risk of debt defaults. All this debt will drag down future growth, of course. But that’s not its biggest impact.
The crisis we were supposed to have
Economic growth doesn’t just happen through expansion. It also happens through reallocation of resources to more productive purposes.
But this reallocation isn’t easy. It involves layoffs, companies going bust and prices falling. Economists call this a recession and claim it’s a bad thing. But consider what happens if we don’t experience such reallocation.
If dying businesses are kept alive by government bailouts. If they keep their hold on resources, preventing more productive competitors from emerging. If asset prices remain high, preventing new investments from being profitable.
Then we lose productivity gains — the only true way an economy can actually grow.
Population growth is the other possibility. It’s especially important to Australia, by the way. Immigration is like a tap which our politicians can turn on and off to goose GDP. That’s one way we escaped a recession in 2008.
But a lot of nations don’t have this tap. Their working age populations are already falling. Without productivity gains, they face economic stagnation.
If you’re expecting an economic revival after COVID-19, I think you’ll be disappointed. In the medium term, I mean. No doubt we could bounce back fast. But only to discover the world’s outlook for economic growth has changed.
Until next time,
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Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend
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