“If you can keep your head when all about you
Are losing theirs and blaming it on you . . .

Rudyard Kipling, If: A Father's Advice to His Son 

Well. It’s been an interesting few months for the world, for each of us as COVID-19 engulfed the world. The IMF has called it the ‘Great Lockdown’. Martin Wolf, as he often does as morphed this to the ‘Great Shutdown’ based on the reality that the global economy would be collapsing even if policy makers were not imposing lockdowns. I’m with him. Just look at the chaos in the USA, Brazil, India, Britain and Russia.

As a business historian and keen observer I’ve been reading and trying to absorb the perspectives, reporting and headlines around what the Great Shutdown means while living it myself. The disconnect between the share markets and reality on the ground is frightening. The rampant speculation and ‘flight’ to find higher returns fuelled by incredibly cheap money will end in disaster and do nothing for the millions of small businesses who will find it hard to recapitalise and open up.

Let’s start with some of the by lines I’ve read over the past three months.

Risk of $300b black hole in global finance

IMF warns of finance system breakdown

Ides of March: $11.6 b flight to safety

Best month for shares since ’88 as Fed. Virus drug fuel rally (one of my favs)

Central banks must print money

Central banks crisis response far from ideal

In Blackrock we trust

After Covid-19 a new global order

Greed, fear: ASX wraps worst year since 2012

Then there’s the whole range of articles (well at least I think they are articles although some suspiciously look like sponsored advertorial) about market…. But I digress.

At the public level the Australian Government, Reserve Bank and banks have done a pretty good job at steering Australia through this global disaster? In fact, if you think about how slow governments are to move on most things – usually at a glacial pace – the speed and quantum of what our government has implemented has been nothing sort of outstanding. And, it was undertaken before any of us caught our breath, literally, from the summer bushfires.

Gaia’s message

Quite early on I took a more philosophic perspective on the impact of the pandemic on the world economy, the Australian economy and, quite literally, my economy. I’ve shared this with my friends.

Gaia (mother earth-think the tree in the movie Avatar if you’re still struggling at this point), has had enough. We’ve been behaving badly towards each other and disrespecting her for some time. She’s tried to guide us, share with us how we’re killing our very home through our avarice, self-absorption, focus on money, more, bigger. We’ve become rude, intolerant, uncaring, focused on the wrong things. Companies have leveraged their balance sheets to the max based on quantitative infinity (QI) and the share markets are still living off this.

Gaia had enough. She’s sent all of us to our rooms to sit and think, contemplate what we’re really doing to ourselves, our families, communities and her.

And, she’s not letting us out of our rooms until we’ve had ‘an attitude shift.’

While I’d like to think this analogy will be the ‘Great Learning’ from Covid-19 I am pretty sure most of us will revert to type and try to get back to normal as soon as we can.

If the share market is anything to go by this has already happened….but this is what I’d really like to explore.

On xx the US Federal Reserve Bank chairman, Jerome Powell promised to ‘use our tools and act as appropriate to support the economy.’ Great, maybe. Shortly afterwards the Bank of Japan followed and then the Australian Reserve Bank did the same.

Or maybe, this isn’t great. Why? The financial markets have come to rely on central banks to cut interest rates in response to any sell-off to let the flow of money reinflate fallen stock prices. Ultra low interest rates policies have made financial markets more vulnerable to a sudden shock…and COVID-19 was THE shock no-one saw coming.

As James Shipton, chairman of ASIC commented in February 2020.

 ‘Stock prices have travelled up the stairs of dirt cheap money have now slid down the escalator on the other side (since then they’ve taken the ‘up’ escalator again)’.

Rana Foroohar likens watching the share market over this period to the seven stages of grief and then pulls us back in to line.

 ‘ …this is simply the correction I have long expected….with mounds of global debt, falling credit quality and decades of low interest rates driving asset prices to unsustainable levels.

The reluctance of investors, politicians and central bankers to accept that this is not  just an example of the natural human tendency to put off pain. Rather it is something scarier and more factual.

The truth is that the economy is now dependent on asset bubbles for survival.’

The same could and should be said about the Australian economy.

Just to go back abit before we move forward. The fundamental cause of the GFC was excessive leverage (debt). With COIVD-19 it’s a supply-side issue (no demand). There is little point in using demand-side measures such as even cheaper money, to deal with a problem on the supply side of the economy. Cheaper money won’t drive demand and it certainly can’t unlock supply chains. It also won’t tempt small business owners to borrow to recapitalise and open up their businesses. Small and medium business owners are rightly working out how to preserve cash and pay down whatever debt they have.

Unconventional monetary policy, Quantitative Easing (QE) has, I’ve said before become Quantitative Infinity (QI). All this has done in Australia is fuel the share market, encourage Australians to take on more debt, take more risks. Rana Foroohar references analyst Luke Gromen’s article The Forest for the Trees in which he states that ‘about 2/3 of the US economy is consumer spending. Rana notes that ‘people’s spending patterns are not based on their income alone. Our personal consumption is also linked to our expectation of wealth held in assets like stocks and bonds’, and in Australia property.

Extremely low interest rates in Australia have fuelled leverage everywhere, particularly for Australian households at 120% of GDP. As households we’re being given cheap debt to spend now . . . but someone has to pay for it, us and our children/grandchildren, in the form of higher taxes, higher GST. There’s no such thing as free QI. At best it’s inter-generational debt transfer. At worst, you’re living beyond your means now and if you haven’t reassessed this during Covid-19 it’s been a wasted opportunity or sheer arrogance.

The 30-year dream run stops

I am constantly surprised about the optimism I hear from people I engage with across my business and personal life, that Australia will bounce back, that it’s not ‘that bad’, we’ve had a blip but we’ll be alright.

I’m not that keen to be dubbed the Nouriel Roubini of my network (and of course I have none of his academic or other qualifications). Nouriel was described as ‘Dr Doom’ when he predicted the 2006-2008 crisis, but Australia has a hard, long road ahead.

• The great shutdown will cause the worst global economic downturn since the Great Depression of the 1930s.
• It will result in a much deeper contraction than the recessions of the early 1980s and early 1990s.
• The IMF predicts a global 6.1% GDP contraction in 2020 with a 4.5% expansion in 2021. This will leave the Australian economy smaller by the end of 2021 than it was at the beginning of this year.
• ‘Over the first half of 2020 we are likely to experience the biggest contraction in national output and income than we have witnessed since the 1930s.’ Reserve Bank governor, Philip Low
• Small and medium business owners will not bounce back in anywhere near the numbers currently being projected because the larger, online businesses have taken a significant portion of their business away.

In May this year Roubini shared that the US (and the world) would be in for 10 years of depression and debt. At the end of June he commented that he expects the US to experience an anaemic recovery followed by a greater Depression over 10 years.

In late July Reserve Bank Deputy Governor, Guy Debelle shared his concerns about rising business failures, the lack of demand to borrow money due to on-going uncertainty. Throughout my network of small and medium businesses there’s now the realisation that they can’t keep operating profitably so they’re starting to make the tough decision to close their businesses permanently. It’s the unknown aspect of ‘how long’.

 

 

The recovery – pick a letter from the alphabet

It didn’t take long, mid-April here in Australia, for the business/government discussion to turn to ‘the road out’.

As a someone who is quick to call out corporate speak (pivot is my ‘word of Covid-19) I’ve been tracking the use of specific letters of the alphabet to describe the potential road, pathway, escalator out of Covid-19. Alas I haven’t seen ‘beam’ or transporter (as in ‘Beam me up Scottie). Here’s a summary of what I’ve read to date in no particular order.

V = V-shaped exit. Short, sharp lock down, no economic activity, strong government support, everyone goes back to ‘normal’. Bollocks. This is not going to happen.

W = W-shaped plunge and pick up. Harsh lock down, open up too early, second wave back into shut down. There’s no steep climb out of this so the last part of the ‘W’ is a complete myth

L = The shutdown of the economy in March-April and then flat-lining for a period of time, a much longer period of time that any of us want to think about right now. This is my pick and the recent Citi report on small business stress says it all, one third of small businesses in Australia only have enough liquidity for three months. Following that, the fiscal cliff of stopping the Job Keeper payments and the decline in white collar jobs NEVER to be replaced will see the Australian economy flat line for at least 2021 if not well into 2022.

The L is what Roubini calls a Great Depression, where growth falls sharply and takes an extended period of time (a decade) to return.

S = Strongman syndrome  (thanks Gideon Rachman for the term). Where governments ruled by egotistical, narcissistic, delusional and arrogant males (my description) don’t give a rats about how many die because they want to stay in power. They then bully every supposedly independent institution, including their supposedly independent central banks to keep printing money to keep pump priming the share market. The top of the ‘S’ is this lot and bottom of the ‘S’ is everyone else.

G = The Gaia (the ancestral mother of all life). Everyone on the planet now realises that we really are ‘all in this together’, that microbes really rule the world or that we’re just one small part of a bigger world (that John Wyndham’s book, The Day of the Triffids was more prescient than Orwell’s book 1984, Douglas Adam’s The Hitchhiker’s Guide to the Galaxy (42) and Arthur C. Clarke’s 2001 A Space Odyssey).

M = I is on the way up (1990-2006) the first half down of the ‘M’ is the GFC. The next ‘half-up’ is post GFC. The last I is the plummet of Covid-19. And the end part of the ‘M’ is the biggie…and this is the intergenerational bomb…revert to the ‘L’ described earlier and imagine this only marginally moves in an upward trajectory for the next decade or two.

The Monetary policy issue

Here’s something that Robert Guy wrote not so long ago:

‘The unleashing – and misfiring – of monetary policy bazooka at a virus arguably  ranks as one of the lamest policy decisions among the pantheon of questionable central bank decisions since the global financial crisis.’

Tell us how you really feel Robert. And he does when commenting on Powell’s comment that his decision to cut interest rates would ease financial conditions.

 ‘The rate cuts hint at the over-inflated sense of omnipotence bred into central bankers over the past decade if they believe that more cheap money can solve a public health emergency. Lowering the cost of funding for those wealthy enough to  own stocks and property does not qualify as helping a health emergency in any sense of the word.

‘Moral hazard is the big winner from the rapid fire succession of rate cuts from the Fed, the Reserve Bank of Australia and other central banks….It projects an impression of central banks, yet again, coming to the rescue of leveraged-up investors who cannot cope with the slighted collateral damage.

‘The pandering to, or the bullying by the global markets and homeowner the past decade or more has gradually painted central banks into a corner.

‘But having created over-valued everything through their cheap money policies, central banks find themselves as the ringmasters of the three-ringed circus that is cheap money, the hint for yield and richly priced assets.’ For Central banks, it’s a race to ZIRP or bust. (AFR 5 March 2020 page 29).

Robert, I agree. Many small and medium businesses are dying or are dead. Most won’t come back, there’s NO V-shaped bounce back. No-one in their right mind (and they’ve now had three or so months with no revenue and plenty of time to work out ‘their mind’) would take on more debt to re-start their business.

All small and medium-sized business owners know that whatever temporary relief and support the government and banks provide is just that, temporary. Why would we take on more debt in an uncertain world? It doesn’t make sense to anyone.

As an economic historian I am all for understanding history and patterns and that we can learn from history. Where we are now doesn’t haven’t have a parallel in history: simultaneous zero (or negative) interest rates, a global supply shut down, economy-wide shut downs, extraordinary government intervention, the rapid move to different working modes, over leveraged nations and households.

As Mark Twain said: History never repeats itself, but it often rhymes.

In the current scenario it does not even rhyme. I’m picking the ‘L-shaped’ future scenario.

As a survivor of the GFC my advice to small and medium businesses: take action now, hope is not an action plan and even if you thought a V-shaped or W-shaped rebound was possible, plan for the L-shaped one. Take action now, this is as good as it's going to get for a long time. 

And get used to a completely different 'normal', whatever that is.