Damien Grant from Waterstone Insolvency wrote in NBR a mere two years ago of the unsustainable nature of the monetary and fiscal strategies being pursued by governments and monetary authorities.
In it he declared “The economic good times are funded by debt-fuelled consumer spending and malinvestment by firms tricked by the low cost of capital. It cannot last. It will not last. We have not solved the problem of business cycles and the next crash will be worse than the one in 2008.”
My thesis was that a decade of cheap money had resulted in an explosion of asset and equity prices and contributed to poor investment decisions. This was a problem because we’d face a crisis when the cycle of lenders throwing money at borrowers to buy white ware, holidays and real estate ceased.
Obviously I didn’t foresee a pandemic, but by focussing on the economic effects of our containment strategies is to ignore an even greater underlying crisis.
Let’s start with the sovereigns. We are fortunate in New Zealand thanks to the fiscal prudence of Dr Cullen, who pared our sovereign debt down to a mere ten billion by the time he left office. Subsequent governments have squandered this legacy but even so, we are well placed compared to our trading partners, who began the 2008 crisis with broken balance sheets and compounded the problem.
In the decade since the US has more than doubled its Federal debt and most other OECD nations have forged a similar path. This caused them no fiscal pain because the cost of borrowing was close to zero. In the US the federal interest cost has fallen between 2008 and today, despite a doubling of their debt.
What happens now?
All western governments are promising to protect their citizens from the economic impact of Covid19 and plunging even deeper into the red. Looking at the cost of borrowing, at least as it was in February, they probably feel sanguine about this approach.
They should not be. Already we have seen interest rates demanded by lenders to sovereigns moving up. There are two reasons for this.
First, if you had capital back in January, when asset prices and equities were high, locking up cash in a low-yield treasury investment was as good as any other opportunity. This isn’t the case today, with investors wanting to remain liquid in periods of uncertainty and opportunity.
The second reason is more troubling. Central bankers, including Adrian Orr, are peddling Quantative Easing as a more sure-fire bet than chloroquine as a means of battling the contagion. Lenders begin to worry that, as GDP is falling and sovereign debt is growing exponentially, the risks of a default and a break-out of inflation becomes inevitable.
But it has not only been governments who have loaded up on debt. Commercial firms and households are also engorged on cheap money, which was fine when the economy was humming and the cost of servicing our debt levels was close to zero.
This golden era has ended. New borrowings are going to be far more expensive and everyone, from the Japanese government to a Tauranga property developer who has a large debt position is going to be forced into default. More troubling, when it comes time to roll over loans lenders are going to be hit hard with rate increases or a demand for redemption. This is when the wall of insolvencies will begin.
We are, globally, in a far weaker economic position than we were in 2008 when many economies were shocked into recession by a relatively trivial problem in the US housing market.
Today we have a vast cohort of mostly insolvent governments, firms and households with no reserves to draw upon during a period of collapsing economic activity and falling tax receipts. Yet we are going to attempt a repeat of the strategies many believed succeeded after the GFC but which, in fact, only delayed the day of reckoning.
Attempts to salvage enterprises as diverse as restaurants to airlines is pointless, as these were kept afloat by consumer spending funded by credit. This process has now ended. We are going to burn billions to maintain an economic order that has come to an end and in the process debase our currency and cripple central governments who will face a reduced tax base from which to service far higher debt burden.
Those who continued to champion deficit spending and new debt to fund infrastructure should now reflect that even if we took on no new borrowings, our debt to GDP ratio is going up as our GDP falls.
It is time to stop looking to 2008 as a reference point to our current predicament. The west faces an existential crisis of a magnitude similar to 1929. We are going to repeat the failed policies of the 1930s; massive state intervention and regulation, with the same tragic results.