May 2020

Since April we have seen politicians around the world trying to roll back on the panic created by the Corona Virus. The machinery of government and its institutions, particularly areas involved in health, led by the World Health Organisation, embraced the idea of pandemic and effectively shut down the world’s economy. Previous global pathogens – Russian Flu, Spanish Flu, Asian Flu, Hong Kong Flu and, more recently, Swine Flu, SARS, EBOLA and MERS – to name but a few over the last hundred or so years, have gone from being treated as “acts of God”, to events that global governments have to embrace and public opinion has demanded that governments should be responsible for solving and protecting the public.

In the modern connected world, which has enabled this loading of responsibility on to government, we are seeing a new phenomenon. The difficulty, however is that as individuals it has become accepted that an individual’s life has near unquantifiable value and therefore government must allocate virtually all its resources to stemming the risk of death in the community in the short term, and there can be no discussion about the long term consequences. We are now at a point where governments of all kinds, whether they be democratic or communist, have reacted in an unprecedented way by, in the name of safely, shutting down their economies. I am ignoring in this context the dysfunctional governments that we see in many parts of the world.
As infection subsides, the most important question is how to now re-start individual economies in a globally connected world. Shutting down businesses for whatever reason is binary and brutal. Companies, like individuals, survive in various states of health, but death or collapse is the moment in time and sudden, when the organisation disintegrates. Re-starting companies is slow and difficult. Even the simplest business requires all sorts of inputs whether it is manufacturing, services or any other organised activity. People, electricity, food if it’s restaurants or entertainment etc, all are dependent on supply chains.

In today’s world, supply chains have become global. Even electricity is dependent on grid systems across countries, as is data processing. This is before you get to the more obvious manufacturing supply chains, parts being shipped around the world that we hear about more and more. Today we are hearing a lot of criticism of international/multi-national companies who have moved manufacturing around the world. This ignores the benefits in the form of lower prices that everyone has benefited from and, as important, it ignores the benefits of bringing work and improved living standards across nations from West to East. The mood, which is politically driven, of restricting imports and using trade negotiations as political footballs will, if carried much further, cause prices around the world to rise. Countries’ politicians claiming to protect their national interest by hampering global free trade is a dangerous and inflationary game, particularly coming at the same time as the disruption resulting from the pandemic’s economic shutdown.

Indications from America are beginning to appear as people restart their lives. There are US indications that existing house prices, and home appliance costs are reflecting shortages, i.e. prices are rising, and even second-hand car prices have stabilised. While there is a temporary glut of goods, supplies will not be available to replace them before the current surpluses are used up. As I mentioned last month, this is also going to happen in the world of raw materials where mines are being shut down and oil drilling has virtually ceased.
This brings us to what I believe is the problem of Central Banks. They seem to have only one hymn sheet, whatever the problem – lower interest rates will fix it. The same music has been played now for at least twenty years and we are at the point where interest rates are being driven to zero or below. The British government last week borrowed £3.8 bn. for three years at a price that means investors will get back less in total then they paid out. Britain has joined Japan and Germany in government borrowing at negative rates. It is extraordinary that a banker should think that interest rate movements of tiny amounts would affect the way well-run businesses invest in productive resources. A properly run business is not going to change its investment plans because interest rates have moved by half a percentage point. These sorts of movements do, however, encourage financial engineering where heavy gearing is used to improve yields. The experience in Japan over a very long period is that lowering interest rates has the perverse effect of increasing savings, while minimally affecting investment.

Today, we have large percentages of the population facing an economic crisis, the logical response is likely to be an increase in savings. People learned after the 2008/9 crisis that borrowing made you vulnerable. That lesson has now been heavily reinforced. Very low interest rates, along with negative interest rates, also have a damaging effect on pension funds, the insurance industry and banks. They also encourage politicians to avoid the responsibility of controlling government expenditure.

Economies around the world are beginning to come out of lock-down, economic activity is re-starting, markets can only be described as euphoric, and Central Banks are worrying about deflation when they should be worrying about inflation. The debate has been about whether a recovery is ‘V’ shaped or ‘U’ shaped. It is most likely to be wiggly or wavy shaped as imbalances are ironed out, and major issues such as unemployment rises when the zombie companies that survived pre-Corona on ever-increasing debt fail to re-open and the politically driven re-shoring of industry doesn’t happen as it requires skills that are not readily available in western economies.

The hope for the longer term is that the problems that have been ignored for a long time, such as the growth of incompetence in Western bureaucracy, are being exposed and will be addressed.

Damon de Laszlo
26th May 2020