IT seems the Government is now concerned that people will be afraid to go back to work.
Let’s have a look at the potential economic impact of the lockdown.
The country, and in fact much of the world, is in a cash squeeze. This means that people and companies are hoarding cash by not paying bills when they fall due and not making unnecessary purchases. While that conserves their cash, it undermines the suppliers’ cash, so the supplier also hoards cash.
Will they still be once they understand the extent of potential economic impact of the lockdown? I wonder. Yesterday the Office for Budget Responsibility released its new coronavirus analysis, which showed a staggering 35 per cent fall in real Gross Domestic Product in the second quarter, and an unemployment spike of up to ten per cent – that is, two million additional people out of work.
So because of the lockdown, businesses not only are not taking cash through the door but few, if any, of their sales on credit are getting paid either. Yes, their costs have fallen and yes, the Government is paying 80 per cent of their wage bill – but that doesn’t solve the problem of paying the other 20 per cent, utility bills, insurance costs and rent, although many landlords (which may well be your pension fund) are allowing rent frees.
Much of the entire economy, six or more million firms and 65million individuals, lacks cash generation and the Government’s support is patchy.
As an aside, note that of the six million or so companies in the UK, only about 2,000 are traded on the London Stock Exchange, of which about 650 comprise the FTSE ‘all-share’ index.
The rest of the companies range from huge private enterprises such as JCB to one-person consulting firms. Those with turnovers of under £50million and fewer that 250 employees are known as SMEs (Small or Medium-sized Enterprises). This is 99 per cent of companies, 50 per cent of UK turnover and 60 per cent of UK employment.
Cash is the lifeblood of any company – they get sick when they don’t have enough and if they run out, they die. The inevitable effect of a prolonged cash crisis is that companies and people start to become insolvent.
As well as a disaster for them, insolvency impacts on the people they owe (creditors). The debts become complete losses, thereby reducing the net worth of the creditor. Too many of them and the creditor’s balance sheet will turn negative which, while not an absolute indicator of insolvency, is not a good sign and indicates that it may struggle to pay its debts as they fall due (which is a definition of insolvency).
Many SMEs use some form of invoice financing, either through their bank or a specialist. Broadly, the invoice financier advances the SME, say 90 per cent of the cash value of a sales invoice and takes the job of collecting the money.
When the customer pays, the financier deducts interest and fees and remits the balance to the SME. If the customer doesn’t pay, the invoice financier pursues him. Depending upon the terms, some may seek to claw back the advance from the SME, others may call on their insurance. Generally, this process is triggered by the debt going 15 to 60 days past due. The invoice financier has to pursue, otherwise his credit insurance is void.
So a delayed payment to an SME hits bank cash flow. As does suspension of mortgage and overdraft interest payments, etc. Remember that banks borrow much of what they lend, all of which needs cash to pay interest.
As we saw in 2008, cash problems in banks are devastating. Fortunately in 2008 the rest of the economy was doing OK and, after a hiatus, was able to generate the profits required to pay the tax needed to cover the interest of the £500billion-plus bailout. If the banks struggle now, there is much less real economy due to the coronavirus lockdown.
How long before SMEs start to go down in bulk? No idea, but it is not in the nature of SMEs to hold much cash (better to recycle it and grow / accelerate the business). I would guess that most SMEs have no more than one to one and a half month’s operating cash at bank, and many will have less. Which means the situation now is that they have one to three weeks cash left, plus perhaps some Government support. Which means that the cascade of insolvency will start before May. Once started, it will be very, very hard to stop.
It is important to realise that insolvency has a human cost, particularly for SMEs, whose finances are often underpinned by directors’ personal guarantees. All too often, the failure of the company means the loss of the family home. The actions of directors leading up to the insolvency are examined to see if the company was trading while insolvent. If it was, criminal prosecutions may result. The process is harrowing. Some don’t survive it.
Even if the economic meltdown can be avoided or arrested, the economic problems remain. The UK already runs a deficit, so it needs to borrow money on the international markets. It also has a huge national debt, which needs recycling. It now has an additional cost running at £50billion or so per month, which it also needs to borrow.
It used to be that the UK was the fifth biggest economy in the world which, combined with the long-established rule of law etc, meant that we could borrow cheaply because investors wanted to lend to us.
The UK government is not alone in shutting its economy down, so the impact on Germany, France and the US will be similar and they will all be seeking additional finance in the same international market at the same time – largely from the same investors. The question is, which investors will prefer to lend to the UK? And at what price?
I don’t know; not even the investors (many of them may be Chinese) know. But for sure they are all working on it. Which means that the UK, like every other country, is in a pre-marketing phase for a series of unanticipated bond issues.
Generally, investors are more inclined to lend to countries that have economies that are working and returning to normal, governments that have both grip and the support of their people. Governments that were printing money (de facto devaluation, sometime disguised as quantitative easing), did not demonstrably have an exit plan or had political problems.
Countries that cannot raise money will eventually default, at which point their economy ends up being run by their creditors. At this point, populations learn the true impact of austerity. Portugal, Ireland, Italy, Greece and Spain all learned this the hard way post-2008. (Arguably, they were cushioned from the full horror by the efforts of the other euro members to save the currency).
The timeframe between the first wave of SME insolvencies and sovereign default is unknowable. Given the speed of all finance, I would suggest shorter rather than longer. The start point is also in practical terms unknowable. My guess is the second half of this month, or maybe we will luck out and get to May.
Avoidance is simple – restart the economy by easing the lockdown.
It’s worth remembering that when the lockdown was introduced to save the NHS, thereby preventing the breakdown of law and order, it was reported that there were some 4,500 intensive care beds in the UK, of which about 1,000 were available.
Three weeks later, the Government (aided as ever by its Armed Forces and those useful chaps known as Sappers) has delivered over 4,000 more, with more to come. The ventilator shortage is also being solved.
While the daily number of new cases has grown exponentially, so has our capacity to deal with the threat to life (more or less doubling every week). And we can continue to increase capacity, indeed increase it faster.
Which means that sometime soon, the NHS front line should be able to cope with the rate of new cases. Especially if, as is hoped, the lockdown has reduced the rate of growth of the infection rate. The bottleneck has moved from beds and ventilators to front line workers’ PPE (Personal Protection Equipment).
But, as we have rapidly produced beds and ventilators, we should be able to rapidly produce PPE. The Armed Forces have more than 300,000 respirators that permit safe operation amid chemical and biological hazards. Why not issue them to those working in Covid-19 environments?
It is unfortunate that we do not have robust data on the spread of the disease. It is lamentable that this is unlikely to change soon, even if test kits can be delivered at 100,000 per day by April 30, the target the Department of Health aspires to (achieving it looks increasingly unlikely). There is not time to wait for scientists to deliver full data.
The lockdown need not end in total. But I suggest that easing it is urgent today; and there may be some low-risk options. If we can shop in a supermarket or go for a walk while maintaining two metres spacing, why can’t we achieve the same in garden centres? Or at racecourses? Or at many visitor attractions? Or even in country pub beer gardens? Or sunbathing in a park? Any of which would ease some SME cash flow and the frustrations of families cooped up in their houses and flats.
The Telegraph reports one adviser to the Scientific Advisory Group for Emergencies (SAGE) stating that the probability of outdoor transmission is near zero.
Most importantly, it would demonstrate to the investing community that the UK has moved on from dealing with the Covid-19 problem to restarting its economy, making us a relatively attractive investment prospect – thereby massively diminishing the probability of economic Armageddon.
Perhaps the return of Boris Johnson’s chief adviser Dominic Cummings may encourage the Government to focus on the relevant realities and get the national economy back on to a sustainable path, which happens to be the only way to save the NHS.