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COVID-19 economic recovery and what really matters

By Lachlan Baird

CEO, Prime Super

The past few months have made us all recognise the things we took for granted before COVID-19: time outside, visiting friends, sport and international holidays, to name a few.

The pandemic has significantly changed our lives and is set to have a lasting impact. There are always bright spots though, more time with family and children has been a real positive, an opportunity to reconnect with what really matters.

The economic impact of COVID-19 is significant. Governments and central banks around the world are doing whatever it takes to keep economies growing. This is leading to significant increases in the debt that will be carried by future generations.

We are now amid a global recession. This recession is different to every other recession that we have seen, as it has been Government induced, that is, the Government has closed businesses and the broader economy to enforce social distancing.

This pandemic has come at an interesting time for the global economy. We are going through a fundamental change in the way business works. Much like the industrial revolution where industrialisation took away many jobs involving manual labour, the current technological revolution is potentially leading to a restructure of the workforce, with many short-term implications to employment.

We have been slowly moving towards more online based transactional business functions like shopping and online banking. The pandemic has accelerated this shift through the forced closure of major shopping centres and retail businesses. Recovery of bricks and mortar-based retail to pre COVID-19 levels will be watched closely. Will we ever be able to shop ‘like normal’ again?

A key driving influence of economies is the cost of money. With many central banks around the world setting interest rates at or near 0 per cent, and Australia and New Zealand at an all-time low of 0.25 per cent we are in an environment where money has no cost. Modern Monetary Theory (MMT) can account for this, but I am not convinced that there will be an easy way forward.

Very simplistically, an asset only has a value when it produces an income. That is, an asset gives the owner some cash from which the owner can support their cost of living. The only real exception is the home, which is essentially an asset that compensates for the need to incur an expense, being rent for a place to live.

We are currently in an environment where the value of a company is based on the potential to earn, not on actual earnings. The hope is that a future investor will pay more for that asset, even if it still isn’t providing an income to the owner. The value of an asset is not linked to the income it produces as much as it has been in the past.

We have seen this before. The tech crash, or bubble, came to an end in March 2000, after a number of years of significant increases in share prices for companies that were internet businesses not earning profits, but were expected to make significant profits in the future.

Tesla is a very interesting example of this. Toyota is the largest automobile manufacturer in

the world accounting for more than 10 per cent of all sales, while Tesla accounts for around 0.7 per cent. Tesla now has a greater market capitalisation than Toyota, even though Toyota is far bigger and more profitable. Does the valuation of Tesla take into account the potential for the major manufacturers to develop a product that can compete with Tesla? Can Tesla meet the potential demand and deliver the shareholder return that such a valuation would require?

Continually lowering the cost of capital and increasing the amount of Government benefits and support means that businesses that are unlikely to be successful in the long run continue to operate. This shuts out new, more efficient businesses from evolving.

The global economy has been on this track since the 2007-2009 Global Financial Crisis. The cost of money has been reducing, Government benefits have been increasing and debt has been increasing. These actions are an attempt to push the solution further down the road, they are simply moving the problem onto another generation to bear the true cost. Now the pandemic has turbo charged this and the debt has to be repaid at some point.

How do we get out of this situation? The hope of central banks is that economies will continue to grow, driving increased taxation and Government repayment of this debt.

In a world where Governments are preventing businesses from trading and Government tax revenues are falling, this will not be possible. The solutions will fall to increases in taxation, debt forgiveness or high inflation to reduce the relative level of debt. All at a high cost of generations to come.

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