So, it’s The Great Lockdown then. That’s the name given to this crisis period by the IMF and I’m hoping there’s another Isaac Newton out there. Well, not quite. Newton famously developed humanity’s knowledge of calculus, light refraction and gravity while quarantined during the Great Plague of 1665. Right now, behind the global public health priority of a CV-19 vaccine, the world is in urgent need of a gravity-defying economic plan. Newton’s falling apple suggested what goes up must come down. The task today is to figure out how a Lock-Down transitions to, hopefully, an Open-Up in the coming months. The laws of gravity and economics are challenging to say the least.
Let’s start with a few numbers. How much are we really down? The IMF reckons global GDP in 2020 will shrink by a higher percentage (3 %) than any period since the Great Depression. That’s even more than the nadir of the credit crisis in 2009. In dollar terms, January IMF forecasts of 3% growth this year have in a matter of weeks seen $5.2 trillion worth of activity evaporate from those 2020 expectations. The IMF think the ultimate cost through 2021 could be closer to $9 trillion – that is the equivalent of Japan and Germany’s economies disappearing. Here are a few other numbers which hint at the scale of the gravitational pull on economic recovery:
- Commodities: The IEA is forecasting oil demand for 2020 to fall by more than 9 million barrels per day (!). In April alone that number will fall by 29 million barrels per day. In effect, global economic activity/consumption has returned to 1995 levels. Good news for the climate but catastrophic for nations dependent on exporting commodities.
- Banks: Ireland might escape the worst GDP implosions likely to hit Italy and Spain but a quick check of bank share prices in Ireland gives some clues as to the scale of capital destruction. The combined market valuations of AIB, BOI and IPTSB amount to just over €4 billion, or just over 20% of the combined book value of these banks ie the market is discounting €16 billion of capital at risk of wipe-out. Then, factor in a 2020 Irish government budget surplus of €2 billion vaporizing into an estimated €19 billion deficit. That’s another €21 billion we might not have in 2021.
- Corporate Debt: Back in 2009 a critical factor in capital destruction was the amount of leverage in the banking system. We have written frequently about the risks of being dependent on “other people’s money”. Fast forward to 2020, and it is clear companies across the globe have feasted on ultra-low interest rates and loaded their balance sheets with debt. The Institute of International Finance estimated corporate debt levels among non-banks had rocketed to $75 trillion by the end of 2019. That figure was $48 trillion at the end of 2009.
Yes, the numbers are quite scary. However, the intention of this article is not to frighten but rather to highlight the difference between two competing emergencies. Governments and central banks everywhere have moved swiftly to address the immediate cash flow issues of citizens and companies experiencing a collapse in income and revenues. The longer term issue is how creditors and debtors deal with damaged balance sheets and the need for additional capital to “Open-Up”.
The Lockdown is a cash flow emergency. The Open-Up phase will probably be phased and slow. The entire world from universities to airlines will need capital buffers to navigate a possibly very changed world. Bluntly, the capital destruction estimated/discounted in the forecasts summarized above suggests too many capital-hungry mouths to feed. Previous years’ financial performances by established corporates may not be a helpful guide to the future. Companies will have to be realistic with their projections and tell their story very well. The risk profile for many sectors has endured a meteor strike and, in a sense, business models will have to be rebuilt, or in start-up terminology, pivot.
Yes, the Great Open-Up will be a capital event without precedent. We are all start-ups now.