The Three D’s- Debt, Default and Deflation

These are not apocalyptic horsemen, but they are three things that we need to be aware of over the next few years, in both our economies and our own finances.

Debt – Throughout the world, government debt is already ballooning as countries struggle to manage their way through this economic crisis. This has been, in effect, the financial equivalent of a heart attack. With this unfortunate metaphor, you may succumb to it, you may recover from it, but you will certainly be damaged by it. The question that we must address for nations, companies and individuals is how do we survive it and how do we minimise the damage?

For countries with ‘reserve’ currencies like the USA, Euroland, the UK, Japan and now China, they can make their own debt and even buy it through the mystical magic of quantitative easing. Therefore, financing whilst still costing money for them, is easier to achieve. If, however, you wish to finance your country’s trade position, you may need to borrow in another currency and thus find yourself exposed to the vagaries of for example, the US$ against your own currency. The worst example of this, is often the serial defaulter of Argentina. Life after this economic heart attack is going to see a huge increase in government debt and alongside some negative interest rates, investors will likely find this very unappealing.

This of course, will also apply to companies and private individuals. The good news, is that interest rates are so low that the cost of finance will seem almost a bargain. However, unless that debt is there to achieve something, like an investment, takeover or expansion, then weaker companies can end up as just a rotting albatross around their necks. These companies are merely kept alive because the banks don’t want to suffer the cost of foreclosure and subsequently need to write off even more debt – here you have the Zombie Companies!

Default – Defaulting debt for nations will be common during this economic heart attack but will hit those developing countries and emerging economies hardest, as they already work incredibly hard to attract new investments, even prior to Covid-19. Struggling companies will mirror this, as they might look to ‘restructure’ themselves at the cost of shareholders, bondholders and of course, their employees. As investors, we need to be aware of these weakened beasts. Some may have to fail, but this is even more reason to make sure that there is new money available for the existing and stronger businesses to get through this crisis. This then, is the unpleasant but realistic world of a wild economic Savannah.

Deflation – we need to be careful here in terms of definition. The term of ‘dis-inflation’ is often used. That is still inflation, but at a lower level – the balloon still fills with gas but at a slower rate. Deflation is where the balloon starts to shrink as the air comes out of it. The result is that values fall, prices fall and of course earnings and jobs fall. Although governments never say it, they actually like inflation, well some inflation… Why? Because over time it erodes the value of the debt. When you have deflation, this cannot happen and thus it becomes far more painful. The trouble is, trying to encourage inflation can absolutely be a dangerous thing.

Therefore, to manage our way through this economic recession and avoid depression, we need to be aware of the three ‘Ds’. The first two, are inevitable but can be manageable albeit with personal as well as corporate pain. The third is an economic virus, for which we have found no reliable vaccine. The most effective way of avoiding it is through clear international economic leadership, co-ordination and management. Sadly though, when we look around the world, the US leadership appears missing ‘in-inaction’, the EU is losing Merkel, and Chinese trade issues are not helping. Any volunteers?

And finally… All disasters can throw up opportunities, no matter how odd they can seem.

Reuters have reported that the dismayed staff at the Ronttosrouva bakery in Helsinki, found that as a result of the virus, all their orders were cancelled last month. At the same time, panicked consumers began to panic buy what they regarded as vital supplies, including loo rolls for some reason. This sparked the idea of a loo roll cake made of oat batter, passion fruit mousse and covered with white fondant.

The first five cakes sold within an hour, and thereafter the cakes became a social media hit. The bakery has now had hundreds of orders and has even been able to hire two extra people.

Like any good sponge cakes, I can only assume that they have two layers, so two-ply Loo Cakes must be a mark of quality.  The owner said, “For us, it’s a game changer and I am relieved because I know all my employees are safe for months now.”. This is how you avoid a wasted opportunity and take advantage of an opportunity of waste.

Have a good week and please keep safe and well.

Justin

 

Image source: fishpond.com