There are two types of viruses: computer and biological ones. Neither of them brings happiness to those who have been affected. However, they do leave an important mark, and in some cases, the negative effects can last years or even trigger new issues.
For example, the coronavirus pandemic has not only caused health issues but also lead us to a new financial crisis. It might have seen as one the shortest for financial markets but we shouldn’t be so naive.
First thing first, indices recovery was a result not so much of a good epidemiological situation, but monetary instruments implemented by the world's most influential central banks.
The only problem is that they also have their own price. Here we need to plant the first question: Who will pay for the Covid crisis bailout?
The answer is very simple – we will. Despite the fact that markets are near record highs, there are still millions of people who weren’t able to recover their jobs. Thousands of companies were closed and most probably will never open again.
Based on a 9.2% unemployment rate in the fourth quarter of 2020, the researchers initially predicted that bankruptcies would finish the year with a 140% increase YoY. It is estimated that U.S. corporations owed $10.5 trillion to creditors earlier this year, a number 30 times higher than it was half a century ago.
It is also important to mention that company filing for Chapter 11 – doesn’t necessarily mean it will disappear. Instead, bigger companies usually do it to restructure and settle on new repayment terms for their debts so they can remain open.
Unfortunately, small and medium-sized enterprises can’t normally afford it.
For now, it may look like U.S. bankruptcy filings have slowed but once again, we shouldn’t be so naive, the bang is yet to come. Most of the companies that should have disappeared from the tax agency radar due to the business close down have simply reincarnated into zombie companies.
Just like the movie “brain eaters” they are neither dead nor alive. The amount of the debt on their balances is so high that any cash generated is being used to pay off the interest on the debt. Thus, the company can’t grow as it doesn’t have spare funds to invest.
This, in turn, means it can’t employ more people. To be fair, this problem is not new, it has been with us for years and the reason is – cheap loans due to low-interest rates.
Many of the zombie companies survive by issuing new debt that will allow funding operating losses and interest payments. If you ask which sectors are on the radar, unfortunately, there won’t be a clear answer.
Basically, every sector is at risk, from entertainment to retail and beverage.
The situation is only getting worse with additional lockdowns. It is also true that some companies do earn from the situation, especially IT businesses, but even they could eventually suffer if the global economy enters into a new crisis, and this is not a scary tale.
But companies are not the only ones who fell into debt distress. According to the IMF, emerging market governments issued $124 billion in hard currency debt during the first six months of 2020, with two-thirds of the borrowing coming in the second quarter.
The US public debt, on the other hand, hit a peak not reached since World War II. The UK government borrowed a net 36.1 billion pounds ($47.1 billion) in September, pushing the total for the first six months of the year to 208.5 billion pounds.
That’s the highest figure since records began in 1993. The increase in the average debt ratio in the euro area is estimated to be over 15%, bringing it over 100%. It will climb by about 20% in France and about 30% in Italy and Spain. And that is obviously not the end…
In this context, the government will have to find ways to repay these amounts of debt, something that won’t be easily achieved. One of the options could be to impose monumental tax increases.
And where all the pressure will come at? As always at the middle-class, and there is no doubt about that. Just like tariffs on Chinese products were paid by US customers.
In the end, the tone of the debt will cause future deficits and will hit the financial strength almost of every economy. Even the U.S. could have to face paying much more in interest than previously forecast. Thus, this money won’t go to hire teachers or paying for hospital stays for the elderly.
McKinsey researchers also suggest that governments will have to optimize revenue streams and contain some public spending. They also believe that using only tax increases to fund the deficit would raise taxation by 50 percent, which would hurt taxpayers, limit corporate investment, and reduce national competitiveness.
The crazy thing is that Americans appear not to be very concerned about the deficit than they have been in recent years. The study suggests that just under half of U.S. adults (47%) called the deficit “a very big problem” in the country today – down from 55% in the fall of 2018.
In conclusion, it is clear that taken efforts to resolve current problems just postpone the ultimate consequences until sometime in the future. If countries continue to increase their debt levels, they could have trouble raising cash at affordable rates.
Other consequences could be depressed economic output and increased risk of a fiscal crisis. Having said that, despite the fact that markets are over positive the situation is far from being the best and real consequences might yet to come…
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