How US financial crisis could cripple Australia

How US financial crisis could cripple Australia

It’s all about America now. The worst recorded outbreak of COVID-19 is happening in the USA and if the world’s biggest economy is pulled under, we will end up paying the price.

The number of official cases in the US has at time of writing topped 100,000, ahead of the official tallies in China and Italy.

Of course nobody believes China’s official numbers, but America can’t use that as an excuse for its botched response to the novel coronavirus. It had weeks to prepare and it failed.

In January, US President Donald Trump said “we have it totally under control.” They absolutely did not. The incompetence has not been limited to the White House. America – the world’s most technologically advanced nation, spent weeks unable to manufacture a functioning diagnostic test.

As a result, bodies are piling up in New York City. A further 247 Americans died in the most recent day – about ten every hour, or one every six minutes. Refrigerated trucks are parked outside New York hospital to help cope because the morgue is overwhelmed. And they are still in the early days of the crisis.

US markets rose on Thursday, driven by a burst of optimism caused by the announcement of a $2 trillion stimulus package. But have markets really reached the bottom? The impacts of the virus are still rippling outward. They will have financial and economic effects that hit the whole world.

WHEN AMERICA SNEEZES…

Want to hear a frightening estimate of where US unemployment is headed? Published by the US Federal Reserve Bank: 32 per cent. Thirty-two per cent!

The US unemployment rate was 3.5 per cent in late 2019. It is extremely hard to imagine how decimated its economy might be with unemployment ten times higher. The 32 per cent estimate is a “back of the envelope” calculation, according to its author, Federal Reserve Bank economist Dr Miguel Faria e Castro.

Surely things can’t get that bad in the USA? Sadly, the latest US unemployment figures show that country is genuinely facing something unprecedented. The number of people submitting claims for unemployment soared over 3 million, far higher than in the darkest depths of the global financial crisis, as the next graph shows.

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The old saying is true, when America sneezes, the whole world catches a cold. America is the world’s biggest economy and if has yet another economic and financial meltdown, Australia’s economic situation will be even worse than it looks now.

THE FINANCIAL SIDE

We imported a lot of our early COVID-19 cases from America. Skiers coming back from Colorado caused a lot of contagion. Now with the borders closed, the next big risk of contagion is financial.

In the past five years, US interest rates have been very low and debt has been highly available. Debt is always the problem in a downturn. This time it is not mortgage debt that is the risk, but corporate debt. Many US companies borrowed heavily. As the next graph shows, corporate debt has been rising very fast. With businesses set to fail, can that money all be paid back?

Markets are already betting some of the debt can’t be paid back. Corporate debt is traded on bond markets, and the price people are willing to pay for it has plunged as the chances of default go up.

One especially vulnerable area is Silicon Valley start-ups. Many of them aim to grow fast and lose money. Back in the good times investors were willing to throw in more money each year to cover their losses. Now that’s a much less attractive proposition. Instead, investors prefer companies like Apple, with huge amounts of cash. Expect more start-ups to fail, and perhaps the venture capital firms that funded them too.

America’s financial system is continuing to function for now, thanks to billions of dollars from the US Federal Reserve. But there is still the risk the US health crisis, which has become an economic crisis, will develop into a financial crisis too.

If it does, Australia will import a second round of trouble from America.

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