salus rei publicae suprema lex

‘the welfare of the people is the supreme law.’

Originally coined by Cicero around 80BC and taken up by John Locke, one of the foremost writers and thinkers of the British Enlightenment in the late 1600s, who referred to it as the “fundamental rule for government”. 

A few weeks ago, a few business owners may have had a guarded eye on the over-exuberant stock markets around the world. Here in NZ business confidence was steady and sentiment positive with no major issues on the horizon. 

What followed is nothing short of extraordinary as small pieces of news regarding an “unusual type of flu virus” began appearing on specialist medical websites and stories began creeping out of a city in China, few had even heard of, became a torrent.

It is fair to say no one could have reasonably been expected to plan for or even realistically expect the events of the last few months to have occurred with such speed, nor the speed and veracity of many nation-states to the issue. Pandemics are far from new and whilst the recent SARS and MERS pandemics certainly created headlines in OECD economies we were not as aligned with China then for trade as we are now, they did not spread beyond a few countries, and their overall economic effect was short-lived.

The somewhat unusual oil production tit for tat between Russia and Saudi added to the catalyst and the subsequent and hardly unsurprising stock market reactions made me reminiscent of sitting on the trading floor of the bank I worked at in the City when Lehman declared Bankruptcy on 15th September 2008.  

The GFC bear market (defined as a 20% drop off highs) was snail-paced compared with the speed of this collapse (and subsequent rise!) and has again meant Governments and Central Banks have been thrust into the forefront in a way that has not really happened before and certainly not in modern times where information (and disinformation) is disseminated so rapidly. 

However, irrespective of the views of the “leader of the free world” the Stock market is not a corollary to the real economy. While they are related the massive swings should be taken with caution. 

A collapse in markets was always going to be different than 2008 as the banking system is quite good currently and would be caused by overly indebted corporates feasting on cheap debt for the last decade. This could be a real problem as servicing these debts has just got harder too as revenues drop – significantly – but many commentators far more qualified than I don’t see a corporate credit crisis as badly as the sub-prime crisis of 07/8, however, I think the secondary effects will be very significant as the eventual “softening” of real asset prices leads to a rise in nominal debt relative to where it was a few months ago.

What we are dealing with here is a combination of major events and moves by most central banks, being the lenders of last resort, are being swung into place. The NZRB was quick to act with bond purchasing (QE) and on a global scale – the US dollar still being the only real global currency – the Federal Reserve have initiated action.   

Whilst there is no guarantee the Fed’s intervention will be just reserved to the single $2.2trillion injection it's a start for the global economy to keep ticking over. For those that are interested $2 trillion in $100 notes (the highest US denomination) weighs 2 million tonnes or 2.26 million cu. Meters or 34,656 40-foot containers.

Historically "real" recessions, driven by a drop in demand and consumer behaviour are more short-lived than financial (2008 subprime/Lehman) and policy recessions (1929/30 gold standard) therefore we may be looking at a credit crunch driven by a drop in revenue but also an issue where the money being pumped into the economy doesn't have the desired inflationary effect as interests rates are rock bottom.  

What we therefore have then is a machination of several factors, a drop in spending, a drop in confidence, no immediate signs on when people will start "normal" lives again, a significant risk to employment, companies and state systems.  It is easy to create doom and gloom in these circumstances, but it will not stay like this forever and as such when, and I do mean when, things return to normality the rebound should hopefully take us back to sensible numbers.

Notwithstanding the above, there will be several effects depending on the depth and duration of various countries policy initiatives to Covid-19. 

1.    Hit in confidence – wealth – a drop in real asset prices

2.    Lack of discretionary spending

3.    Supply-side disruption

RBNZ has stepped in to increase liquidity in the market by purchasing NZ Government Bonds but also widening this to Corporate paper too (with appropriate haircut) however this does not necessarily help NZ’s SMEs. Whilst the Government is rapidly introducing, in partnership with the Banks, a Business Finance Guarantee Scheme where the Government underwrites 80% of the loses on default. 

This is a helpful addition but this is a risk-sharing scheme and relies on the banks coming to the party now and over the coming months and will require the usual loan application process and risking.

So what can be put in place NOW to cushion the effects but also ensure companies can return to productivity as quickly as possible driving GDP.

Steps Now

A 6-12 month plan needs to be drawn up and simply look at a best-case and a worst-case. Use the Government wage support and the relief the IRD and banks are going to be putting in place.  

Understanding and controlling your cash flow is critical. When making a decision consider how easy it is to correct/unwind the consequences of your decisions if needed. 

• Income – where does it come from? How sustainable is it?
• Fixed assets – premises (do you own your own, or landlord), plant and equipment (secured/unsecured)

Also, think beyond the confines of your own business and it's cash flow for a second for the "so now what" thinking the secondary effects. How are suppliers, customers, competitors going to be affected?  

The rate of change is extraordinary as is the uncertainty. Things change all the time anyway…we’re just evolutionary wired to ignore it as it doesn’t necessarily immediately affect us and as a species, we are generally really bad at secondary thinking. Even taking a day or so to make decisions could be a business life or death decision; running with the crowd is not necessarily the right answer at times. 

But you do need to assess how long can your business survive without revenue and what can be done to mothball/preserve the value? As such one of the most important things you need to do is assess your

• Intangibles – relationships, IP, people, knowledge, brand…how can they be preserved?

Whilst the Government needs to rapidly address the Insolvency terms of the Companies Act (the balance sheet limb assets>liabilities needs to be reviewed on an “event”) and leeway for directors it should not stop you thinking ahead of the official advice and packages - delaying is not an option.

Whilst you want to preserve income if you can your immediate thought is controlling outgoings and stop outgoings however remember your business is part of a chain, pay what you can.

Seek help and advice where you can.  

A "new normal"

"flattening the curve" and "New normal" are rapidly entering my lexicon of hated words….oh and “unprecedented”. However, it is a required word sadly.

Central banks and retail banks can only do so much…they cannot generate income for a business. I predict we are probably not that far away from a mass Universal Basic Income experiment on an "unprecedented" (sorry!) scale. 

Many governments are viewing this as being on a war footing. The ECB’s former president Mario Draghi has said as much and Trump has enacted wartime powers, the Defense Production Act, to compel factories to produce required items.  

The analogy is slightly off however I feel In a shooting war a Government will spend liberally and whilst central banks are increasing liquidity (the Fed’s balance sheet is now estimated to be $5tn) we can't reason with the enemy or necessarily understand it.  Wars also destroy fixed assets that require rebuilding, a pandemic doesn’t – other than the need to build some more hospitals maybe or do some fix-ups – and can lead to protracted recovery due to ongoing uncertainty and lack of confidence. 

However, I think NZ responses have been good and will lead us to be a safe haven not just for people but also business, provided we undertake some different thinking and be brave.

The principles will remain the same “what problem are you solving”, “what value is there in you solving this problem” and “why should you by the one to solve it”? Profit is made where there are constraints and bottlenecks…these may not be in the same place as they were a few weeks ago but they will be there – probably more of them!

NZ’s SME’s

We need to focus on productivity and growth and the NZ Government has acknowledged this recently with the Elevate growth fund. What needs to be done very quickly now is a similar scheme whereby regional private equity/venture capital operations can access co-investment government money; alongside risk-aware private capital to help preserve and mothball value so that turnaround times are immediate when we see the signs of improvement.  

Whilst appreciating this is a novel scheme with little international analogue – currently – I believe that once suitable companies are identified the funding will be in place much quicker than a guaranteed bank loan. Furthermore, a PE/VC model is better placed to help with business support and expertise than a bank may be in the current environment.

This is not the time for valuation conversations so this money needs to be placed into companies in the form of convertibles that can be relatively easily unwound once revenues start to flow. This invested money will be used, alongside Government wage subsidy, tax breaks and bank support to ensure the components of a business aren't lost forever.  The fact that this will be, at the outset, in the form of equity upside there is reduced cash layout and alignment to create success down the line

A skilled private equity/VC firm will be able to independently assess the merits of which business to save and which ones could be turned around quickly in a new environment.  

“Regional Business Support Funds” need to be urgently created to either support a marginal trading position or to safely mothball them and protect them if not trading or to ensure that IP and experience are not lost and valuable fixed assets are preserved. 

Without several simultaneous schemes and differential thinking, there could very well be large levels of unemployment, reduced discretionary spending, businesses will lose trust in each other without this kind of direct support to NZ SME’s a recovery could take decades. 

Lender of last resort could become the owner of last resort – avoid a moral hazard by selecting as best as possible the companies that will be back up and running creating productivity and growth. This will sustain employment, spending and stability…

...salus rei publicae suprema lex.

Keep safe everyone