Covid-19 has upended the world. The New Normal is a 10-part series looking at the stunning ramifications for the world of economics and business. Part three looks at how the pandemic caused households to have lower debts and more cash.
Shutting down swathes of the economy has been quite an experiment. The Government wanted to stop the spread of the virus, which meant forcibly stopping physical contact and mobility.
Blocking economic activity bunged up the usual flows of money around the system. To try to preserve businesses and jobs, the Government pumped in cash, in a mixture of grants and loans.
Now the economy is reopening, the state of finances of each family and business will dictate its future.
The shift in just a few months has been dramatic. Businesses stuck with bills to pay but no customers have racked up vast debts. The Government backed a series of lending schemes to keep firms alive. Now they have to work out how to repay the funds.
Meanwhile households – in aggregate, if not in every case – have generally racked up surplus cash. By and large jobs have either stayed safe or been rescued by the furlough scheme. Money kept coming in, even as they were denied the opportunity to spend.
The Bank of England has totted up the results: companies borrowed £32bn from banks in March alone, it found – 30 times their usual monthly borrowing. That was driven by big companies making use of credit facilities.
Since then, smaller companies ramped up borrowing, aided by Government-backed loans.
“Net lending to small and medium-sized companies was a record £18.5bn in May and £10.7bn in June, substantially more than the previous monthly high of £0.6bn in 2016,” the Bank of England said.
Larger companies have issued £50bn of bonds and £14.3bn of equity so far this year.
By contrast households are typically much better off. Deposits in bank accounts rose by £17bn per month on average from March to June, more than three times as fast as the usual rate of £5bn.
At the same time balances on credit cards plunged from more than £72bn at the start of the year to below £62bn by the end of June, effectively wiping out five years of growth in debt on the plastic.
Overall consumer debt is down from more than £225bn to just over £207bn.
Total mortgage debts edged up, in part because around two million households took repayment holidays at the height of the crisis.
This does not mean they are struggling – around one-third suffered no change in income – but are acting carefully to build up a buffer in case of future job losses.
It is largely better-off families who have been able to save more. The lower-paid are more likely to have been furloughed, for instance, reducing their income by 20pc.
But overall, households have lower debts and more cash. It helped they were already less indebted before this recession than they were going into the financial crisis.
What does this mean for the “new normal”?
Consumers can rejoice. Some might still be wary of the virus, and typically families save more as a precaution when times are rough. But as and when they want to spend, they certainly have the means.
Lower credit card debts mean the plastic has been freed up for another spree. Higher savings mean balancing prudence with fun is a lot easier.
Because this has been a short recession, lasting just two months, compared to the five quarters of the financial crisis, Martin Beck at Oxford Economics says there is a good chance spending will return relatively rapidly. People have not had time to build new spending habits.
“It is like a windfall – people didn’t plan to save this money, they were generally ‘forced’ to accumulate it. The psychological evidence is that people tend to spend windfalls,” he says.
So far, retail sales numbers suggest he is right, returning to pre-pandemic levels in June.
For businesses, however, mounting debts mean the outlook is more bleak.
“A splurge in borrowing might usually point to investment and economic growth. But in this case, the lending largely reflects the ‘life raft’ offered by the Government,” says economist Elizabeth Martins at HSBC.
“The worry is that many businesses will struggle to repay these loans, leaving the Government with the bill.”
After all, the Treasury wants the companies to survive, not to be destroyed in the debt collection process.
It could mean the debts are eventually written off, or repaid in a similar way to student loans that take a slice of income each month to make the bill affordable.
The Office for Budget Responsibility anticipates a £17bn bill for the Treasury as companies fail to repay the costs, though if the economy underperforms its forecasts, it could be twice as much.
There are serious consequences for the borrowers, too.
If companies focus on paying down pandemic loans, they are not borrowing to invest and grow. Innovation could suffer. Wages and living standards will struggle to improve.
Weak productivity growth was already a national problem before the pandemic, with low investment rates a serious concern.
Now investment intentions are languishing below the levels seen in the depths of the financial crisis, Bank of England surveys show.
That chimes with official data showing investment down by around one-quarter in the three months to June.
Even as other types of economic activity rebound, debts combined with major uncertainty mean investment is unlikely to come back quickly.
Fears of a second wave, nerves over serious shifts in the structure of the economy, and the potential for Brexit risks to pop up again could all delay big spending decisions by bosses.
Economists at Nomura predict businesses will invest around 14pc less over 2020 than they did in 2019, a bigger fall than in consumption or Government spending.
The recovery will be dire too. While GDP as a whole is forecast to fall by around 10pc this year then rebound 6.4pc in 2021, investment will only grow 1pc next year and 2.6pc in 2022.
The risk of a surge in interest rates could also play on bosses' minds, even if nobody expects borrowing costs to rise for the next few years. The Bank of England warns that companies that took Government-backed loans may have to refinance them in years to come at higher rates, weighing them down further.
Overhanging business debts mean the “new normal” is likely to look a lot like the old normal, just worse: extremely slow productivity growth, holding back productivity and living standards for years to come.
Read part one: Central banks prop up the world after Covid – but who pays?