The coronavirus crisis within the economy is far from over – because reopening creates a whole new type of risk

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I have long suggested that the big issue for the economy when facing the challenge of coronavirus was not surviving the lockdowns - we now know how to do that - but in managing the recovery. At that point, I have always argued, the real problems will be revealed.

Most especially, companies deprived of working capital (cash, in common parlance) as a result of losses incurred not made good by loans, and by a combination of lost skills (whether through simple lack of practice or significant staff turnover) will face the crisis of trying to get back to trading at the scale that they were working at pre-March 2020 and will discover that the thinned out resources at their command will fail, and they will too.  To put this in the language of business, the effort to be what they once were will represent for them what is described as over-trading, which is the phenomenon of stretching available resources too thinly with the risk that the whole edifice then fails.

I fear that the evidence to support this prediction is growing. In the FT this morning this is noted:

The number of companies in significant financial distress has risen at the fastest rate in more than seven years, sparking warnings that “the dam of zombie businesses could be about to break” when government Covid-19 support comes to an end in the summer.

The report comes from insolvency firm Bebies Traynor, which has been using a consistent measure of such stress since 2014. Basically measuring the number of firms revealing stress in their credit status, plus those suffering court orders against them, they now think 720,000 businesses are in distress. That's a 100,000 increase in a quarter. It's also a significant proportion of the number of firms that they must be monitoring in the UK.

Of course, some firms are always in such distress. Business failure is normal. But this trend is not. If the data does reflect likely forthcoming failure - as this firm clearly thinks that it does - then this indicates real problems to come, just as I predicted there would be at this stage of the recovery cycle.

This poses a real challenge for the government. Not only does this create the real risk of substantial losses on the loan facilities that it made available - many of which will not be repaid if this rate of failure happens - but such a loss of capacity could be severely disruptive to the economy over the year or more ahead.

It has to be admitted that new companies might rise, phoenix-like, from the ashes of many of these failures. But that ignores another issue, and that is the multiplier effect within business failure. The shareholders of many companies may well have a perverse incentive to shut up the old shop and reopen as a new one over the coming year or so, shedding liabilities for loans that will prove extremely burdensome to repay if they do just that. And let's be clear, they can often walk away from their debts at present, precisely because limited liability provides them with that opportunity. But it is not only the government to whom they will owe money. They will also owe their suppliers and if the knock-on effect of failure is big - and it may well be so - then the moral hazard implicit within all limited liability structure may well create a real risk to companies that as yet are showing no stress at all.

Even if we avoid another lockdown (and I think the chance that we will avoid such an event very low indeed) the risk to business at present is exceptionally high. Those who predict sunny days ahead really can't read the runes of cash flow. And cash flow is king. It's just that most economists have never run a business and so they really do not know that.