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Lockdown aftermath: Tax or inflation

6 April 2020

We're in the middle of week two of the great Covid-19 lockdown of 2020.

Businesses have ground to a halt.

The government is handing out cash like there's no tomorrow (for some that may be true).

However, at the end of all this we'll be in deep economic doodoo.

Even governments can't magically make debt disappear and the billions they're spending right now have to come from somewhere and here's a sobering fact:

The only source of money the government has is YOU, the taxpayer.

So where do you think they're going to get the money to repay all those billions?

Clue: the tooth fairy has nothing to do with this.

Yes, if you think things are bad right now then the present is peanuts compared to the post-lockdown world.

As I've said before in this column we're going to be at risk of a very steep downward economic spiral that will require some very prudent management and direction to mitigate.

Firstly, many people will be out of work and relying solely on the money that government is handing out. Although some will, most of the jobs that have been placed into stasis will not return... or at least not for long.

With the international component of our tourism industry (the largest earner we have/had) completely wiped out for the foreseeable future, a huge number of workers involved directly and indirectly in that sector will be out of work for a year or more.

This alone will mean that demand for the goods and services produced by other workers will be significantly reduced. The flow-on effect is one of even more lay-offs and lost jobs. It doesn't require a rocket-surgeon to see that there's a feedback loop in effect here and every time a job is lost it means less money and more jobs lost as a result.

Those who are lucky enough to remain in employment are not going to save us much from this suppressed demand because they will find themselves carrying a huge burden -- the burden of repaying the debt incurred by government. This will involve massive increases in direct and indirect taxation.

Look for significant hikes in income tax and GST. A rise to 20% GST is almost guaranteed and 25% would not be a surprise to some.

Or perhaps the government will take the other road to recovery.

I'm talking about inflating away the debt.

If it were to continue pouring cash into the economy so as to sustain demand for goods and services through cheap credit and handouts then this would have a huge inflationary effect.

There are some real benefits to this approach.

The effective scale of debt would be reduced over time and the Kiwi dollar would plunge in value, thus making our exports more competitive and creating jobs in the process.

Of course there are no free lunches. Times of high inflation generally see interest rates skyrocket which can be bad news for those who are heavily mortgaged or carrying other debt.

A falling dollar also makes it harder for the government to repay international debt, which is usually incurred and repayable in USD.

As you can see, there are many very difficult challenges ahead for the government and the people of NZ. This could be the making or the breaking of the nation. We will either come out of this stronger and more efficient than we were before -- or we could find ourselves weakened to the point where even more of the nation's assets and land end up in the hands of wealthy offshore entities - with China looking to be the biggest winner there.

Anyone care to bet how the government will try to manage this situation and how successful they'll be?

Another question to ponder... how long before we "recover" from the post-lockdown hangover?

I think that's more than enough for a Monday.

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