Submitted by Michael Every of Rabobank
Too much - and still not enough
Another remarkable day in what is clearly fin-de-regime. Most people don’t want to see it like that, but a month, a week, or even a day ago they didn’t think this was anything more than the flu. Things have already irrevocably changed and whipsaw market action reflects that this is the case. The only issue is how much further they change from here, and hence where markets settle.
In the US we have seen a virus fiscal package swell from USD500bn to USD850bn to USD1trn to USD1.2trn. That is 5.6% of GDP, or what GDP was before it suffers what is likely to be an epic contraction in Q2. Given the fiscal deficit was already 5% of GDP and rising, let’s say hello to double-digit deficits.
Of course, the hope is for a rapid recovery, and not all of that sum is spending: it’s deferred taxes we can pretend will be paid, assuming that rebound; and it’s loans to support businesses. However, when you have a collapse in demand and a supply shock, is your first response to want to borrow more to tide you over? Perhaps for a month or two. Yet if this is going to last 12-18 months, as some health experts are suggesting, then surely the temptation is just to shut down and restart a new business when we are virus-free? Or, take the loan, pocket it, and then close down? In which case, even USD1.2trn is nowhere near enough for a recovery and Steven Mnuchin, who saw no recession days ago and now sees a risk of 20% unemployment, is actually right for once.
What will be needed is massive, immediate state support into the economy via direct transfers to households. Notably, former Democratic presidential candidate Andrew Yang has spoken to the White House about his long-standing proposals for Universal Basic Income (UBI) of USD1,000 per person per month: and that does not sound a million miles away from Mnuchin “looking at sending checks to Americans immediately.” Yet there a crucial caveats: how long for, and who is paying for it? I am sure the White House isn’t thinking of 12-18 months. 210m adults times USD1,000 times 12 or 18 is a staggering sum of money closer to USD4trn, or 18% of GDP: welcome to a 20-25% fiscal deficit? (And yes, expect some US TV anchors and commentators to be confused by the kind of figures being thrown around here.)
Likewise, UK Chancellor Rishi Sunak pledged GBP330bn, or 15% of GDP, to support the economy, on top of a three-month mortgage payment holiday and a slew of tax deferments, and to do “Whatever it takes.” Again, however, when asked by the press why firms should borrow rather than just close and then reopen debt-free in a year or so, answer there came none. And what of people who rent rather than own houses? If this is not just a blip, then “Whatever it takes” is going to have to mean 15% of GDP in real economy support.
Does anybody seriously think this will ever be repaid in taxes by an economy that will emerge with higher levels of debt, and the same structural low productivity and inflation and growth? No. Given this is “war”, the BOE and the Fed, etc., will be called in for fiscal support instead – as a slew of talking heads on Bloomberg TV--none of whom had ever previously supported MMT before as far as I am aware--all came out to demand yesterday morning.
After all, it isn’t like the Fed isn’t already offering trillions to the markets via an ever-expanding alphabetti spaghetti of channels. One can hardly keep up with the scale and breadth of them. The minutiae are covered superbly in the US by Philip Marey, who rightly saw yesterday’s expansion, or rather retreat, back to the kind of Fed primary dealer support available in 2008; and in the Eurozone by Elwin de Groot and Bas Van Geffen, who have been writing on TLRTOs and their ilk. Yet at root, each mechanism is merely a pipeline from the central bank and its fiat money power to various interest groups who need cash. For example, the new Primary Dealer Credit Facility lets the Fed lend USD against stocks, whose value--in a world where markets go and down 10% a day--will be determined by the Bank of New York Mellon. If we are already going that route, why not the Yang/UBI one too – especially if it is the only thing that is actually going to work?
Meanwhile, ticking away in the background is the USD64trn question of the most important pipeline. Not oil, with which we are choked, and where some are talking about the need for negative prices to stop the stuff flowing(!) Rather, Fed swap lines.
As we have repeated endlessly, the USD is THE global currency and Eurodollar is absolutely vital to understand. When you have an economic and financial crisis, everybody wants to tap local central bank liquidity; but when you have a global economic and financial crisis, everybody wants to tap US central bank liquidity. We live in a world in which emerging markets, now a huge slice of the economy, are addicted to USD borrowing, and have more outstanding USD debt than ever. They are desperate for dollars, and won’t be earning many from trade as global demand collapses.
The Fed has already opened swap lines with the major western central banks and Japan to ensure that they can get access to USD, which they can then use to swap with local currency, so easing USD funding pressures there. Yet the Fed has NOT offered this swap facility to emerging markets. Pressure is building on it to do so in order to prevent a USD liquidity squeeze hitting them on top of real economy damage from the virus: but can it and will it?
Consider that a Fed swap line is a precious political commodity. It says that your currency is, when needed, as good as USD: it has value in an emergency like this. Yes, the Fed would generate a lot of good will by offering swap lines to EM, and it would cement the USD’s global role even further. Yet money is power, and some critics allege the US has long manipulated the USD global liquidity cycle to first flood EM with liquidity, and then take advantage of the inevitable cyclical liquidity retreat to pick up assets at pennies on the dollar. Does it want to give that up?
Crucially, is the Fed going to extend swap privileges to the PBOC? The same China that was in a trade war and is still is in an undeclared Cold War with the US? That just announced it will kick out a slew of US journalists from both the mainland AND supposedly-autonomous Hong Kong? That has had officials publicly claiming COVID-19 is a US military operation? The implications of doing it and not doing it needs a whole report in itself – but either way there is a whiff of fin-de-regime about it.