Submitted by Michael Every of Rabobank
Hand A, Hand B, Handout
Yesterday saw Fed Chair Powell in the spotlight, and he had a few key things to say. First, things are looking grim for the economy. Rather than merely cheer-leading that H2 and 2021 were going to see a V-shaped US recovery he stated “the path ahead is both highly uncertain and subject to significant downside risks.”
The UN would agree, with what looks like a vast underestimate that 130m people may slip into poverty globally in the wake of the virus: we could actually see that happening in just one or two large economies if things aren’t handled right. Even Australia just saw a jobs number of -594K, even worse than expected, and the US equivalent of nearly 8 million. (The wunderkind at the ABS did manage to replicate their usual monthly statistical bafflement, however, in showing that the unemployment rate only rose from 5.2% to 6.2% vs. 8.2% expected. *Sigh*.)
However, Powell dismissed the need for negative interest rates, even if US futures markets have been flirting with the idea, adding that the evidence that they are effective as policy “is very mixed”. That’s being generous given negative rates have failed to generate a recovery in Japan or Europe, and technically are a form of partial default reflecting that there is just too much private-sector debt out there.
Then Powell made clear that the Fed can only lend, not spend, and that the path forward needs to be fiscal. Indeed, “Additional fiscal support could be costly, but worth it,” he added. Indeed. And what a refreshing change from the economic illiteracy displayed by Trump economic advisor Stephen Moore, who talking on The Hill argued that state spending can never create a job or produce any kind of recovery because it just moves money from one hand to another. Is this mantra really what they are thinking in the White House? ‘Moore is less’?
Moore openly implies if a bank makes a loan to company A for project X, creating USD de novo to do so, and that new USD debt/money circulates around the economy, then this is economic growth – even if that loan has to be paid back with interest from within the same economy (so from hand A to hand B). Yet if a government issues a bond for project Y, which the central bank buys with USD created de novo, and that new USD debt/money circulates around the economy, this is NOT economic growth – even when the debt carries almost no interest and/or does not have to be paid back at all in some cases. (Even Italy, within the straightjacket of the Euro, which the German constitutional court wants to tighten the straps on further, is expanding state spending by EUR55bn: yes, it’s completely inadequate – but it will help growth.)
This is not to say that all state spending is good, or useful, or even necessary; this is not to say monetization is how we should all start our day. Yet not all private borrowing is good, or useful, or even necessary – and they can’t monetize in an emergency. To not understand the role of government stimulus in this new age of MMT and unprecedented socio-economic crisis surely displays an awesome political tin ear or an iron skin, or both. (On which note, the UK Daily Mail yesterday flagged that the currently very generous British government is going to tighten its belt post-Covid, with pay freezes --even for the heroes currently getting clapped? I guess claps are free…-- and tax hikes. Won’t that help a struggling, demand-weak economy?)
Powell, by contrast, does perhaps get it(?) However, what’s interesting is he is saying this even as stocks are still riding high overall, the last few days aside, with debates over whether this is a bear-market rally or a new bull market.
So let’s be a little cynical. Perhaps --just perhaps-- the Fed is happy to see a larger fiscal deficit because it knows this not only counters a huge shift to net saving by the private sector as unemployment soars and corporations sit on their hands or downsize; it also helps keep the US external balance in the negative. In other words, the larger the US fiscal deficit, the larger the current-account deficit, and the more USD might be able to leak out to emerging markets. That is likely going to matter again soon.
After all, China’s Global Times is claiming Beijing is drawing up a list of US individuals and entities to be “punished” if they continue to pressure it over Covid-19: this as two bills are now at various stages before Congress, one of which includes the provision of sanctions vs. China, including its ability to access the US financial system. Moreover, following the US decision not to allow a government pension fund to invest in Chinese equities, we are seeing a trial balloon in the same direction for the private sector. A conservative US think-tank, the National Legal and Policy Centre (NLPC), has approached the CEO of the world’s largest asset manager to request it to divest its holdings of 137 Chinese firms listed in the US, of which 30% are allegedly “under the influence and ultimate control of the Communist Party of China”, which raises “ethical questions”. The NLPC specifically cites the precedent of such investment firms recently divesting from fossil fuels on ethical, not financial, grounds to argue that failing to apply the same benchmark in terms of human rights “will amount to empty virtue-signalling.”
Might this activist divestment trend grow? Just look at the current geopolitical and US domestic political backdrop. President Trump is falling further behind Biden in the polls, and just tweeted:
“As I have said for a long time, dealing with China is a very expensive thing to do. We just made a great Trade Deal, the ink was barely dry, and the World was hit by the Plague from China. 100 Trade Deals wouldn’t make up the difference – and all those innocent lives lost!”
No olive branch there. This suggests that --as we have repeatedly warned-- the risks ahead are still a three-step drying-up of USD flows to China: trade, tech, and capital. Broader USD shortages would then erupt as China has to scale back on its own purchases, or devalue hugely, or both.
In which case the Fed is right not to be worrying about hand A and hand B, but just handing USD out. Because we will all need them, and still be clamoring for them.