Wednesday, July 22, 2020

Fiscal & Monetary Policies Inflating Bubbles While Fighting Virus

Asset prices around the world are melting up. It isn’t just stock prices that are soaring. It’s also the prices of inflation-protected bonds. Precious metals prices are moving higher too. Home values are appreciating as well. Some of these bullish trends may be driven by expectations that the billions of dollars being spent on a vaccine will pay off. Undoubtedly, the main reason for the widespread bull markets in assets is the fact that governments around the world are spending and printing trillions of dollars, euros, yen, and yuan to offset the economic shock from the Great Virus Crisis (GVC). Consider the following:

(1) Vaccines. Typically, it takes roughly a decade for a new vaccine to go through the various stages of development and testing. However, the urgency of the pandemic, which has killed more than 600,000 people worldwide, has resulted in a mobilization of global medical resources rarely seen before in human history. Billions of dollars, provided by both the public and the private sectors, are funding the global campaign to develop tests, vaccines, and cures for the virus.

For example, the Trump administration has launched “Operation Warp Speed” with the goal of delivering 300 million doses of a safe, effective vaccine for COVID-19 by January 2021, as part of a broader strategy to accelerate the development, manufacturing, and distribution of COVID-19 vaccines, therapeutics, and diagnostics. Congress has directed almost $10 billion to this effort through supplemental funding, including the CARES Act.

More than 100 clinical trials of dozens of potential coronavirus treatments are already underway around the world. Yesterday, we learned that the early trial results for two vaccine candidates—one developed by the University of Oxford and AstraZeneca and the other by the Chinese company CanSino Biologics—showed that both were safe and could induce immune responses in participants. But the next phase will be critical to demonstrate that the potential vaccines can protect against infections.

For the Oxford-AstraZeneca and CanSino vaccine candidates, the next step in testing is known as “Phase Three” of human clinical trials. It’s in this stage that scientists will be able to see whether a potential vaccine truly works to prevent coronavirus infections. The newly released clinical trial results showed that the Oxford-AstraZeneca vaccine candidate triggered the production of both antibodies and T cells, which can recognize and attack virus cells.

(2) EU ups the ante. On April 9, Eurozone finance ministers agreed on a new coronavirus stimulus package worth €540 billion, but couldn’t agree on a crucial decision: whether to issue joint debt instruments, called “corona bonds,” that would combine debt securities from the 19 Eurozone countries. Germany and the Netherlands, traditionally more fiscally conservative than Italy and Spain, were holdouts.

On July 21, a new agreement was reached authorizing the European Commission (EC), the executive arm of the European Union (EU), to create a €750 billion recovery fund, which will be distributed among the countries and sectors most impacted by the coronavirus pandemic, and will take the form of grants and loans.

The new deal means that the EU will become a major borrower in global financial markets for the first time. It plans to repay the money by 2058. Nevertheless, the EC intends to propose new taxes on financial transactions and fines on greenhouse gases released by companies. Tech companies can also expect a “digital levy.”

(3) ECB is on the case. Undoubtedly, some of the new bonds will be purchased by the European Central Bank (ECB), which is currently buying government bonds as part of its Pandemic Emergency Purchase Program (PEPP), which totals €1.35 trillion. The PEPP started on March 18 with a commitment to make €750 billion in open-ended asset purchases. It was expanded on June 4 by €600 billion.

The ECB’s balance sheet has soared by €1.62 trillion since the week of March 13 through the July 17 week (Fig. 1). Securities held for monetary purposes rose €552 billion during that period.

(4) Japan writes a blank check to fight the virus. In Japan, Prime Minister Shinzo Abe’s government has rolled out combined stimulus spending worth ¥234 trillion ($2.2 trillion); that boosts its annual budget spending to ¥160 trillion, with new debt issuance totaling ¥90 trillion. To cushion the economic fallout from the virus, the new stimulus programs include handouts to 126 million residents of ¥100,000 (just under $1,000) each.

On July 21, Finance Minister Taro Aso said that the Japanese government’s budget won’t set a spending cap on requests aimed at fighting the COVID-19 pandemic for the fiscal year that begins in April 2021. The budget ceiling is usually set around mid-year by the Finance Ministry to keep tabs on spending requests from ministries for next year’s budget, to be compiled in December.

The government would ask ministries to keep requests for other spending in line with the current fiscal year’s initial budget totaling a record ¥102.7 trillion, Aso said at a Cabinet meeting. The government then would set aside an unspecified amount of budget requests to respond to “urgently needed expenses” to battle the fallout from the coronavirus.

(5) BOJ is on the case. The Minutes of the June 15-16 Monetary Policy Meeting of the Bank of Japan (BOJ) was released on Monday. After easing monetary policy in March and April, the BOJ kept policy settings unchanged and maintained its view that the economy will gradually recover from the damage caused by the pandemic. The BOJ’s balance sheet has soared by ¥64 trillion ($600 billion) since February, through June (Fig. 2).

(6) Another CARES package in the US. The CARES Act was passed on March 27. It provided $2.2 trillion in various short-term support payments as state governors issued stay-in-place executive orders to slow the spread of the virus. It was widely expected that they would gradually lift these restrictions in a few weeks, reopening the economy. The first round of support payments is running out for many households and businesses, while the reopening of the economy has been slowed by rapidly rising cases.

On Monday, congressional lawmakers returned from their recess and started working on a second relief package. They are under pressure to come up with something this week. Though the CARES Act allows the $600-per-week federal boost to state unemployment insurance to be paid through July 31, most states’ weekly benefits are based on a cycle that ends on a Saturday or Sunday, making this week the last one that recipients will get that extra money unless lawmakers intervene fast.

(7) The Fed is on the case. The US federal budget deficit totaled a record $3.0 trillion during the 12 months through June (Fig. 3). After the CARES Act was passed, the Congressional Budget Office (CBO) estimated that it would total $3.7 trillion this year. The CBO may have to add another $1 trillion to $2 trillion to its estimate if the economic recovery stalls and if Congress passes CARES Act II.

No problem: We are all MMTers now! We all believe in the magic of Modern Monetary Theory. In response to the GVC, the Fed embraced the theory and its practice on March 23 with its programs of QE4Ever and No Asset Left Behind (NALB). The Fed already has financed more than half of the currently projected FY2020 federal budget deficit by purchasing $2.1 trillion in Treasury securities over the past year through the July 15 week (Fig. 4).

Among the biggest proponents of MMT are former Fed Chairs Ben Bernanke and Janet Yellen. Last month, they signed a public letter from more than 150 economists that called on Congress to pass another big spending bill to extend and broaden the CARES Act. In a joint July 17 blog post, they commended the Fed’s response to the pandemic: “Broadly speaking, though, the Fed’s response has been forceful, forward-looking, and comprehensive.” In other words, Fed Chair Jerome Powell did what they would have done. We guess that they’ve provided Powell lots of advice in recent months, which he acted upon.

What about the federal deficit? Bernanke and Yellen are all in on MMT: “Following our advice would further increase the already record-level federal budget deficit. With interest rates extremely low and likely to remain so for some time, we do not believe that concerns about the deficit and debt should prevent the Congress from responding robustly to this emergency. … [A]t some point, we will have to think through how to ensure the long-run sustainability of federal finances. The top priorities now, however, should be protecting our citizens from the pandemic and pursuing a strong and equitable economic recovery.”

Read that excerpt again and think about it. Contrarians should be alarmed. What could possibly go wrong with this who-cares-about-deficits approach? Well, let’s see: i) inflation might make a surprising comeback; ii) bond yields might rise; and iii) if the Fed imposes yield-curve control to put a cap on the bond yield, the dollar might take a dive, which could boost inflation.

(8) The PBOC is on the case. The People’s Bank of China (PBOC) continues to flood the Chinese economy with more and more credit during the GVC, as it has ever since the Great Financial Crisis (GFC). Over the past 12 months through June, social financing totaled a record $4.5 trillion, led by a record $2.7 trillion in bank loans (Fig. 5 and Fig. 6). Bank loans are up a whopping $18.9 trillion to a record $23.3 trillion from $4.4 trillion at year-end 2008, when the government started to respond to the GFC with massive credit expansion (Fig. 7).

(9) Bottom line is a bottomless pit. A billion here, a trillion here and there add up to serious money. With the help of MMT, government deficits are a bottomless pit. If they can be financed so easily with easy money without boosting inflation, why do we bother collecting taxes? I would be a big advocate of MMT if my taxes were cut to zero. Let’s give it a try! Why not? Anything is possible in the Twilight Zone.

While MMT hasn’t boosted inflation as measured by consumer prices, so far, it certainly is boosting asset inflation, potentially fueling the Mother of All Meltups (MAMU), which potentially could set the stage for the Mother of All Meltdowns (MAMD).

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