If You Want Blood, You Got It

Submitted by Michael Every of Rabobank

“It’s criminal; there ought to be a law

Criminal; there ought to be a whole lot more”

Yesterday’s G7 meeting heard the great and the good say that they were prepared to use fiscal measures to fight the virus, where appropriate, and that central banks were also standing by. Then there was a brief interlude where we all thought: ‘is that it?’ Obviously markets did not like that; and then the Fed stepped in within an emergency 50bp rate cut, taking Fed Funds to 1.25%.

Guess what? The market didn’t like that either. Equities tanked, the S&P down 2.8%; bond yields plunged, with the 10-year US Treasury down around 15bp yesterday and a further 2bp this morning to take us clearly through the 1% level I spoke of being inevitable just a few days ago; and USD tanked against most crosses. So aggressive was the Fed action that our US strategist Philip Marey has brought forward his expectation of when we get back to zero lower bound there from September to June. He now sees a 25bp cut at the scheduled meeting on 18 March, again inter-meeting in early April, at the 29 April meeting, and at the 10 June meeting – with risks of more 50bp moves taking us there more lumpily.

“You get nothin’ for nothin’; Tell me who can trust””

For the Fed, and for all of us, the fact that their precious equity market tanked is deeply concerning. So is that fact that the 10-year is sub-1%. Clearly, they would have hoped to have seen stocks up and at last the longer end of the yield curve showing some signs of enthusiasm about all the lovely liquidity that is flowing around. Instead, their 50bp bazooka is—as we feared, and repeatedly stressed—merely a pop-gun in the face of a virus that doesn’t care what the borrowing rate it. Monetary policy alone is going to be useless. Or rather even more useless than it already is.

Logically, in a true pandemic the only way monetary policy can help is to support fiscal policy, for example in overcoming critical supply shortages via capital for new hospitals and local production of key goods (e.g., the WHO warning that protective gear supplies globally are “rapidly depleting”). This is exactly what monetary policy does during a major war: ensure a victory that transcends day-to-day politics. Of course, as we have also pointed out many times before, in doing so we pull back the curtain to reveal not just what its critics allege–a central bank that favours capital over labour and assets over wages–but that the fundamental foundations of how the political-economy works are not set in stone, but rather sand.

“We got what you want; And you got the lust”

Capital is not just accrued from saving, as in the neoclassical model, and bank loans are not just made from deposits. Paul Krugman struggles with this, and so do many others in the economics field, but money as we use it today is endogenous, not exogenous. Banks create it via debt with new loans, which then create deposits; and governments can always create it at will if central banks are willing to help – which they always do in a major crisis.

The key issue is, what is a major crisis? Obviously a war. Yet is this virus? It could well be; and with the 50bp flopping, and QE and reverse repo in the toolkit, and the Fed’s balance sheet as a % of GDP actually low compared to the Eurozone and Japan–and US President Trump hardly shy about expanding the fiscal deficit–the ingredients for this policy cocktail are all arguably in place. The second issue is that once you have shown the public that this can be done in an emergency, you then have to explain to them why it should NOT be done more often. (Or at least, not for them: it’s fine for the financial system, as in 2008-09, for example.)

Moreover, if the US is doing it, everyone else is going to want to do it too, surely? Except it is far from clear that everyone else can: Germany is obviously allergic to this kind of thing; and for smaller countries running trade deficits, more so with twin fiscal deficits, good luck persuading markets that you can be trusted with such a radical monetary-fiscal policy.

“If you want blood, you got it”

So first reactions to what happened yesterday are to smash the USD. Even CNY has rallied hard, despite the fact that the Caixin services PMI out today also collapsed to depression levels of 26.5. Yet once this phase passes, people will see that ONLY the USD has both local and international demand if we are to embrace MMT to fight the virus. What else is international trade going to be conducted and priced in? And note that there is going to be a whole lot less trade if things continue like they are – at which point people will soon flip to wondering where the USD needed to cover record global USD debt is going to come from.

Indeed, here is irony for you. When the US is performing well, with a strong economy, there are plentiful USD available via trade and ‘risk on’ markets. That argues for a weaker USD in many ways. When the US is in recession there are far fewer USD available via trade and ‘risk off’ markets. That argues for a stronger USD in many ways. Only the potential availability of Fed USD swap lines might help mitigate to some degree: and it remains to be seen how generous and (geo)political they might be under this White House. Which given a global recession now inevitable says:

“Blood on the rocks; blood on the streets; blood in the sky; blood on the sheets.”

You wanted that 50bp, Mr Market? You got it.

So let’s wrap up with Super Tuesday. At time of writing, and counting, Joe “Night King” Biden has won handily in Alabama, Arkansas, Maine, Minnesota, Massachusetts, North Carolina, Oklahoma, Tennesse, and Virginia. However, Sanders has won California, Colorado, Utah, and Vermont, and remains ahead in the delegate count at 49% to 39% (Bloomberg has 4%, which perhaps he plans to sell to Biden to make a profit on his USD500m campaign investment so far). In short, the Democrats are a toss-up between putting forwards a candidate who would likely embrace MMT and one who would run screaming from it…vs. a president who is surely more likely to embrace it. (Just look at his Fed tweets.)