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April 9, 2020
NewsNavigating public debt perspectives amidst the COVID-19 crisis
The
COVID-19 pandemic – and the global response to it – presents a serious threat,
not only in terms of public health, but also to our communities, our economies
and our investments.
With the US
economy facing as many jobless claims in the last two weeks as it did for the
entire duration of the 2008/09 financial crisis, the economic effects of the
health crisis are unprecedented. With the world in some kind of burn-out, we
are amidst, what is by far, the deepest recession in living memory - it is no
wonder that financial markets have faced the fastest bear market of all time.
Government
orders effectively halted most of the economy in an effort to “flatten the
curve” and ease the strain on healthcare systems. As a result, we saw an
unprecedented economic shock which, contrary to what is normally the case, was
not caused by the excesses of economic agents. Instead, it was the result of
the fact that the majority of activity was brought to a standstill by
governments. The pandemic is what economists call an externality. Governments
and central banks around the world have responded to it by unleashing enormous
fiscal and monetary stimuli and other support measures to ease the burden on
workers and the economy. In essence, developed countries have thrown the fiscal
rulebook out the window, embracing further unorthodox monetary and fiscal
policies, in something which looks like a de-facto nationalization of the
credit markets and lifeboat support to citizens and corporates.
While
avoiding cynicism, we need to be realistic; easing lockdowns is going to be a complex
calibration exercise in managing the trade-off between public health and the economic
impact. For now, it is generally assumed that we will see partial and
progressive exit strategies that segregate certain clusters of the population
or certain economic activities, coupled with mass testing. Another perspective
could be the ‘shock and awe’ strategy for which hospitals (perhaps on
parameters such as the availability of critical care beds), could drive stop-and
go rules for confinement. Clearly, there is no one-size-fits-all strategy and we
should expect different opening-up methods across regions. The common thread
should be some kind of risk-adjusted modelling, undoubtedly requiring
significant shifts in the way society organizes itself.
Macro-economic
history teaches us that tepid reactions from authorities have been catalysts of
some of the worst recessions, depressions and financial crises. Critics of
unorthodox monetary policy have been flourishing since the global financial
crisis. From our perspective, those are mostly sterile. Why are people spending
so much time and energy trying to figure out alternatives to past history? Re-writing
it with what if, or what else, scenarios is useless. It is not the time for
“should’ve, would’ve, could’ve”.
Acting as
pain alleviator, public stimuli measures are effectively the monetization of
the future deficits. Levels of sovereign debt in terms of GDP will be abyssal
and we are clearly observing some transfer of corporate risk to the state.
Yogi Berra
(famous American professional baseball catcher) once said “the future isn’t
what it used to be” – this is my favourite reminder that humility is essential
when making any kind of prediction. COVID-19 reminds us that money managers are
not paid to make forecasts, but to adapt to a perpetually changing context. The
day will come when critics will have to digest the quote of Mike Tyson saying
that “everybody has a plan until they got punched in the face”. Could
governments and central banks have acted differently, protecting the orthodoxy
of public finance and money creation? Maybe. But don’t ask us how. Eloquently
put: “Any hesitation in throwing everything but the kitchen sink at the health,
employment, state aid and financial rescue interventions that are needed will
literally kill citizens and destroy the economy.”[1]
European
leaders are still struggling to coordinate fiscal initiatives. Officials have
been active in trying to quell highly-controversial comments from the Dutch
Finance Minister (who called for an investigation into Spain’s proclaimed lack
of budgetary capacity to cope with the pandemic). As the Portuguese Prime
Minister put it, this is against the spirit of the EU. The running conflict between
anti moral-hazard defenders and financial solidarity supporters is again calling
into question the sense of belonging for many European countries. The question
raised by the French Finance Minister “are we together or are we not?” sounds
quite relevant.
Fiscal and
budgetary measures will allow already-significant deficits to balloon even
further, a fact that will be exacerbated by collapse in tax revenues from
depressed economic activity. Crossing the Rubicon and breaking the taboos of
orthodoxy is crucial as the war-time analogy goes. “Whatever it takes”
strategies could mean that central banks will metamorphose from their role as
the lender of last resort, to become buyers of last resort. Similarly,
governments could evolve into moratorium courts, insurers and bailout organisations,
or more broadly the prominent economic agent of our time, far above corporates
and households. For both these bodies, the risk of too little, too late far
outweighs the risk of too much, too quick.
In the aftermath
of this horrific pandemic, austerity measures will likely be part of the price
tag. Peace time will allow us to reassess the risk of using traditional
government bonds to buffer equity volatility. But without any doubt,
US-Treasuries were among the few places to hide during the “Great Cessation” we
are currently enduring.
To conclude
with a constructive perspective, we are convinced that creativity will successfully
help navigate the public debt burden. Monetary
policy has been fertile ground for a couple of years. At the end of the day,
don’t be surprised if money printing supplants borrowing for some major
economies and supranationals. Let’s wait and see if we will call it a zero-coupon
perpetual bond, helicopter money or the inglorious Modern Monetary Theory.
[1] Vox
article «To fight the COVID pandemic,
policymakers must move fast and break taboos”
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