The King of Sovereign Subprime

Doug Nolan


The past week witnessed 6.6 million new U.S. unemployment claims, pushing the two-week surge to a sickening almost 10 million. The U.S. economy is sliding into the steepest of downturns, with awful consequences for society, economic structure and financial stability. But this week’s CBB will focus more on the global economy.

April 2 – Bloomberg (Emily Barrett): “Foreign official holdings of Treasuries stashed at the Federal Reserve fell $109 billion in March, the largest monthly drop on record, as international governments and central banks struggled with the economic fallout from the new coronavirus. The decline showed up in the Fed’s weekly custody data, with the latest figure released Thursday showing a $24 billion drop in the week to April 1. The sales amid the past month’s pandemic-fueled turmoil are a further signal of the global rush to raise U.S. dollars…”

The Greenspan Fed in the early nineties collapsed short-term rates to, at the time, an unprecedented 3.0%. With the banking system severely impaired following late-eighties excess – and exploding fiscal deficits exacerbated by Saving & Loans and bank bailouts – Greenspan orchestrated a covert banking system bailout. The capacity of banks to borrow cheap (3.0%) and lend dear (7-8%) provided a powerful mechanism for replenishing depleted capital.

Aggressive reflationary policy measures come with consequences. Federal Reserve policies were a godsend to the fledging leveraged speculating community. The “government carry trade” (borrow at 3% to lever in higher-yielding Treasury and Agency securities) was tantamount to free money. With speculative leverage boosting liquidity and securities prices – along with hedge fund assets – speculative excesses soon gravitated to corporate Credit, derivatives and, importantly, the emerging markets.

The Fed’s 25 bps rate increase in February 1994 pierced the speculative Bubble. Mexico, having been on the receiving end of large speculative flows, was in deep crisis by the end of the year. The peso, which had essentially been pegged to the U.S. dollar, collapsed in December. The “Tequila Crisis” saw contagion effects ripple throughout Latin America and other developing markets.

I thought at the time the destabilizing flow of speculative Bubble “Wall Street Finance” to EM had run its course. But the Clinton administration partnered with the IMF for a $50 billion Mexican bailout. Emboldened, the hedge fund industry bounced back strongly from the 1994 bond and derivatives market dislocation.

The inflationary boom in securitizations, GSE Credit, and market-based finance more generally didn’t miss a beat. Rather quickly, powerful speculative flows (and underlying leverage) to the emerging markets resumed – with the booming Southeast Asian “Tiger Economies” a prime target.

Pegged currencies (“fixed currency regimes”) were an integral facet of 1990s boom and bust dynamics. Why not borrow cheap in these exciting new Wall Street funding markets to lever in higher-yielding EM debt instruments with currencies pegged to the U.S. dollar. At the same time, the booming U.S. derivatives industry was cranking out term sheets, making EM speculation easier than ever before. If you weren’t playing the melt-up in late-1996, you were a nobody.

By early-1997, booms were overheating. The Thai baht suffered huge speculative outflows in the spring and was forced to devalue by the summer. A devastating regional collapse had begun – Indonesia, Malaysia, Philippines, South Korea and beyond. The pegged currencies regime suffered a spectacular domino collapse.

It was a catastrophic crisis - utter financial, economic and social meltdown. I most recall the deplorable ethnic strife that erupted in Indonesia (specifically, attacks on ethnic Chinese businesses). Currency collapse in South Korea provoked its citizens to donate $2 billion of its gold to be melted down and used to service the nation’s international debt obligations.

EM contagion made it to the Russian ruble and bond market in 1998, with the spectacular Russia/LTCM collapse pushing a severely impaired global financial to the edge. The dangers of New Age speculative finance were conspicuous. So was the extent global policymakers were willing to go to backstop this financial apparatus. The Fed orchestrated another bailout in 1998 – providing powerful stimulus to U.S. Bubble Dynamics that had attained critical momentum. It was off to the races (Nasdaq almost doubling in 1999).

Speculative finance is just too enticing to resist. After the dreadful 1990s experience, I expected EM economies to adopt measures to insulate their systems from “hot money” flows. What unfolded was something altogether different – and fundamental to the current unfolding collapse of the global Bubble.

Following the nineties' episode, EM economies came to believe (or were convinced) that holding large stockpiles of dollar reserves was key to currency and system stability. And stockpile they did. After beginning 2003 at $2.3 TN, total International Reserve Assets held globally surpassed $12 TN by 2014.

Over this period, Chinese reserves jumped from $300 million to $4.0 TN. South Korean reserves jumped four-fold to $400 billion. Brazil $36 billion to $390 billion; Mexico $40 billion to $200 billion; Russia $42 billion to about $500 billion; Indonesia $30 billion to $130 billion; Taiwan $15 billion to $480 billion; Thailand $12 billion to $45 billion; and Turkey $20 billion to $110 billion.

I’ve long had issues with this global structure. For one, unrelenting demand for dollar reserves accommodated persistent U.S. trade and Current Account Deficits – with attendant domestic and international imbalances. There was no market mechanism to discipline U.S. over-borrowing and spending. Dollar liquidity flowed to EM, where EM companies would exchange dollars for local currency from the local central bank – with these dollars immediately recycled into U.S. Treasury, agency and other debt securities.

The lack of market discipline was also fundamental to U.S. deindustrialization, with our fateful shift into consumption and “services” (why produce, among other things, ventilators, face masks and other “PPE” when they can be cheaply acquired from China).

The flooding of dollars globally ensured mounting excess and deepening complacency. Leverage finance flowed freely into EM, spurring protracted booms and New Paradigm thinking by EM policymakers. For China and EM more generally, 2008 was but a hiccup. Reflationary finance flooded the world, pushing fledgling Bubbles to unprecedented extremes. In the U.S., the recycling of “Bubble dollars” back into Treasurys was instrumental in bolstering the view that any amount of debt issuance could be financed at low yields (“deficits don’t matter”).

This dysfunctional global Financial Structure ensured a protracted period of self-reinforcing Credit and speculative excess coupled with deep structural impairment. The massive accumulation of non-productive debt and speculative leverage was always an accident in the making. A momentous consequence of the unfolding crisis is a likely breakdown of this global financial arrangement.

Federal Reserve Assets expanded another $557 billion this week, with a five-week gain of $1.653 TN. The Fed has been aggressively buying Treasury and Agency securities, along with announcing a program to purchase U.S. corporate bonds (and bond ETFs). The Fed is employing a long list of lending facilities - backstopping the banking system, primary dealers, commercial paper, municipal debt, corporate Credit and, soon, even “main street.”

The Federal Reserve has also expanded international swap arrangements, where it exchanges dollars for foreign currencies with its global central bank partners. This week the Fed announced a new program that allows central banks to borrow against Treasury holdings held in custody at the New York Fed.

There is no doubt that unprecedented policy measures come with unintended consequences.

There have already been complaints that Fed purchases have worsened instability and market distortions throughout the MBS marketplace. I fear more momentous market dynamics globally.

In all the late-nineties global market chaos, U.S. securities provided a bastion of stability. The Fed and Treasury Department’s capacity to employ system-stabilizing measures was unmatched. The Fed’s ability to stabilize U.S. securities markets provided a momentous competitive advantage over other regions and nations. The resulting U.S. market and economic resiliency were fundamental to late-nineties “king dollar” strength – that came at the expense of deflating EM Bubbles.

The dollar index gained 2.2% this week to 100.576, just below recent multi-year highs. I fear “king dollar” dynamics are exacerbating an unfolding EM crisis poised to dwarf the nineties. Of the more than $16 TN foreign currency-denominated debt globally, $11.9 TN is denominated in U.S. dollars (BIS, June 2019). Estimates vary, with EM dollar-denominated debt as high as $5.8 TN (Barron’s).

One unintended consequence of massive U.S. fiscal and monetary stimulus has been an escalation of flight out of EM currencies. Especially over recent years, the combination of rampant dollar liquidity and sizable troves of EM international reserves underpinned massive “hot money” flows into EM financial systems and economies. And with the dollar The International Currency of Leveraged Speculation, EM economies responded to the intense demand for their higher-yielding securities with unprecedented debt issuance – way too much dollar-denominated.

This week from the Wall Street Journal (Avantika Chilkoti and Caitlin Ostroff): “Emerging markets borrowed $122.6 billion through sovereign dollar-denominated bonds last year, according to the latest Dealogic estimates, up from $63.3 billion in 2009. Nearly $24 billion of sovereign emerging market dollar-denominated bonds are set to mature this year.” From the Financial Times: “The overall debt burden of so-called ‘frontier’ markets — the smaller, lesser-developed countries — reached a record $3.2tn last year, equal to 114% of their annual economic output.” And from Bloomberg: “Households around the world now have $12 trillion more debt than they did during the run-up to the 2008 financial crisis.”

It is difficult to envisage this terrible pandemic attacking a global financial system and economy at more fragile states. A heavily indebted world is heading into the worst crisis since World War II. I fear the emerging markets are at the epicenter, with dollar-denominated debt the Achilles heel.

The South African rand sank 7.4% this week. Currencies were down 6.7% in Mexico, 5.8% in Hungary, 4.7% in Brazil, 4.5% in the Czech Republic, 4.1% in Turkey, 4.0% in Poland, and 3.5% in Chile. In the changed environment, scores of companies, financial institutions and countries will struggle mightily to service large debt loads. For many, dollar-denominated liabilities will prove unmanageable.

No nation has accumulated more dollar-denominated debt than China. With its trove of international reserves, large trade surpluses with the U.S., and a quasi-pegged currency, Chinese companies and financial institutions have enjoyed unlimited access to cheap dollar funding markets. Notably, China’s now fragile banks and homebuilders have accumulated enormous dollar-denominated liabilities. This debt mismatch heightens systemic vulnerability to disorderly renminbi devaluation. How large is the levered China “carry trade”?

From the “Periphery to Core” analytical framework, China remains the “Core” of this problematic global currency mismatch. Crisis Dynamics have engulfed the “Periphery,” with key EM economies now succumbing to a “contagion” of illiquidity and market dislocation. Expanded Federal Reserve swap facilities worked to arrest global collapse. I expect effects to prove fleeting.

That China appeared to gain the upper hand on the virus has provided hope. Beijing’s aggressive efforts both to bolster its markets and restart its economy support the constructive view of China pulling EM economies and markets back from the brink. But with pandemic conditions rapidly deteriorating around the world, it may prove more a case of EM pushing a wavering China toward the precipice.

Over this incredible boom cycle, China became banker to the world. As financier to “frontier” economies, the Chinese banking system evolved into the King of Sovereign Subprime. Funding “belt and road” and other initiatives, China formulated a massive “captive finance” operation for nations previously starved of finance and investment. It now faces the prospect of a dramatic drop in capital goods export orders and thousands of customers lacking wherewithal to pay their bills.

As an analogy, automobile manufactures repeatedly succumb to the urge to “go subprime.” Lending to buyers previously unable to obtain financing is a sure way of boosting revenues. And so long as the general economy holds up, manufactures report booming profits both on auto sales and from “captive finance” businesses lending at above-market rates.

Unfortunately, things invariably turn really sour when the bust arrives. Not only do auto sales tank and used car prices sink (vast buildup in used-car inventories). The finance business turns into an unmitigated disaster. The perils of subprime surface as soon as growth slows. Before long, massive losses wipe out all previously reported “profits,” as bad loan charge-offs and servicing costs spiral.

Years of Federal Reserve market interventions and the perception global central bankers have everything under control are coming home to roost. The same can said for the belief that the great Beijing meritocracy can handle any crisis. The deeply-embedded view that Chinese officials could adeptly and, when necessary, forcefully manage their economy, financial system and currency created precarious fragilities that are in the process of being exposed.

China’s economy is today acutely vulnerable to collapsing demand, both domestically and internationally. Its $40 TN plus banking system goliath (add “shadow” lending) is a spectacular accident in the making. In the past, I’ve made the point that China’s huge international reserve position appears relatively less impressive with each passing year (of booming Credit and financial system expansion). With China’s reserves at $4.0 TN and Total Banking System Assets at $26.9 TN, reserves were about 15% of bank assets in mid-2014. Today, with reserves down to $3.1 TN and Bank Assets up to $41.7 TN, this ratio has been cut in half to 7.4%. There is also the issue of the liquidity, availability and transparency of these reserve holdings.

“The West will never allow Russia to collapse.” “Washington will never tolerate a housing bust.” “Central banks have everything under control.” I greatly fret ramifications for the day markets question Beijing’s capacity to stabilize China’s currency and Credit system. Perhaps they have the coronavirus situation contained. Yet it’s foolhardy to disregard the reality that Chinese officials have lost control of their economic and financial systems. Sure, massive liquidity injections and “national team” support have bolstered securities market prices (Shanghai Composite down only 9.4% y-t-d). Yet I believe this only ensures more destabilizing adjustments in the near future. Beijing is losing its bet that the coronavirus is a short-term financial and economic phenomenon.

I’m comfortable with the analysis that the Chinese economy suffers from epic maladjustment. Running trade deficits with many EM economies, there is no doubt that weakness in Chinese demand will hit many economies hard. And the EM and global downturn will be one more blow to the already disabled Chinese export machine. With my view of no near-term return to normalcy, spiraling bad debt problems are a certainty. The Chinese banking system hangs in the balance.

From Henry Kissinger’s Friday evening Wall Street Journal op-ed: “Nations cohere and flourish on the belief that their institutions can foresee calamity, arrest its impact and restore stability. When the Covid-19 pandemic is over, many countries’ institutions will be perceived as having failed. Whether this judgment is objectively fair is irrelevant. The reality is the world will never be the same after the coronavirus. To argue now about the past only makes it harder to do what has to be done.”

That the coronavirus crisis is a catalyst for piercing history’s greatest Bubble greatly broadens the scope of institutional failure. “The Coronavirus Pandemic Will Forever Alter the World Order,” is the title of Mr. Kissinger’s insightful piece. “While the assault on human health will—hopefully—be temporary, the political and economic upheaval it has unleashed could last for generations.”

Confidence in government will be shattered for years to come. Here in the U.S., we run up national debt past $21 TN - and fail to accumulate a reasonable stockpile of ventilators, masks and PPG. No preparation for a pandemic? After the downfall, it will take generations to restore faith in central banks. If trust in Wall Street has been thin, just wait. And right now Washington is hell-bent on destroying trust in government finances. We continue to witness behavior ensuring a systemic crisis of confidence in the financial markets and policymaking.

It’s a different world now. The chasm that developed between inflated expectations and deflating economic prospects gapped wider than ever. Prospects for a ravaging EM meltdown keep me awake at night. The existing financial structure, dominated by unsound debt, leveraged speculation, derivatives and free-flowing finance – I don’t see how it works going forward.

When EM citizens come to appreciate their boom experience has left them with unmanageable debt loads – and see their nation’s reserve holdings depleted in fruitless currency support operations – there’s going to be hell to pay. The house of cards is being exposed – and a crisis of confidence is at this point unavoidable. A domino collapse of currencies, Credit and banking systems, and economies has become a frighteningly high probability outcome.

In such a scenario, how would a crisis of confidence in Chinese finance be held at bay? Will Beijing turn more insular as it confronts calamitous domestic issues? Or would a more aggressive global stance be considered advantageous in the face of mounting domestic insecurity and dissent? The upside of Bubbles, buoyed by an optimistic view of an expanding “pie,” is conducive to cooperation, assimilation and integration. The downside unleashes a demoralizing slide into antipathy, disintegration and confrontation.

Kissinger: “We went on from the Battle of the Bulge into a world of growing prosperity and enhanced human dignity. Now, we live an epochal period. The historic challenge for leaders is to manage the crisis while building the future. Failure could set the world on fire.”

Experimental treatment

Governments are spending big to keep the world economy from getting dangerously sick

The help is targeted at companies and individuals. More will be needed




Acharacter in a novel by Ernest Hemingway once described bankruptcy as an experience that occurs “two ways: gradually, then suddenly”.

The economic response to the covid-19 pandemic has followed this pattern.

For weeks policymakers dithered, even as forecasts for the likely economic damage worsened.

But in the space of just a few days the rich world has shifted decisively. Many governments are now on a war footing, promising massive state intervention and control over economic activity.

The new phrase on politicians’ lips is “whatever it takes”—a line borrowed from Mario Draghi, president of the European Central Bank (ecb) in 2011-19. He used it in 2012 to convince investors he was serious about solving the euro-zone crisis, and prompted an economic recovery. Mr Draghi’s promise was radical enough.

Politicians are now proposing something of a different magnitude: sweeping, structural changes to how their economies work.




There are unprecedented promises. On March 16th President Emmanuel Macron of France declared that “no company, whatever its size, will face the risk of bankruptcy” because of the virus.

Germany pledged unlimited cash to businesses hit by it. Japan passed a hastily compiled spending package in February, but on March 10th supplemented it with another one that included over ¥430bn ($4bn) in spending and almost four times as much in cheap lending. Britain has said it will lend over £300bn (15% of gdp) to firms.

America may enact a fiscal package worth well over $1trn (5% of gdp). The most conservative estimates of the total extra fiscal stimulus announced thus far put it at 2% of global gdp, more than was shovelled out in response to the global financial crisis of 2007-09.

That sinking feeling

In part this radical action is motivated by the realisation that the coronavirus, first and foremost a public-health emergency, is also an economic one.

The jaw-droppingly bad economic data coming out of China hint at what could be in store for the rest of the world. In the first two months of 2020 all major indicators were deeply negative: industrial production fell by 13.5% year-on-year, retail sales by 20.5% and fixed-asset investment by 24.5%. 

GDP may have declined by as much as 10% year-on-year in the first quarter of 2020.

The last time China reported an economic contraction was more than four decades ago, at the end of the Cultural Revolution.





Grim numbers are starting to pile up elsewhere, not so much in the official statistics, which take time to be published, as in “real-time” economic data produced by the private sector.

Across the world, attendance at restaurants has fallen by half, according to OpenTable, a booking platform. International-passenger arrivals at the five biggest American airports are down by at least 30%. Box-office receipts have crumpled (see chart 2).

The disruption to international travel will hurt trade, since over half of global air freight is carried in the bellies of passenger planes. The combination of disrupted supply chains and depressed demand from shoppers should hit trade far harder than overall GDP, if the experience of the last financial crisis is anything to go by.

Already, the American Association of Port Authorities, an alliance of the ports of Canada, the Caribbean, Latin America and the United States, has warned that cargo volumes during the first quarter of 2020 could be down by 20% or more from a year earlier.

Official data are now starting to drip out. The Empire manufacturing index, a monthly survey covering New York state, in March saw its steepest drop on record, and the lowest level since 2009. In February Norway’s jobless rate was 2.3%; by March 17th it was 5.3%. State-level numbers from America suggest that unemployment there has been surging in recent days.

All this is fuelling grim forecasts. In a report on March 17th Morgan Stanley, a bank, estimated that gdp in the euro area will fall by an astonishing 12% year-on-year in the second quarter of the year. The Japanese economy is forecast to contract by 2% this quarter and 2% next.

Most analysts see global gdp shrinking in the first half of the year, with barely any growth over 2020 as a whole—the worst performance since the financial crisis of 2007-09.

Even that is likely to prove optimistic. On March 17th analysts at Goldman Sachs noted that they had “not yet built a full lockdown scenario” into their forecasts for advanced economies outside Europe. Forecasts for America, which is at an earlier stage than Europe and Asia when it comes to the outbreak, remain Panglossian; very slow growth in China and a big recession in Europe could by itself be enough to send the world’s largest economy the same way.

Steven Mnuchin, America’s treasury secretary, warned this week that the country’s unemployment rate could reach 20% unless Congress passes a stimulus package.

A negotiating ploy?

With shopping malls emptying, factories grinding to a halt and financial markets buckling, lawmakers may be loth to challenge the claim.

Despite stomach-churning declines in gdp in the first half of this year, and especially the second quarter, most forecasters assume that the situation will return to normal in the second half of the year, with growth accelerating in 2021 as people make up for lost time. That judgment is in part informed by China’s experience.

More than 90% of its big industrial firms are officially back in business. Its stockmarket had been one of the world’s worst performers in early February but is now the best (or rather, least bad). There remains, however, a risk that global containment and suppression of the virus will need to continue for a year or longer. If so, global economic output could be dragged down for much longer than most people expect.

Perhaps the greatest lesson of the global financial crisis was that it paid to act decisively and to act big, convincing markets and households that policymakers were serious about countering the slump. If done right, central banks and governments can end up doing a lot less than they actually promised. A pledge to bail out banks makes it less likely savers will withdraw deposits and make a rescue necessary.

This time around, central banks sprang into action. Since February the Federal Reserve has cut interest rates by 1.5 percentage points. Other central banks have followed suit. Further deep rate cuts are not possible, though; interest rates were very low long before the virus began to spread.

Let’s get fiscal

Not all central banks are acting as boldly as they can. China has room to cut interest rates—its benchmark rate is 1.5%—but has held back in part because inflation is quite high (largely as a result of African swine fever, which hit pig stocks, raising prices).

Central banks could try more creative policies. On March 19th the ecb’s governing council agreed to launch a €750bn bond-buying programme, covering both sovereign and corporate debt. But the real action is now taking place on the fiscal front.

Governments are falling over each other to offer bigger and better stimulus packages. All countries are spending more on health care, both in an effort to find vaccines and cures and to increase hospital capacity. However, the bulk of the extra spending is on companies and people.

Take companies first. China, where the outbreak has slowed, is now trying to get people out and buying things. Foshan, a city in Guangdong province, has launched a subsidy programme for people buying cars. Some cities have started giving out coupons that can be spent in local shops and restaurants. Nanjing this month gave out e-vouchers worth 318m yuan ($45m).

Most countries, however, are in or about to enter the worst part of the outbreak. As customers dry up, many firms will go bust without government help. Calculations by The Economist suggest that 40% of consumer spending in advanced economies is vulnerable to people shunning social situations. Firms in leisure and hospitality are especially rattled.

The Moor of Rannoch hotel, in about as rural a part of Scotland as it is possible to find, says its insurer will not be paying out a penny for lost custom, since covid-19 is a new disease and thus not covered under its policy.

One approach is to reduce firms’ fixed costs, largely rent and labour. China’s finance ministry will exempt companies from making social-security contributions for up to five months. The government has also temporarily cut the electricity price for most companies by 5% and enacted short-term value-added-tax cuts.

The British government has extended a one-year business-rates holiday to all companies operating in the retail, hospitality and leisure sectors. Yet for many firms, no matter how much the government helps them reduce costs, revenues are likely to fall further.

So measures may be needed to allow firms to maintain cashflow. Many banks are offering hefty overdrafts to tide corporate clients over. To encourage banks to keep lending, Britain has promised them cheap funding and state guarantees against losses. For very small firms, many of which do not borrow at all, it is offering non-repayable cash grants of up to £25,000.

Other countries are enacting similar plans. The Japanese government is helping small firms by mobilising its state-owned lenders to provide up to ¥1.6trn of emergency loans, much of it free of interest and collateral requirements. Small firms qualify for help if their monthly sales fall at least 15% below a normal month’s takings.

Bavaria, a rich state in Germany, announced on March 16th that small and medium-sized companies with up to 250 employees could receive an immediate cash injection of between €5,000 and €30,000. The European Commission has already relaxed state-aid rules so that governments can channel help to ailing companies.

The second part of the fiscal response is about helping people, and in particular protecting them from being made unemployed or suffering a drastic drop in income if that does happen.

Ugo Gentilini of the World Bank counts more than 25 countries that are using cash transfers as part of their economic response to the virus.

Brazil will give informal workers, who make up roughly 40% of the labour force, 200 reais ($38) each. Small businesses will be allowed to delay tax payments and pensioners will get year-end benefits early. Australia is instituting a one-time cash payment of A$750 ($434) to pensioners, veterans and people on low incomes.

Northern Europe has led the way on implementing policies that make it less likely firms lay off workers. Germany has relaxed the criteria for Kurzarbeit (“short-time work”), under which the state pays 60-67% of the forgone wages of employees whose hours are reduced by struggling firms. Applications are going “through the roof”, according to the federal labour agency.

The use of Kurzarbeit probably halved the rise in unemployment during the recession of 2008-09. More firms are now eligible to use it, temporary workers are covered, and the government will also reimburse the social-security contributions companies make on behalf of affected workers.

Bringing home the Danish bacon

In Denmark firms that risk losing 30% or more of their workforce will see the government pay 75% of the wages of employees who would otherwise be laid off, until June. Norway’s government has beefed up unemployment benefits, guaranteeing laid-off workers the equivalent of their full salary for the first 20 days.

Freelancers whose work vanishes for more than a fortnight will get payments equivalent to 80% of their previous average income. In Sweden the state will cover half of the income of workers who have been let go, with employers asked to cover most of the rest.

So far America has passed more modest legislation. Federal funding for Medicaid, which provides health care for the poor, is likely to boost spending by about $30bn, assuming it remains in place until the end of December, reckons Oxford Economics, a consultancy. America also has a new paid-sick-leave policy for some 30m workers, including 10m who are self-employed, worth just over $100bn.

But in that regard America is merely catching up with other rich countries, which have far more generous sick-leave policies. America also has fewer automatic economic stabilisers, such as generous unemployment insurance, than most other rich countries. As a result, its discretionary fiscal boost needs to be especially large to make a difference.

It might be. The Trump administration’s plan to funnel money directly to households, if approved by Congress, is the most significant policy. It bears some resemblance to a scheme that was introduced in February in Hong Kong, in which the government offered HK$10,000 ($1,290) directly to every permanent resident.

Mr Mnuchin is thought to favour a cheque of $1,000 per American—roughly equal to one week’s average wages for a private-sector worker—with the possibility of a second cheque later. Some $500bn-worth of direct payments could soon be in the post.

Some economists are leery about such a policy. For one thing, it would do little to prevent employers from letting people go, unlike the plans in northern Europe.

Another potential problem, judging by Hong Kong’s experience, is administration of the plan: the territory’s finance secretary hopes to make the first payments in “late summer”, far too far away for people who lost work last week. Mr Mnuchin promises that payments will happen much sooner.

Chequered past

America has done something similar before, with results that were not entirely encouraging.

The government sent out cheques in both 2001 and 2008 to head off a slowdown. The evidence suggests that people saved a large chunk of it. The psychological reassurance of a bit of extra cash could be significant for many Americans, but the sums involved are not especially impressive.

Bernie Sanders, a Democratic presidential contender, is not known for his smart economic policymaking, but his suggestion of $2,000 per household per month until the crisis is over is probably closer to what is required.




Indeed, more fiscal stimulus will be needed across the world, especially if measures to contain the spread of the virus fall short. After the Japanese government passes the budget for next fiscal year at the end of this month, it can begin work on a supplementary budget that takes the virus into full account. Britain’s Parliament has given Rishi Sunak, the chancellor of the exchequer, carte blanche to offer whatever support he deems necessary, without limit.

How much further can fiscal policy realistically go? Last year the 35-odd rich countries tracked by the imf ran combined fiscal deficits of $1.5trn (2.9% of gdp). On the not-unrealistic assumption that the average deficit rose by five percentage points of gdp, total rich-country borrowing would rise to over $4trn this year. Investors have to be willing to finance that splurge.

The yield on ten-year Treasury bonds, which had fallen as low as 0.5% as fears of the virus took hold and traders sought havens, has recently risen above 1%. This is probably due to firms and investors selling even their safest assets to raise cash, but might reflect some anxiety over the scale of planned government borrowing.




Still, 1% is still extremely low by historical standards. For a variety of reasons, including population ageing, there is—in normal times, at least—unprecedented demand for low-risk government securities. The Bank of Japan has promised to buy as many bonds as necessary to hold the yield on its government’s ten-year bonds close to zero.

Investors remain queasy over some rich countries’ bonds, especially slow-growing European states. The ecb’s latest intervention should allow heavily indebted economies viewed with suspicion by markets, such as Italy, to borrow more cheaply—though it does not fully dispel doubts around the euro zone’s willingness to act to avert crisis.

The question of financing the spending splurge may be more one of practicalities than of feasibility. America’s Treasury cannot issue trillions of dollars of new bonds overnight. It can, however, issue notes and bonds to the Federal Reserve, which could then credit the Treasury’s account, allowing vast sums to be spent immediately, points out Ian Shepherdson of Pantheon Macroeconomics, a consultancy.

The bonds could then be sold to investors at a later date. This approach amounts to money-printing, but with little risk of runaway inflation in these straitened times.

The economic hit from covid-19 will be bad enough for rich countries, in both human and economic terms. But they are in a relatively fortunate position, with strong health-care systems, and investors who, for now, remain willing to lend to them on cheap terms.

Poorer countries, where the threat posed by the virus is also growing rapidly, have less room to borrow and job markets with a higher share of informal workers who are ineligible for many protections.

The rich world faces tough times, but will get through the crisis. The prospects of poorer places are far less certain.

China’s property sector is at the epicentre of the crisis

Indebted developers threaten a domino effect on western credit markets

Paul Hodges and Daniël de Blocq van Scheltinga

A branch of Centaline Property Agency in Hong Kong
A branch of Centaline Property Agency in Hong Kong © Bloomberg


Second-order impacts are starting to appear as a result of China’s lockdowns. These are having a big impact on the critical property sector, which makes up as much as 25 per cent of gross domestic product.

Housing sales fell almost 40 per cent in February and seem likely to be down again in March, while developer Evergrande cut prices to try and maintain its cash flow. This creates growing risk in the offshore dollar market, where property developers have been significant borrowers, with Fitch already warning of possible defaults.

It is unclear whether local authorities can provide much support, as their dependence on revenue from land sales means their own position is weakening.

Rightly, the world’s attention has focused on the impact on public health of the coronavirus pandemic and the best ways of mitigating it. But as Martin Wolf highlights, the virus is an economic emergency too, with the ability to plunge the world into a depression. Talk of the reforms made to the world’s banking systems since 2008 misses the point.

The risk is now centred on the vast build-up of corporate debt since the global financial crisis, under the easy money policies of the world’s central banks.




China’s property sector is unfortunately the epicentre of this debt. As we noted here in August: “Its tier 1 cities boast some of the highest house-price-to-earnings ratios in the world, while profits from property speculation allowed car sales to rise fourfold from 500,000 a month in 2008 to 2m a month in 2017.”

Last month’s collapse of car sales back to 2005 levels of 244,000 confirms the damage that has been done.

Sales by China’s top 100 property developers plunged by 44 per cent in February, and Caixin reports that over 100 builders went bust in the January-February period, normally one of the busiest times for property sales. Equally worrying, as Caixin’s chart below illustrates, is that, although the largest developer, Evergrande, bucked the trend, this was only because it cut prices by 25 per cent in February and offered 22 per cent reductions this month.

There are few signs of a sustained upturn, with S&P reporting that housing starts were down 45 per cent across January-February.

S&P adds that property sales could fall 20 per cent this year, if the effects of the lockdowns are still being felt in April, as seems likely.




The issue is that we are now starting to see second-order impacts of the lockdowns emerge, particularly in terms of consumer affordability and supply chain disruption:

· The economic impact of the initial lockdowns was focused on two areas — companies and consumers. Companies were shut down, and consumers were quarantined

· In turn, this led to a number of key impacts within and outside China

· Within China, demand disappeared for a wide range of products as consumers were unable to leave their homes; supply also disappeared as companies shut down

· And ‘out of sight’, critical logistic arrangements were being completely upended by quarantine measures, and the need to prioritise essential food/medical supplies

We can probably assume that truck drivers are slowly being released from emergency duties and from quarantine (if they travelled from infected areas across provincial borders). But we have no idea if their basic equipment — containers, specialist materials, etc — is in its normal place.

We do know, however, from the shipping industry that its activity has been severely disrupted, with ships away from their usual moorings and many idled due to lack of work; containers and crew are equally disrupted.

It is safe to assume that most Chinese companies and consumers are short of cash and that consumers will cut back on all but essential spending, further depressing demand. This creates the risk of a vicious circle, whereby property sales remain depressed, reducing developer cash flow still further after most building activity came to a standstill during the lockdowns.

As Caixin reported: “Credit rating agency Fitch Ratings identified seven Chinese corporations with a high risk of refinancing in a recent report, six of which are in the homebuilding sector, citing concerns about near-term capital market debt maturities and the unpredictability of the epidemic.” A further sign of stress, as the Financial Times has reported, is that land sales are now running at less than a quarter of average levels.

Two key facts highlight our concerns:

· Chinese developers ramped up their offshore dollar borrowing by 52 per cent to an all-time high of $75.2bn last year, according to Centaline Property Agency, as onshore funding became more difficult.

And as S&P reported in November, before coronavirus hit: “For some developers, offshore yields to maturity have surged well beyond the mid-teens, reflecting low investor confidence.”

· Chinese borrowers also tend to operate on a short-term basis, with an ICE BofA index of Chinese high-yield securities in dollars having 2.7 years to maturity, compared with 5.9 years for a similar US index.

We have warned here for some time that China’s property market has been ‘subprime on steroids’. Property sales have been buoyed by vast government stimulus programmes. And western investors have flocked to lend in the offshore dollar market, attracted by the high interest rates on offer compared to those in their domestic markets under central banks’ zero-interest rate policies.

On Wednesday, the renminbi weakened beyond Rmb7 to the US dollar, adding to the difficulties developers will face in servicing their dollar debts.

The potential for a domino impact on western credit markets from a coronavirus-related downturn in China’s property market should already be keeping regulators up at night.


Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

Global lay-offs surge as 6.6m Americans file jobless claims

About 4m French workers are in a temporary unemployment scheme, while 800,000 have lost jobs in Spain

Mamta Badkar in New York, Brendan Greeley in Washington, Victor Mallet in Paris and Daniel Dombey in Madrid


The surge in job losses came as governments across the globe have taken increasingly aggressive measures to restrict movement © AFP via Getty Images


Global job losses have surged with millions of Americans and Europeans seeking unemployment benefits as lockdowns imposed to slow the spread of the coronavirus pandemic wreak havoc on some of the world’s biggest economies.

A record 6.6m Americans filed for jobless aid last week, the US labour department said on Thursday, more than double the 3.3m that applied for benefits two weeks ago and far higher than economists’ forecasts.

More than 10m Americans filed new claims for unemployment benefits in the second half of March, a massive surge in unemployment in the world’s largest economy.

“It is and continues to be an eye-watering number. It continues to confirm our worst fears about the speed of lay-offs,” said Torsten Slok, chief economist at Deutsche Bank Securities. “[Job claims ] tells you that government programmes are too late, and companies have already reacted.”Editor’s note

US markets closed higher on Thursday despite the negative numbers as investors were buoyed by hopes the oil price war between Russia and Saudi Arabia. The S&P 500 closed up 2.3 per cent, the Nasdaq Composite was 1.3 per cent higher. The price of Brent crude was closed up 21 per cent at $29.94 a barrel.

Asian bourses largely followed the US gains on Friday morning, with the Topix up 0.9 per cent in early trading, South Korea’s Kospi and Australia’s S&P/ASX 200 were 0.8 per cent higher respectively.

The bleak US jobless numbers came after countries across Europe reported similarly dire employment data, with governments using state-funded schemes in an attempt to avoid permanent losses.

Line chart showing the dramatic rise in US unemployment claims in the last weeks of March 2020


About 4m French workers — equivalent to a fifth of France’s private sector employees — have been temporarily laid off in the past two weeks but are still being paid after their employers applied for the government's partial unemployment scheme.

Spain, which has the third-highest number of confirmed coronavirus cases after the US and Italy, recorded the biggest jump in unemployment in its history, with more than 800,000 people losing their jobs last month. The country was already grappling with joblessness of 14 per cent and almost all the job losses came from people on temporary contracts, who represent more than a quarter of the workforce.

In the UK, almost 1m people have applied for universal credit, a state benefits scheme, while in Ireland about 34,000 companies have signed up for a government wage-subsidy programme in less than a week.

The surge in job losses came as governments across the globe have taken increasingly aggressive measures to restrict movement as they battle to contain the Covid-19 outbreak, with the total number of confirmed cases passing 1m. More than 50,000 people have now died from the disease.

The restrictions have forced businesses to close their doors, throttled international trade and battered financial markets amid warnings of a global recession worse than the 2009 global crisis. They have also led to fears of an emerging market debt crisis as commodity prices have fallen and currencies tumbled against the dollar.

US President Donald Trump last month said the cure should not be worse than the disease. But in a change of tone this week, he warned that the US death toll could reach up to 240,000 even if Americans followed the strict social distancing guidelines that the White House has recommended remain in place until the end of April.

Covid-19 confirmed cases breach one million


He told the US to be ready for a “painful” two weeks.

Western governments have launched multitrillion-dollar rescue packages to help cushion the impact on economies, but firms are laying off or furloughing staff in vast numbers, particularly in the retail and hospitality as restaurants and shops have closed. 

California reported the largest number of jobless claims in the US at 878,727, while Pennsylvania reported 405,880, according to early state-level estimates that have not been seasonally adjusted. Meanwhile New York, which has emerged as the biggest US hotspot for Covid-19, reported 366,403 claims.

The False Crisis Comparison

During the 2008 crisis, unprecedented actions by the US Federal Reserve were both appropriate and decisive in addressing the primary source of the shock: a devastating blow to the financial system. In the COVID-19 crisis, the Fed cannot play the same role, because it is addressing the financial repercussions of a shock to the real economy.

Stephen S. Roach

roach114_Win McNameeGetty Images_jeromepowellfederalreserve


NEW HAVEN – In an effort to get a handle on the economic and financial consequences of the COVID-19 pandemic, the first instinct is to search for precedents and remedies in earlier crises.

Many have pointed to the 2008 global financial crisis (GFC) as the most relevant example, especially in the aftermath of the extraordinary monetary-policy actions announced by the US Federal Reserve on March 15. That would be an unfortunate mistake.

What worked 11 years ago won’t work today.

The COVID-19 pandemic is the mirror image of the GFC. The policy response needs to be crafted accordingly.

The GFC was, first and foremost, a financial shock that took a severe toll on the real economy.

COVID-19, by contrast, is a public-health crisis. Draconian containment efforts – lockdowns, transportation bans, and restrictions on public assembly – are producing a shock to the real economy, with devastating consequences for businesses, their workers, and the financial sector.

During the GFC, unprecedented actions by the Fed were both appropriate and decisive in addressing the primary source of the shock: a devastating blow to the financial system. In the COVID-19 crisis, the Fed cannot play the same role, because it is addressing a secondary shock: the financial repercussions of the primary shock to the real economy.

Instead, the Fed’s response must be seen as necessary, but not sufficient, to address the COVID-19 crisis. It is a delicate role, to say the least.

The Fed’s policymaking at moments of crisis must always be managed judiciously. As the crisis intensified, it was certainly in a tough place. However, its rare Sunday announcement of emergency actions on March 15, just two days before a regularly scheduled policy meeting, conveyed a sense of urgency that undoubtedly heightened investors’ fears and stoked rumors of an imminent liquidity crisis. We will never know if the Fed would have been wiser to wait a couple of days.

Yet this episode underscores an uncomfortable truth: We have become far too dependent on monetary fixes for all that ails the world. In the days that followed the Fed’s Sunday surprise, the added carnage in financial markets sent a strong message: The “big bazooka” of central banks that worked effectively in putting a floor beneath plummeting markets in late 2008 and early 2009 is not only the wrong weapon to address a public-health crisis; unfortunately, it also lacks live ammunition.

This, of course, was the big risk all along. After having failed to normalize policy rates in the aftermath of the GFC, central banks had limited options to address the inevitable next shock. Time and again, we find out that the next shock is never the same as the last. Yet we always seem to fixate on a redesign of policies, regulations, and economic structures that is conditioned by the last crisis – leaving us woefully unprepared for the one to come.

Crises can be arrested only by attacking their source. In the midst of the COVID-19 pandemic, the focus must be on virus containment. That will require creative and expeditious actions, focusing first and foremost on public-health infrastructure and the science of COVID-19 containment and mitigation.

Some have used the wartime analogy to emphasize the magnitude and scope of the policy response now required. While this is appropriate, it assumes a degree of political consensus that is sorely lacking in today’s polarized environment. Sadly, the combination of domestic polarization, national protectionism, and global fragmentation is especially problematic in bringing us all together to fight a global problem.

As always, when this crisis passes, there will be great introspection on how we got into this mess. This will undoubtedly include a reassessment of globalization, which once seemed like an economic panacea for poor and rich countries alike.

Courtesy of a sharp expansion of world trade, along with a concomitant explosion of global value chains, relatively poor developing economies could benefit as producers by reducing poverty and boosting living standards, while the developed world would benefit as consumers by being able to purchase cheaper goods (and increasingly services). The “win-win” of globalization practically sold itself.

But globalization has also led an interdependent world to an unfortunate fixation on the sheer speed of economic growth: the faster the growth, the bigger the “wins” for both producers and consumers. Unfortunately, this overlooked the quality of growth – not just sorely needed investment in disease mitigation and public-health infrastructure, which the COVID-19 crisis has made glaringly apparent, but also investment in environmental protection despite the equally patent evidence of climate change.

The GFC playbook was designed for a world facing threats to the quantity of economic growth. It cannot be the answer for a world facing a shock stemming from deficiencies in the quality of that growth. Monetary and fiscal policies can temper short-term distress in financial markets and hard-hit businesses and communities. But they don’t address the urgent priority of disease containment and mitigation.

There is broad consensus that the best way to restart the global growth engine is by flattening the COVID-19 infection curve, both in individual countries and worldwide. That, not the monetary and fiscal policy template of the last crisis, must be the laser-like focus of policymakers during this crisis.

History attests to the resilience of the modern world economy in the aftermath of negative shocks. That offers grounds for hope of a self-generating rebound.

But it can be realized only after COVID-19 is contained.


Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.