Coronavirus Helicopter Money

By John Mauldin

I write this letter early Friday morning after a week in New York visiting with many fellow market participants. And lots of phone calls, both to analysts and medical experts. I had originally planned a completely different letter but circumstances changed.

Humility is a good thing to have when you’re forecasting the economy or markets. You never know what relevant facts you might be missing, so it’s best not to be too confident.

In my annual and decade forecasts, published just two months ago, I said recession probably wouldn’t happen this year, absent an exogenous event.

Now, thanks to COVID-19, I am far less confident in that forecast. We have an exogenous event underway that might change everything.

Today we’ll consider where this is all headed and what could happen—not medically (others can address that) but economically. The coronavirus could take us all someplace we really don’t want to go.

Policy Shocks

Some of my libertarian friends like to say the best thing government can do is nothing. I believe there are some things only governments can do. One of them is respond to viral epidemics. So far, the government response has been, let’s just say, not up to par. That finally seems to be changing.

The Federal Reserve injected some $600 billion into the market yesterday and promised a great deal more.

The analysts I trust have reached a consensus that US rates will soon be near or at the zero bound. All well and good in a financial or business cycle recession, but that’s not what we have today. We have a biological pandemic (the WHO has finally begun to use that word) that is clearly changing consumer behavior patterns. Low interest rates and easy money are not going to change those patterns.

I am a believer in the free market and individual decisions. I don’t blame anyone who decides it is in their best interest to stay home and avoid crowds. That is their own personal decision. However, the collective decision of many consumers to reduce their activities has the very real probability of causing a recession soon.

RSM economist Joseph Brusuelas produced a handy flowchart showing how these situations tend to evolve (click the link below for a larger image).

Source: Real Economy

We have three different shocks underway.

The supply shock will become more visible in the coming weeks as the Asian export pipeline runs dry, with unpredictable but possibly widespread effects on US businesses.

The demand shock is already hitting as travel slows, people avoid large gatherings, and consumers reduce discretionary spending.

The financial shock is well underway in the markets, as you are probably aware. The last few weeks brought volatility we haven’t seen in a long time.

The response to all these shocks is both monetary (central banks) and fiscal (governments). The monetary side is quite limited in what it can do.

Interest rates are already near zero and below zero in some places. Plus, easier credit doesn’t address the problem. Cheap financing won’t speed up the supply chain or make people want to travel again. Nor will it help corporate earnings if customers aren’t spending.

In this scenario, the policy response is mostly fiscal. When Milton Friedman talked about “helicopter money,” he was referring to central banks, but governments have helicopters, too. And the engines are revving up everywhere coronavirus strikes.

In China, the central bank has avoided macro stimulus measures but Beijing and local governments show little restraint otherwise. They are cranking up all kinds of infrastructure projects and subsidizing businesses to pay workers for the containment periods. Banking regulators are letting small businesses delay debt payments. Some are also being exempted from social insurance taxes for the next few months.

Hong Kong is simply giving away cash, with every adult set to get the equivalent of $1,285. I suspect this is about more than virus relief, though. It might also reduce some of the recent protests.

Japan is allocating trillions of yen to subsidize workers who were forced to stay at home, often with children whose schools the government closed. Small companies will get zero-interest loans. Prime Minister Shinzo Abe promises more is coming, too.

In hard-hit Italy, Prime Minister Giuseppe Conte says he will deliver “massive shock therapy” to an economy that, in theory, should be practicing fiscal austerity. That era seems to be over. The government is planning a debt moratorium, including mortgages. How they will do that in one of the world’s weakest banking systems, and still stay in the eurozone, is unclear.

The ever-flexible European Union is preparing to relax limitations on “state aid” its members can provide. They may (shudder) even create a “coordinated” fiscal stimulus package.

Will the US do likewise? I think it’s inevitable. The Trump team and Democrats are already floating ideas. Wall Street people and various industry leaders are practically begging for help. The pressure will only grow as more companies lose revenue and more people find themselves unable to work. This being an election year, some sort of package will pass with bipartisan support. The worse this gets, the larger it will be.

Note, all this will be on top of whatever they allocate to pay for coronavirus testing, treatment, and (eventually) vaccines. It also doesn’t count the various “automatic stabilizer” programs that will kick in as more people lose jobs and income. And it will all happen as tax revenue falls for the same reasons.

Whether or not all this helps the economy or not, it will certainly expand a federal deficit that was already set to exceed $1 trillion this year. I suspect it will end up doubling that number even if the coronavirus threat recedes soon. The politicians now have a perfect reason to spend more money and they are going to seize it.
That is just how it Works.

My Best Guess on the Future

As bluntly as I can put it, this is not a financial recession (yet). We are in a biological crisis and it is creating panic. Much of that panic is simply because of the “unknown unknowns” surrounding COVID-19.

We know it is more contagious and it appears to be more lethal. We are not really sure how lethal, but clearly none of us want to get the virus. This is introducing an enormous amount of uncertainty into the markets and the business world, neither of which like uncertainty.

This is the yield curve as of Friday morning before the markets opened from Bloomberg. Rates have risen a bit from their bottom two days ago, but this is still rather shocking.

Source: Bloomberg

In a conversation last night, several participants mentioned well-known names who feel that the US 10-year government bond may approach zero before this is over. Dear gods…

A Consumer-Led Recession

This graph hit my inbox this morning from the brilliant Danielle DiMartino Booth of Quill Intelligence. It shows clearly how travel is slowing, which we knew, and will likely slow even more as major events are cancelled or postponed.

Source: Danielle DiMartino Booth

A few anecdotal observations:

As I walked around New York this week, I would ask the taxi drivers and restaurant personnel how business was. They all said it was down. Interestingly, higher-end restaurants seem to be slow - perhaps because they have been ordered to use only 50% of their normal seating capacity. I mentioned this to my friend Ian Bremmer and he pointed out that many New Yorkers have second homes outside the city. They have either left town or are working from home.

One money manager noticed that his trades were executing more slowly. In trying to figure out why, he finally realized the traders he uses were all at home on their Wi-Fi which was slower than the Wi-Fi at their offices. Not a big deal, but those traders also aren’t going out to buy a sandwich for lunch. Bad news for restaurants.

My associate Patrick Watson and his wife Grace run a rather high-end hair salon in Austin. They’ve been doing so for almost 20 years. Their sales fell 14% in early March from the same point a month ago. Haircuts and color are discretionary spending. Gray-haired people can, and some evidently are, deciding to let their roots show rather than go to the salon.

Question: Does this change behavior going forward? Do we find out that staying home with Netflix and pizza is as good as an upscale Italian restaurant and theater? I mean, not the quality of the food, but just the experience and how we enjoy life.

How many other hundreds of ways is this particular pandemic going to affect our lives and our lifestyles going forward? That is completely unknowable, but it is something to ponder.

I get that the Federal Reserve and the government feel they have to do something. But their tools are generally geared to helping Wall Street, not Main Street.
I think this note from Woody Brock sums it up very well.
          More on the Crisis and the Markets

Two weeks ago, I sent out a crisis memo warning that the market could soon drop to 17,500 on the Dow. I stressed that the true threat to the economy and to profits and employment was not only interruptions in the supply chain, but more importantly the first implosion of the SERVICE sector we have ever seen.

This is now just what we are seeing as movie theaters, airlines, “events” of all kinds, schools, universities—all closed down. And the Dow today is down from 29,000 to 21,000. A further drop to our predicted 17,500 could occur within a week or two.

In this brief Memo I wish to add a few points regarding the volatility of the market. 

      Pricing Model Uncertainty

The main point concerns the role of what we have called “Pricing Mode Uncertainty” (PMU)—a concept we introduced some 14 years ago.

Our fundamental theorem was that the greater the amount of PMU there is in a market, the greater the degree of price overshot upward and downward there will be. The proof was game theoretical and was presented at a conference at Stanford University.

The degree of PMU rises with the degree to which investors admit that they do not understand the mapping of “news” into prices.

In the efficient market theory, it was simply assumed that all investors would—upon hearing the news—agree on the “correct” new price of the asset. There was thus no PMU and thus very low volatility.

In the current case where no one understands what the “news” really is, much less how it will impact asset prices, PMU is MAXIMAL thus implying huge price swings of the kind we have and will experience.

Intuitively, the reason underlying our theorem is that the greater the PMU level, it will be rational for all investors to drive price trends much further up and down. The logic is fascinating—the math very complex.

One very important form of investor ignorance today concerns the markets view that it is prospects for corporate earnings that will matter most. This is wrong.

What will matter are the collapse in profits and survivability of millions of privately owned proprietorships and partnerships whose profits are not even included in index earnings data.

It is these firms who could end up firing millions of workers and going under. THIS is what will impact Main Street and unemployment—often long before official earnings of large corporations are even computed.

The data we have for understanding the lives and behavior of these small firms that employ most Americans is sparse and scarcely looked at.

This is one further reason not to listen to data-junkies or self-styled “quants” who loathe anything subjective.

This is the time for very subjective judgements—backed up by compelling deductive LOGIC of a kind that has all but disappeared in today’s rage for “evidence-based truth”—a fatuous concept at best.

Don’t Ask, Don’t Test

My friend Ben Hunt wrote two weeks ago that we were in a period of “don’t ask, don’t test.” He has been extremely critical, and rightly so, about the slow response in getting tests available. There is real reason to believe that the promised 1 million tests are really not there.

That being said, it will get better and when we actually start testing at scale, I suspect we will find a lot of people have the coronavirus. My extremely informed sources, who do not want to be named, consider it quite reasonable to expect 100,000 people in the US will test positive in a relatively short time.

The mainstream media will breathlessly report each increase and their locations and what is happening at the local hospitals. How do you think people will respond as the number of cases approaches 100,000 with no sign of slowing?

Eventually the number of cases will begin to decline. Dr. Mike Roizen thinks there is an 80% chance that by the end of April we will have seen the total number of cases peak and begin declining, and that the coronavirus is like its predecessors. This particular coronavirus is worse in that it is more contagious and that it will live outside the body for a period of time. Warm weather in the past generally helped.

There’s been a great deal of concern about the outbreak and number of deaths in Italy. The Italian hospital system is, to be kind, simply inadequate for this scenario.

The WSJ noted a few days ago:

In Italy, which has the oldest population in the world after Japan, 58% of COVID-19 patients who died so far were over 80 years old, and a further 31% were in their 70s, according to the National Institute of Health, Italy’s disease-control agency… It should also be noted that, like many socialized medical systems, Italy’s system has a personnel challenge… There aren’t enough specialized doctors and nurses to staff intensive-care units.

On a positive note, the US has three times the per-capita number of ICU beds as Italy, and they are far better equipped. So hopefully we will fare better, if it reaches that point.

This is an economic/investment letter, so when should we think about getting back into the market? Consider this chart from Gavekal, which again came this morning. It shows Chinese equities bottomed when daily new COVID-19 cases peaked.

Source: Gavekal

Europe and the US seem to have the same pattern of cases as China.
Which means that we will peak as well at some point.

Source: Gavekal

My personal plan for my own portfolio, other than the private funds that I own, is to wait until the number of US COVID-19 cases begins to peak, as I believe that will probably be the time of peak panic, and then I will get back into the market.

I will be looking for dividend and fixed income opportunities, as after all I am 70 years old, and I tell all my clients at that age they should be looking for more fixed income. Right now, I don’t have enough but I think there’s going to be a great buying opportunity in the not-too-distant future.

There are going to be some opportunities of a lifetime in the not-too-distant future. Please be prepared to take advantage of them.

Seriously, as troubling as this pandemic is, I’m confident humanity will invent vaccines and treatments while hospitals develop ways to deal with it. Next year, and for a few years after that, it would not surprise me if we all get our COVID-19 vaccine just like normal flu shots.

One Major Caveat

Right now, the corporate bond market seems to be relatively (and I use the word loosely) not acting as badly as you might expect. However, the oil price crisis brought on by Saudi Arabia and Russia could push some energy companies to the brink of insolvency. Those assets will be bought by firm hands, as it was in the last oil crisis. But if it triggers a problem in the high-yield and junk bond markets, this recession can get a lot worse. It is something we have to pay attention to.

I think it highly likely our government will do some crazy things in the next few months. However, there are some fiscal policies that actually make sense. I’ll give you three specific ideas.

First, President Trump should suspend the tariffs he has imposed on China and other countries. They represent billions in taxes on American consumers. It is not the case, as he claims, that China is paying them. We are paying them, to the tune of billions every month, in higher prices for imported goods. (Yes, we’re importing less since China shut itself down, but that won’t last forever.)

Ending tariffs would be a large, direct stimulus to the US economy. Better yet, it can happen immediately. The president imposed the tariffs on his own authority and he can end them that way, too. He doesn’t need to negotiate with Congress, nor does he need Democrats to cooperate. It could happen almost immediately. Markets would celebrate, too.

Second, with Treasury bond yields now below 1%, and actually below zero after inflation, we should start refinancing as much of the federal debt as markets will accept—which at the moment seems to be a lot. The Treasury Department already has wide authority to issue new debt and it could sharply reduce the government’s interest costs. Those savings could be applied to more helpful programs. As with the tariffs, this could happen quickly.

Third, issue very long-term bonds (50 years+?) and use the proceeds to rebuild our crumbling infrastructure. We Americans who travel internationally (or used to) and see the airports, highways, and trains in other developed countries are constantly ashamed of what we have in the US. There’s just no excuse. This is the one kind of spending where government debt actually makes sense, and would provide plenty of jobs, too. Make money available to completely rebuild the crumbling water systems in many cities.

Will they do any such thing? I know we are all cynical about politics, and with good reason. But if we can’t get past politics-as-usual and pull together in what threatens to be a genuine national crisis, then we have even deeper problems.

I am an optimist and I have faith in my country. As Winston Churchill supposedly said, “Americans can always be counted on to do the right thing, after they’ve tried everything else.” The process may be ugly but I believe we will reach the right place, eventually. Let’s try to skip some steps.

New York and Back to Puerto Rico

As I finish this letter, I will be heading off to another meeting before going to the airport and back to Puerto Rico. I have been in New York putting some final touches on a radically new investment management service, sort of my dream team on steroids. Literally, what we will be doing was not even possible a few years ago. Technology has opened doors that absolutely boggle my mind. More on all that in a few weeks.

As I wrapped this up, Mike Roizen called to report 60% of the patients he was going to see today have cancelled. This is one of the nation’s top doctors. Appointments with him are tough to get and are often people with serious conditions. Yet many are giving them up. That’s how bad the fear is getting.

One last point, at dinner last night, there was universal agreement on our frustration with President Trump’s decision to suspend air travel from Europe. That may be the right call. I am not privy to the information they see. But to do so without giving our allies a heads up is simply unforgivable. They found out just like the rest of us. You simply do not treat your allies like that.

Not to mention your own citizens who are in Europe wondering if they will be able to get back. Really? If you have to close off air traffic for our own safety, fine. Make the hard call. That’s what presidents are supposed to do. But you pick up the phone and call your allies and give them some notice.

We have to work with Europe. I think they are going to be a lot less willing to work with us in the future when they can’t even trust us to tell them in advance of difficult decisions. I am in agreement with many things that Trump has done. But this one mystifies me.

And with that I will hit the send button. You have a great week and as I said last week, start putting together a watch list of things to buy at fire sale prices.

Your looking to make a bull market call analyst…

John Mauldin
Co-Founder, Mauldin Economics

Sunday night special

The Federal Reserve acts again, as market turmoil continues

Other central banks follow up with emergency measures

Central banks are not known for their spontaneity. They do not tear up their calendars lightly.

And when they do, it is not usually a good sign. Both the Bank of Japan and America’s Federal Reserve were scheduled to hold policy meetings later this week. But neither felt they could wait that long.

On March 15th—a Sunday—the Fed cut its benchmark interest rate by a full percentage point, lowering it to the range of 0-0.25%, as low as it has ever gone. It was the central bank’s second emergency cut outside a scheduled meeting in less than a fortnight.

The Fed also made it cheaper and more convenient for banks to borrow directly from its “discount” window (an option banks have traditionally avoided because it makes them look desperate).

And to ease the shortage of dollars evident in the currency-swap market, it lowered the cost of the swap lines it has extended to central banks in the euro area, Japan, Britain, Canada and Switzerland.

If that was all it needed to do, it could probably have waited until its regular meeting on March 17th and 18th. But it also faced a more urgent problem in two of the most important financial markets in the world: those for mortgage-backed securities and American Treasury notes.

In times of crisis, such as recessions, wars or today’s covid-19 pandemic, investors flock to American Treasuries as a safe haven, driving their prices up and their yields down (for more coverage of the pandemic, see our coronavirus hub).

But on occasions last week, the price of Treasuries had fallen alongside those of risky assets, such as shares (which tumbled again in Asia and in early European trading on March 16th).

And unusual gaps had emerged between the prices of closely matched securities, such as Treasuries of similar maturities. Yields had become “wiggly”, as Darrell Duffie of Stanford University described it to the Financial Times.

Ironing out those wiggles is usually the job of hedge funds and other financial institutions that buy the cheaper instrument and sell its more expensive cousin. But this kind of arbitrage seemed to break down last week as financial institutions withdrew from the market and clung to cash.

In response, the Fed first tried making it easier for these institutions to finance themselves.

Then it began buying more Treasuries itself, accelerating a previously planned schedule of purchases. At the weekend, it said it would buy on a far greater scale, purchasing at least $500bn of Treasuries and $200bn of mortgage-backed securities, at whatever pace is necessary to smooth out the market.

Jerome Powell, the Fed’s chairman, was immediately asked if this buying amounted to “quantitative easing”, the term applied to the Fed’s previous rounds of asset-buying during the Great Recession. But although the purchases look, swim and quack like QE, they have a different purpose: quantitative stabilising, not easing. QE, which is a way to loosen monetary policy when interest rates are already as low as they can go, can be necessary even when markets are functioning smoothly.

Conversely, stabilising markets is sometimes necessary even when rates are higher than zero. (Indeed, one member of the Fed’s policymaking board, Loretta Mester, was in favour of the asset purchases but against cutting interest rates by a full percentage point.)

Simply put: if these purchases were merely another round of QE, the Fed would not have needed an unscheduled weekend meeting to announce them.

Will further measures be necessary? Certainly these ones failed to restore immediate calm to the markets. Following falls in stockmarkets across Asia and Europe on March 16th, the Dow Jones Industrial Average fell by an astonishing 13% and the S&P 500 index by 12%.

After all, Mr Powell himself had pointed out that the economy was likely to shrink in the second quarter, as firms and people hunker down to avoid infection.

Growth could be as low as -5%, at an annual pace, according to Goldman Sachs. Efforts to slow the spread of the virus also inevitably slow the economy. In China, which has gone further than most countries to contain the pandemic, industrial production shrank by 13.5% in January and February, compared with the previous year.

Nonetheless, Mr Powell does not think that negative interest rates are likely to be “appropriate”. Nor is the Fed seeking legal permission to buy a wider range of assets, beyond the safe, government-backed securities it is now allowed to purchase.

The Bank of Japan cannot afford to be so particular. It introduced negative interest rates more than four years ago and has been buying equities, through exchange-traded funds (ETFs), for even longer. Although Japan has been more successful than Europe or America in slowing the spread of the covid-19 virus, its economy was already shrinking before the epidemic emerged.

On March 16th its central bank said it would buy corporate bonds (and commercial paper) worth ¥2trn ($19bn) by September and double its purchases of ETFs from ¥6trn to ¥12trn a year. But as Marcel Thieliant of Capital Economics, a consultancy, points out, the central bank had already begun buying ETFs at a furious rate over the previous week and that did not stop Japan’s stockmarket plunging.

Other central banks have followed the Fed’s lead: the Bank of Korea and the Reserve Bank of New Zealand also cut rates on March 16th. Central banks, as the Fed’s Mr Powell pointed out on Sunday, can ease borrowing costs and improve liquidity.

But they cannot provide more direct help to households and small firms that are suffering during the outbreak. In both America and Japan, central banks are now waiting for a more concerted fiscal response to the covid-19 crisis. “We do think the fiscal response is critical,” Mr Powell said, “we're happy to see that [fiscal] measures are being considered and we hope they are effective.”

One of the most famous meetings in Fed history was held on a beautiful weekend in October 1979. Known as the “Saturday night special”, it heralded a brutally effective campaign against inflation.

The covid-19 virus is not a dragon that central banks can slay. But Mr Powell will hope his Sunday night special proves equally effective in quelling the pandemic’s disturbing financial side-effects.

Why the Fed dislikes negative rates

Evidence is not conclusive that such a change restores confidence and economic activity

Gavyn Davies

Traders work on the floor of the New York Stock Exchange (NYSE) after the opening bell of the trading session in New York, U.S., March 13, 2020. REUTERS/Lucas Jackson
The New York Stock Exchange: Markets are beginning to think that 'lower for longer' will become 'even lower for even longer' © Reuters

We are in remarkable and unprecedented times.

Fears about the coronavirus pandemic and its effect on the world economy have led to a dramatic collapse in the returns on US Treasury bonds, with both the 10-year and 30-year bonds now yielding less than 1 per cent.

Even more unusual is that investors are now expecting short-term interest rates to be close to zero for the next couple of years, and stay well under 1 per cent for the next five years.

What markets are telling us is that the US Federal Reserve’s recent emergency 50 basis point rate cut and its decision to pump trillions of dollars into the financial system on Thursday have failed to do the trick. Further cuts in the policy rate, right down to almost zero, may also not be enough to stabilise the economy and return inflation to the 2 per cent target.

Markets are beginning to think that “lower for longer” will become “even lower for even longer”, with policy rates uncomfortably close to zero for much of the 2020s. This is not a good outcome for the yield curve or the global economy.

That raises the question of whether the Fed should go negative. The European Central Bank and the Bank of Japan have already shifted policy rates into negative territory, essentially charging institutions for parking cash with them.

If the Fed joined them, it might be a sufficiently dramatic move to convince investors that the current economic shocks are temporary, prompting long-term rates to rise again. But the Fed leadership seems reluctant to do this, even under the extreme liquidity strains seen recently.

When the problem of the zero lower bound on rates first reared its head a decade ago, the major central banks initially thought rates could never go into negative territory, because this would induce a stampede out of bank deposits into notes and coin, which of course yield zero.

In the event, this shift did not occur in the expected size, and some central banks — such as Denmark’s — have been able to move policy interest rates to minus 0.75 per cent. This has now become the “effective” lower bound, though the ECB on Thursday refused to go below minus 0.5 per cent.

Former Fed chairman Ben Bernanke has suggested that negative policy rates in the US could be useful in some circumstances, but this has not seemed to persuade Mr Powell or current Federal Open Market Committee members.

Here are the three main reasons why.

First, it is not clear that the central bank is permitted under legislation to take this action, as Michael Feroli of JPMorgan and others have pointed out. The 2006 law that allows the Fed to pay interest directly to banks only says that depositors “may receive earnings” and does not contemplate the charging of fees.

Some lawyers have interpreted this as ruling out negative rates. Congress could, of course, change the law, but the Fed is reluctant to ask for this, in case the ensuing political debate leads to demands for additional congressional oversight of rate decisions.

Second, the specific institutional features of the US financial system make it difficult to go negative. In particular, the existence of money market funds, which hold about $4tn in assets and are sometimes treated by depositors like bank accounts, could be a problem.

Back in 2008, it caused enormous turmoil when one such fund “broke the buck” and was no longer able to protect investors’ principal. Although regulations for such funds have changed, the Fed still seems concerned that negative returns in these funds could cause panic in stressed market circumstances.

Third, and most important, the experience with negative policy rates in Japan and the eurozone does not provide conclusive evidence that such a dramatic change actually restores confidence and economic activity. Instead, there appears to be a “reversal” rate of interest. Below a certain point, really low negative rates not only do not stimulate the economy, they weigh it down.

This occurs because negative rates act like a tax on the banking system. Banks may respond by restricting credit rather than making the additional loans needed to get money out into the real economy. Although the evidence on these effects is mixed, the Fed certainly does not see a conclusive case for action.

It is possible that if markets continue to sink, the world economy stumbles badly and governments do not step up with fiscal stimulus, the Fed may have to think again about the fundamental reforms that would be necessary to make deeply negative rates possible in the US.

For now that still appears to be off the agenda. Nevertheless, global nominal interest rates have collapsed to zero, with the US seemingly close to joining the “permanently zero” club. For the markets, this will be a new world order (see box below).

Zero global rates across the yield curve

If policy rates stay close to zero for long periods, but never go negative, there would be important consequences for the likely future shape of the yield curve, the optimal mix of bonds and equities in investors’ portfolios, and the dollar. Several of these consequences have already become apparent in Japan.

While it is theoretically possible for bond yields to turn negative, even if policy rates are expected to remain in positive territory indefinitely, it seems unlikely that this could last for long. As John Maynard Keynes implied in his Treatise on Money in 1930, bond yields carry duration risk which normally should require a positive risk premium compared to cash. He thought there would be a “limiting point” on the minimum possible level for bond yields.

This remains true today, so bond yields would remain very low but positive if short rates stay close to zero. The implication is that long duration bond yields could fall no further and would no longer play any useful role in hedging equity risk in a balanced portfolio.

Another implication is that quantitative easing or other similar measures would no longer tend to reduce policy rates or bond yields, so may not send the dollar lower. In fact, in a risk-off situation where there is a flight to quality in global markets, the dollar would be likely to rise, even if the Fed is trying to ease monetary policy. This may already have started in recent days.

The Bundesbank

Healing the rift in Europe’s single currency

The central bank is one of Germany’s most trusted institutions

FEW POST-WAR economic institutions have been as successful as the Bundesbank. Its tough stance on inflation in the 1970s ensured that, while the world battled double-digit price rises, those in Germany were relatively contained. Its credibility with the public and markets was so strong that other countries were keen to harness its might, leading to the creation of the single currency in 1999.

Jacques Delors, a European politician, once joked not all Germans believe in God, but they all believe in the Bundesbank. Others in Europe were ready converts, ceding monetary sovereignty to the European Central Bank (ECB), which is based in Frankfurt, and was at first heavily influenced by German economic doctrine.

The Bundesbank has a distinct role and identity—it represents Europe’s biggest economy at the ECB, runs payments systems, operates in the bond markets and continues to be admired by most Germans. But relations with the ECB have soured, partly as a result of the euro-zone sovereign-debt crisis.

After 2011 influence gradually drained away from the Bundesbank and power became concentrated under Mario Draghi, then president of the ECB (see article). His successor, Christine Lagarde, wants a fresh start. Both sides need to make up. If they do not, they risk a botched response to the next recession and a deadly seeping away of German voters’ trust in the euro.

Like most Germans, the Bundesbank has a horror of debt-monetisation and an aversion to inflation. Its austere philosophy has come into conflict with the ECB’s efforts to hold the euro together and prop up growth. In a court case in 2013 Jens Weidmann, the Bundesbank’s boss, gave evidence against Mr Draghi’s commitment to do “whatever it takes” to save the euro through unlimited bond purchases (outright-monetary transactions, or OMTs).

By the end of Mr Draghi’s term, the quarrel seemed personal. Interest-rate cuts and the resumption of quantitative easing (QE) last autumn prompted a backlash in the German press. Mr Weidmann has supported rate cuts, but German public opinion has turned against the ECB on his watch. Bild, a German tabloid, has depicted Mr Draghi as a vampire feeding on German savings.

All central banks benefit from debate—indeed, some could do with more of it. But the stand-off could harm the ECB. When a downturn strikes, it cannot afford to be side-tracked by infighting. And recession is an ever-present risk. In the last quarter of 2019 output either fell or stagnated in France, Germany and Italy, which together make up around two-thirds of the euro zone’s GDP.

Because interest rates are already negative, the ECB’s best hope for providing stimulus would be to buy more bonds. But this would eventually require raising the ECB’s self-imposed limits on the share of a country’s debt it can hold. The Bundesbank would almost certainly resist that.

A more insidious risk is a leaching away of faith in the single currency from its largest member state. That would be a disaster, undermining the viability of the euro in the long run, and posing a mortal threat to both the ECB and the Bundesbank.

Both sides have work to do. The Bundesbank is entitled to its own philosophy. But it needs to accept that the facts have changed. Its fears that loose monetary policy would cause a surge in inflation have not materialised. Agreeing to a proposal to make the ECB’s inflation target symmetrical around 2%, by removing the “close to, but below” wording, would signal that it is principled but not ideological.

And it could wield its influence at home more effectively. Isabel Schnabel, Germany’s new pick for the ECB’s executive board, has begun to take on misconceptions of its policy—showing, for instance, that real interest rates on savings deposits in Germany are close to their average over the past 24 years. Mr Weidmann could do more to defend collective decisions.

In return for the Bundesbank taking more responsibility, the ECB should try to bring it back into the fold. On paper it makes decisions by consensus. But by the end of Mr Draghi’s term the dissenters were being left by the wayside.

So far the signs are promising. Ms Lagarde’s arrival makes it easier to leave behind the emotional baggage of the Draghi era. She has vowed to be more inclusive and launched a wide-ranging strategy review. This is an opportunity for Mr Weidmann. To his credit, he has become less uncompromising, saying last year that OMTs are part of the ECB’s toolkit, and cautioning against Germany fetishising its own fiscal rules. Ironing out the differences today could spare the ECB from a speculative attack in the next recession.

The Bundesbank is still a mighty intellectual and institutional force. But that will count for little if its intransigence causes Europe’s economy to weaken needlessly. And if the single currency falters, obstinacy will be self-defeating.

Annexation: the return of a dangerous idea

It is not illegitimate to change borders, but it must be done through negotiation

Gideon Rachman

James Ferguson Web

Do you ever lie awake at night, dreaming about annexing part of a neighbouring country? If so, you are not alone.

A recent opinion poll for the Pew Research Center reveals that startling numbers of Europeans are not satisfied with their nation’s borders. Asked whether there are “parts of neighbouring countries that really belong to us”, 67 per cent of Hungarians replied in the affirmative, as did 60 per cent of Greeks, 58 per cent of both Bulgarians and Turks, 53 per cent of Russians and 48 per cent of Poles. Such sentiments even lurk in western Europe — 37 per cent of Spaniards, 36 per cent of Italians and 30 per cent of Germans also agree with the statement.

In normal times, these kinds of ideas would not matter much. Hungarians, for example, can bemoan the 1920 Treaty of Trianon, which, as they see it, resulted in the loss of two-thirds of Hungarian land, without believing regaining that territory is a practical idea. The danger is that these are not normal times. The idea of annexation — long taboo in international politics — is creeping back into the global political discussion.

The single most important development came with Russia’s seizure of Crimea from Ukraine in 2014. Only a motley crew of countries, including North Korea, Venezuela and Zimbabwe, have recognised Russian sovereignty over Crimea. But five years on, Moscow is tightening its grip on the territory. Most of the world now tacitly accepts that there is little prospect of Crimea being returned to Ukraine. In that sense, the annexation has worked.

The current Israeli election is being fought against the background of a debate about whether Israel should formally annex roughly one-third of the West Bank. Although these areas have long been controlled by Israel, most countries regard them as occupied Palestinian territory.

US president Donald Trump’s peace plan for the Middle East proposed recognising Israeli sovereignty in large parts of the West Bank, and Benjamin Netanyahu, the Israeli prime minister, is itching to announce their incorporation ahead of the vote on March 2.

So far, the Trump administration has restrained Mr Netanyahu from announcing a formal annexation.

The US should maintain that position, for reasons that extend well beyond the Middle East.

The unilateral alteration of another international border, without the agreement of both parties involved or an international treaty, would contribute to the sense that this is one of those times in history when the lines on international maps are being redrawn.

Would-be annexationists, all over the world, would take heart. But if the acceptability of annexation spread, it would result in bloodshed and the displacement of populations. As Carl Bildt, the former prime minister of Sweden, has warned: “Europe’s borders have been drawn in blood and to change them will draw blood again.”

What is true of Europe is truer of Asia. In Japan, Prime Minister Shinzo Abe has made the reclamation of islands lost to Russia after the second world war a central focus, although he makes absolutely plain that this should be done by negotiation. By contrast, the Chinese government has always insisted on its right to end Taiwan’s de facto independence by military means.

To be clear, people in all countries, whether Russians, Chinese, Hungarians or Israelis, are free to cherish their theories about their nation’s frontiers. Borders have shifted throughout history and there will always be groups that — for ethnic or religious reasons — feel they are stranded in the wrong country.

The best way of dealing with such dilemmas is robust agreements on minority rights or dual-citizenship arrangements. But it is not inherently illegitimate to argue for a change of borders. The key is that any such change has to be done through negotiation.

The origins of the modern taboo against annexation lie in the 1930s. Adolf Hitler’s move into the Rhineland, followed by Germany’s annexation of Austria and the dismemberment of Czechoslovakia, were allowed to succeed. Generations of postwar politicians learnt a lesson: permitting takeovers to go unchallenged is profoundly dangerous and ultimately results in war.

When international borders have been altered in recent years, it is almost always when a new country has waged a successful struggle for independence, often after a history of oppression.

But allowing a new nation such as East Timor or South Sudan to break free, usually via a negotiated and internationally recognised independence referendum, is very different from allowing an existing nation to forcibly seize part of a neighbour’s territory.

The taboo on annexation was enforced rigorously in the last decades of the 20th century. It is why Britain chose to fight Argentina over the Falkland Islands in 1982; and why the US assembled an international coalition in 1991 to push back Iraq, after its invasion of Kuwait.

The year of the first Iraq war was also the year of the break-up of the Soviet Union, which led to the creation of 15 sovereign states. To Russia’s credit, the dissolution of the USSR in 1991 was done largely peacefully and by international agreement.

Moscow’s decision to annex Crimea 23 years later, represented a reversion to unilateral aggression. It must remain an isolated example, rather than the harbinger of a new era.

Federal Reserve announces more emergency support for markets

Central bank to provide up to $500bn in overnight funding after signs of strain emerge

Colby Smith in New York

The Federal Reserve expanded its intervention in short-term funding markets on Monday after signs of strain emerged despite the US central bank’s emergency measures of the previous day.

The New York arm of the central bank said it would be willing to provide an additional $500bn in overnight funding in the repo market, where investors swap high-quality collateral like Treasuries for cash.

The offer came on top of previously announced Fed support for the repo market.

Last week, it said it was willing to make $500bn in three-month loans and $500bn in one-month loans on a weekly basis through to April 13. It had already been providing up to $175bn in overnight loans and $45bn in two-week loans twice per week.

Gennadiy Goldberg, a rates strategist at TD Securities, said the Fed acted because repo rates were elevated in early Monday trading. At one point, the repo rate rose to 2.5 per cent. It subsequently settled at about 1 per cent.

The sign of funding pressure “had begun to spook the market”, he said, especially after the Fed dropped interest rates to zero on Sunday in its second emergency cut so far this month and announced at least $700bn in asset purchases.

Actual demand for the Fed’s cash remains elevated, but far below the maximum amount on offer by the central bank. On Monday, the New York Fed saw $130bn in bids for the overnight loan, and just $18bn for the one-month loan.

Still, Mr Goldberg said the take-up by market participants was hovering at a record high. He added that the Fed’s repo operations “address the symptoms, not the cause” of what is ailing financial markets, but were helpful because “they can activate it quickly when there are signs of stress”.

He joined a chorus of investors and strategists urging the Fed to take action to support the US commercial paper market, used by companies to raise short-term funding.

Borrowing rates have lept in recent days, and Mr Goldberg said this was adding to market anxieties. He said he hoped for a fix within the week.

Gold, Silver: A look at history to gauge how far prices will fall

Jim Wyckoff

(Kitco News) - As the global coronavirus pandemic early this week goes from bad to worse from a world markets and economic perspective, gold and silver markets have sold off sharply because traders “can” sell them. Traders of U.S. stock index futures can’t sell as of this writing because they are untradable and locked down the daily trading limits. 

The safe-haven status of gold and silver markets is temporarily thrown out the window as margin calls in stocks and stock index futures are prompting many, many traders to throw up their hands and liquidate the trading positions they can, in order to stay solvent. 

The present panic in the global marketplace rivals and arguably now exceeds the panics seen in historical market shocks of the past few decades—namely the stock market crash of 1987, the September 11, 2001 terror attacks on the U.S. and the 2008 global financial crisis.
For gold and silver, an examination of the longer-term price charts can provide some perspective on how for prices may fall in this present unstable markets environment.
See on the monthly continuation chart for nearby Comex gold futures that prices in March have scored a rare and technically bearish “outside month” down—whereby the trading range of the month of March exceeds the trading range of February both on the upside and downside. 

The next longer-term technical support area for nearby gold futures is the $1,375 area. Below that the $1,250.00 area comes in as longer-term chart support. And then there is solid longer-term chart support at the 2015 low of $1,046.00, basis nearby futures.
For silver, the picture may be a bit clearer. Futures prices Monday hit an 11-year low and blew past what were solid longer-term technical support levels. The next downside price objective for nearby Comex silver futures is the 2008 low of $8.40. That low occurred during the 2008 financial crisis.
Importantly for precious metals traders: Keep an eye on crude oil prices. Nymex crude oil as of this writing is trading below $29.00 a barrel. This strongly hints of raw commodity price deflation setting in—a very bearish omen for the entire raw commodity sector. 

Do not look for the precious metals markets to sustain any solid price recoveries until crude oil prices push back above $35.00 a barrel. 

The outlier in this scenario may be gold. Keen markets turmoil still could invite safe-haven demand for the yellow metal that could at least stabilize that market.

Reality Check

The Brutal Logic of Coronavirus

The only way to defeat this pandemic is to approach it with the seriousness it deserves. It is time for a radical acceptance of reality.

A DER SPIEGEL Editorial by Lothar Gorris

A woman in Düsseldorf on Monday: 'It's not exaggeration, it's not hype and it's not a conspiracy theory.'
A woman in Düsseldorf on Monday: 'It's not exaggeration, it's not hype and it's not a conspiracy theory.' / Martin Meissner/ AP

This week's DER SPIEGEL is filled almost entirely with articles about one single issue. Ever since the first issue of the magazine came out in 1947, that has happened just three times.

The first was when DER SPIEGEL owner and Editor-in-Chief Rudolf Augstein was arrested in 1962, the second was following the fall of the Berlin Wall in November 1989, and the third was in the days following the Sept. 11, 2001, terrorist attacks in the United States.

This time, it is for the coronavirus.

There are likely some readers wondering if we have perhaps become addled by fever. In general, the media has been accused of overwrought, alarmist coverage of the pandemic. And it is true that in the digital era, news coverage has frequently followed the belief that only overexcitement and hysteria can generate the desired attention from readers. We, too, haven't always been good at shying away from hyperbole.

But in this case, the accusations miss their mark. "Corona hit us like a tsunami," a doctor in a northern Italian hospital told a DER SPIEGEL reporter earlier this week. And just like a tsunami, this pandemic is a natural disaster. It's not fiction, it's not an exaggeration, it's not hype and it's not a conspiracy theory.

Only those who understand that will be able to react appropriately, with the tools of logic and solidly rooted in scientific knowledge. It is time for realism. Time for the radical acceptance of reality.

We still don't know enough about this virus. There still aren't any drugs that can stop the course of the disease or decisively mitigate its symptoms. A vaccine has not yet been found. And nobody knows how long it will take. We have no choice but to learn to live with the epidemic.

We do know, however, that the virus spreads exponentially and that a fifth of all those infected become seriously or even critically ill. We don't know precisely what the death rate is in a well-functioning health care system, but medical professionals believe it to be around 1 percent. It is primarily the elderly who are at risk.

We also know that we cannot allow the virus to continue spreading unchecked, because an exponential rise in the number of infections would overwhelm our hospitals and increase the death rate.

That isn't alarmism, it's just the facts rooted in logic and mathematics. It is important to slow down the number of infections and spread them out over a longer timeframe, and there are ways to do that.

It is easy to see from countries that are a few weeks, or even just a few days, ahead of Germany -- places like China, South Korea and Italy -- what is in store for us here: It starts with the cancellation of large events and the closure of schools and universities.

It then continues with the sealing off of entire cities, regions and even countries -- draconian quarantine measures affecting millions of people. Borders will be closed, public life will go into hibernation and shops will shut their doors for a time. At some point, production could slow down as a result of the plunge in consumption.

The logic of the virus could mean that it won't just paralyze individual countries, but the entire world.

It would be a first in the history of humanity, which has grown closer together than ever before and has thus become more vulnerable.

In Germany, we are still in the early stages when it comes to the number of infections and the severity of the measures imposed to stem the spread. German Chancellor Angela Merkel and her cabinet have been accused of doing too little, their reluctance to move quickly likely a function of the desire to limit damage to the economy. But the facts of the epidemic hardly allow for such an approach. The chances are high that Germany, too, will soon slow to a stop.

That's not panic. It's logic.

The question is how long the standstill will last. The longer it lasts, the greater the disruption to the global economy will be. Stock exchanges have already had a brutal week.

We will have little choice but to withdraw into our private dens while governments do all they can to protect their populations. But the coronavirus itself and the consequences it will have for the global economy can only be addressed globally.

But it isn't all bad news. Around the world, scientists are busy researching the coronavirus, outfitted with significant funding.

That effort, too, is likely unprecedented in human history. It gives us cause for hope.