Free Exchange

Economies can rebound quickly from massive GDP slumps—but not always

History suggests full recovery takes, on average, about five years

It will be some time—years most likely—before the full extent of the economic blow from covid-19 can be estimated with any confidence.

As ever more of the global economy enters a prolonged shutdown, it seems increasingly clear that the world is facing a drop in output unprecedented in its breadth and intensity.

Some analysts see in the growing economic disruptions and market panic the first stirrings of an economic collapse more serious than the global financial crisis of 2007-09.

Joachim Fels, an economist at pimco, an investment fund, recently warned that in the absence of sufficiently aggressive action from governments the world could face a market meltdown and ensuing depression. All downturns create discomfort, but the pain of a slump—even a very steep one—depends greatly on how long it lasts.

History suggests that rapid rebounds from enormous output losses are possible, but not by any means guaranteed.

Some economies, perhaps those of Singapore or even South Korea, could find a footing by the second half of the year, sufficient to offset some of the production lost during the first half. But the probability that others could experience extreme declines in gdp in 2020—perhaps as large as 10%—grows by the day.

Falls of that magnitude are not especially unusual in developing economies, where growth is highly volatile. (To take just one example, there have been ten years since 1980 in which real gdp in Libya has fallen by at least 10%, between which plunges the economy has experienced annual growth spurts of as much as 125%.)

In industrialised countries swings of that scale are exceedingly rare.

An analysis of data gathered by the World Bank reveals that since 1960, across rich countries, there have been only 13 instances in which an economy experienced an annual decline in gdp of at least 5%, only three cases in which output fell by at least 7% in one year (Finland in 2009, and Greece in 2011 and 2012), and none in which output dropped by more than 10%.

In the rich world, clusters of large decreases in gdp appear on the heels of the 1973 oil crisis, during the Asian financial crisis of 1997-98, and as part of the global financial crisis and its aftermath.

A longer perspective reinforces the rarity of such events. Economic historians at the University of Groningen, in the Netherlands, maintain a cross-country set of gdp data stretching far into the past. Since 1870, across 18 industrialised economies, there have been only 47 instances in which a country experienced an annual decline in output of more than 10%.

Most are associated with world wars and the Depression; of the 47 large output declines, 42 occurred between 1914 and 1945 (see chart).

How do countries fare after suffering such economic blows? Recoveries are occasionally quite rapid. At the end of the world wars, a few economies experienced near-immediate bursts of growth—partly, but not always, because of rebuilding.

The beleaguered Italian economy grew by about 35% in 1946. By 1949 it had already recovered all the ground it lost during the war and then some. The German economy shrank by a staggering 66% from 1944 to 1946, then grew at an annual average rate of 12% over the subsequent decade.

In other cases rebounds are less robust. In 1924 real output in both Germany and Austria remained below the levels before 1914. Across the period from 1870, it took an average of five years for output in countries that experienced declines in gdp of more than 10% to regain their peak (see right-hand chart).

Importantly, this reflects the fact that the main causes of economic contraction—world wars—persisted and disrupted activity for several years. French output fell by more than 10% per year in 1940, 1941, 1942 and 1944, for example. Yet focusing on more recent experience, and on smaller initial output declines of just 5%, does not dramatically change the picture.

Among the rich economies which experienced annual drops in gdp of more than 5% since 1960, output took an average of four years to return to its previous level. Again, there are examples of immediate, robust recovery. By 1999, for instance, real gdp in South Korea had already risen well above the peak reached in early 1997, before the Asian financial crisis struck.

Recoveries from the global financial crisis, in contrast, have been more sluggish. The Italian economy entered the covid-19 crisis having failed to regain the level of real output it achieved in 2008.

Catch the trade winds

Any lessons from these experiences should be applied to the world’s current situation with care. A dangerous pandemic working its way across a highly integrated global economy is an unprecedented event. Still, a few historical patterns are worth noting. First, and most obviously, the duration of the economic pain depends on how much goes wrong as a result of the initial shock.

Germany and Austria fared worse than other first-world-war combatants because they lost the war and their empires, and suffered state collapse and hyperinflation. If countries today can survive massive output declines without sustaining much institutional damage, that bodes well for the pace of recovery.

Second, large drops in output often accompany a fracturing of global trade networks. The success with which those trade ties are restored matters for the robustness of the economic rebound.

Western Europe enjoyed explosive growth in the years after the second world war, thanks in part to efforts to knit trade back together—a very different outcome from that following the first. Similarly, the world must hope that trade recovers quickly when the pandemic ebbs.

And third, it is important to get macroeconomic policy right.

The global financial crisis, and the euro-area debt woes which followed, did not kill millions of people or destroy valuable infrastructure, but the sluggish recovery that followed left Europe both economically and politically vulnerable to new shocks.

Even the mildest brush with the coronavirus could prove economically destructive if governments are reluctant to provide enough stimulus. The world should be able to bounce back to growth once covid-19 is brought under control. It has only to avoid the errors of history.

This pandemic is an ethical challenge

To avert disaster, solidarity between countries must be as strong as within them

Martin Wolf

Coronavirus eclipse
© James Ferguson

The coronavirus seeks only to replicate. We seek to halt that replication. Unlike the virus, humans make choices. This pandemic will pass into history. But the way in which it passes will shape the world it leaves behind.

It is the first such pandemic for a century. And it comes to a world that — unlike in 1918, when the Spanish flu hit — has been at peace and enjoys unprecedented wealth. We should be able to manage it well. If we do not do so, this will be a turning point for the worse.

Making the right decisions requires that we understand the options and their moral implications. We now confront two fundamental sets of choices: within our countries and across borders.

In high-income countries, the biggest choice is how aggressively to halt transmission of the virus. But we also need to decide who will bear the costs of that choice and how.

Some continue to argue that it is wrong to force the economy into a depression to suppress transmission of the virus. This, they suggest, will cause unnecessary disruption. If, instead, the virus is left to spread relatively freely, we can achieve “herd immunity”, sustain the economy and still focus resources on the vulnerable.

Yet it is not clear that the economy would fare better under this relatively laissez faire “mitigation” policy than under one of determined “suppression”. Long before government-imposed lockdowns, many people stopped travelling or going to restaurants, cinemas or shops. Decisive action to suppress the virus and follow up with testing and tracking of new infections could well end the inevitable economic slump even sooner than otherwise.

G0610_20X Chart showing how the global economy is moving into a slump

What seems quite certain is the global health system would fare much better under suppression than mitigation. Under the latter, argues the Imperial College Covid-19 Response Team, the health systems of the UK and US would be overwhelmed: large numbers of predominantly old people would be left to die untreated.

It was presumably to prevent this from happening across China that the government suppressed the virus so fiercely in Hubei. Could a health calamity that is unacceptable in China be acceptable in the UK or US?

Yet the critics are also right: it will be impossible to close large parts of our economies for very long. If suppression is to be tried, it must be successful quickly and resurgence of the virus must be throttled. Meanwhile, central banks and governments must seek to keep as much of the economy going as possible, preserve as much productive capacity intact as possible and ensure that the people, above all the vulnerable, are generously protected in whatever way a country finds practical.

G0610_20X Chart showing accumulated non-resident portfolio flows to EMs

The solidarity between countries needs to be as strong as within them. The financial instability and looming recession (probably depression) we see coming will inflict huge harm on emerging and developing countries.

The IMF states that investors have already removed $83bn from emerging economies. The fall in the prices of commodities, upon which many emerging and developing countries depend, is also deep.

These countries must also grapple with the domestic spread of the virus and the weakening of their own domestic demand. Their ability to manage these internal and external pressures is limited. The outcome could be huge economic and social disasters. The IMF itself already faces 80 requests for rapid financial support. The aggregate external financing gaps of emerging and developing countries are likely to be far beyond the IMF’s lending capacity.

G0610_20X Chart showing investor sell-off of both emerging markets equities and debt

These vulnerable countries will benefit if high-income countries succeed in suppressing the disease and rescuing their economies. But this will not be true in the short run. Emerging and developing countries will need much assistance. That will also help every country’s economic recovery. The virus is a shared challenge. So, too, is the coming global slump. Practicality and the demands of solidarity justify generous help.

The same is true within the eurozone. The defining characteristic of a currency union is that individual members have given up the insurance of fiscal autonomy and a sovereign currency in favour of collective mechanisms. During the global financial crisis, that largely failed a number of member countries.

Yet, in that case, a moralistic argument could plausibly assert that it was in good part their own fault. This pandemic is not anybody’s fault. If the eurozone cannot show solidarity in such a crisis, its failure will be neither forgotten nor forgiven.

The wounds will be deep, perhaps mortal. Without visible solidarity in a crisis for which nobody bears blame, the European project will be morally, maybe practically, dead.

G0610_20X Chart showing how Commodity prices and emerging market stocks have tumbled

Any cross-border aid cannot, moreover, be purely financial. Medical help will be needed too. A crucial step will be ending the spate of export controls that are destroying medical supply chains.

Fortunately, the disease we now confront is nothing like as bad as the plagues that repeatedly devastated the lives of our ancestors. Yet it is still something virtually no living person has experienced. It is a practical challenge that must be met with well-informed decisions. But it is also an ethical challenge. We should recognise both aspects of the decisions we must make.

G0610_20X Chart showing how Coronavirus has hit emerging market currencies

Do leaders project calm and use reason?

Do we defeat the disease, while minimising the economic damage?

Do we ensure that the weakest people and countries are protected?

Do we choose solidarity over hostility and global responsibility over inward-looking nationalism?

Do we seek to bequeath a better post-pandemic world, not a worse one?

Unlike viruses, human beings have choices. Choose well.

Fed to provide extra $2.3tn in loans

Central bank moves to support high-yield debt market and help stricken municipalities 
James Politi in Washington and Colby Smith in New York

© AP

Jay Powell said the Federal Reserve would use its powers “forcefully, proactively and aggressively” until the economy recovers from the coronavirus shock, as the US central bank moved to offer an extra $2.3tn in credit and support the market for high-yield corporate debt.

In remarks by webcast to the Brookings Institution on Thursday, the Fed chairman said the emergency measures being rolled out in recent weeks were necessary given the “very unusual circumstances” of severe economic and financial dislocations, but would be rolled back once the crisis eased.

“We are deploying these once lending powers to an unprecedented extent, enabled in large part by the financial backing of Congress and the Treasury. We will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery,” Mr Powell said. 

The Fed chairman added that the “emergency tools” would be “put away” once recovery set in and “private markets and institutions are once again able to perform their vital functions of channelling credit and supporting economic growth”.

Mr Powell’s comments came as the economic damage inflicted by the coronavirus pandemic was highlighted by data showing that 6.6m people filed for jobless benefits in the US in the past week, bringing the total of America’s newly unemployed to 17m since the cascade of business shutdowns caused by the virus.

The Fed has already slashed interest rates close to zero and expanded its balance sheet in a big way by buying up Treasury debt and government-guaranteed mortgage-backed securities. On Thursday, it further ramped up its emergency action by detailing new loan facilities worth $2.3tn to deliver credit to small businesses and municipalities. It also expanded measures introduced last month to back corporate debt markets.

Among the new steps, the Fed said it would be setting up a tool to support a $350bn lending fund that is part of a $2tn fiscal stimulus package passed by Congress last month.

The move should help banks more rapidly move the loans off their balance sheets, improving participation in the plan. The Fed said it would “extend credit to eligible financial institutions that originate [small business] loans, taking the loans as collateral at face value”.

The Fed also said it would create a separate lending programme for “Main Street” — which was also authorised in the stimulus legislation — through which it will buy up to $600bn in loans with a backing of $75bn from the Treasury department.

The Fed has been under pressure to offer more backing for struggling state and local governments as well — and said it would also be setting up a facility to buy municipal debt to help them “manage cash flow stresses”. The “Municipal Liquidity Facility” would offer up to $500bn in loans, with $35bn from the Treasury.

The Fed said it would purchase up to $500bn of short-term notes directly from US states, including Washington DC, counties with a population of at least 2m people and cities with at least 1m residents.

The central bank move was just the latest illustration that the Fed was willing to do whatever it takes to support financial markets. Randy Frederick, vice-president of trading and derivatives at Charles Schwab, said. “We've heard from the Fed that they have their checkbook out, and it's a blank check.”

The Fed stopped short of directly intervening in the longer end of the curve in the primary and secondary markets for municipal debt, where states and cities raise cash, but it said it would “closely monitor conditions” in those markets and “will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments”. 
In addition to setting up new lending tools, the Fed said it would also increase the size and scope of facilities aimed at helping corporate credit markets. It had initially announced its historic step to shore up those markets last month — a move it had not done during the 2008 financial crisis. The Fed will now buy riskier debt, adding junk bond exchange traded funds to the list of assets it will buy.
“I’d rather have [the Fed] do too much and unwind it later, then have something blow up or have there be any kind of stress that isn’t in line with fundamentals,” said Tim Horsburgh, investment strategist at Invesco.
In his speech, Mr Powell noted that there were some limits to the Fed action, in that the central bank had “lending powers, not spending powers” and could only provide loans to entities with the expectation of repayment, rather than direct grants. “In the situation we face today, many borrowers will benefit from these programmes, as will the overall economy. But there will also be entities of various kind that need direct fiscal support rather than a loan they would struggle to repay,” he said.
On Thursday, the central bank said it would also expand the crisis-era TALF facility, which gives it the ability to buy securities backed by student, car and credit card loans, as well as loans to businesses through the Small Business Administration.
Now, triple-A rated commercial mortgage-backed securities and triple-A rated newly issued collateralised loan obligations, or investment vehicles that contain pools of leveraged loans, can be used as collateral.
According to the Fed, these programmes will support up to $850bn in credit, backed by $85bn from the Treasury department. Towards the end of the speech, Mr Powell offered some hope that the US economy will eventually bounce back quickly, given its strength going into the crisis and steps taken by economic policymakers to dampen the fallout.
“There is every reason to believe that the economic rebound, when it comes, can be robust”

Emerging Markets Need a Better Safety Net. It Already Exists.

Central bank swap lines have prevented a global liquidity crisis. They could also pave the way to finally provide currency stability to developing countries

By Jon Sindreu

In the Covid-19 crisis, central banks’ currency swap lines may offer a way to radically reshape the global monetary system while changing very little.

Emerging economies cannot afford the huge fiscal packages announced by Western countries to counter the impact of the pandemic. More than 90 countries have now asked the International Monetary Fund for help. The IMF may even lend money without its usual imposition of budget cuts.

But even so, it will need to be paid back, and is unlikely to be enough to offset fickle global capital flows: Outflows from emerging-market assets amounted to a record $83 billion in March, according to the Institute of International Finance.

Oil exporters, like South Africa in particular, risk following Argentina and Lebanon in defaulting on debt payments. The MSCI EM Currency index, down 6% this year, has much further to fall if it follows the pattern of 2008.

The key danger is a prolonged economic slump, and the IMF isn’t designed to give nations the freedom to spend their way out of it. A new system needs to be set up that circumvents the key financial constraint on emerging markets: Central banks can buy domestic government debt, but can’t print other nations’ money.

Both rich and poor countries outside of the U.S. are now grappling with the pre-eminence of the dollar as the ultimate international settlement currency. Foreign greenback debt amounts to $12 trillion, figures by the Bank for International Settlements show, and in periods of crisis companies struggle to find enough dollar liquidity.

The Federal Reserve is managing this by providing dollars to other major central banks through swap lines. Emerging markets should have access too. As of last week, the Fed now allows them to exchange their Treasury holdings for dollars. The IMF could also launch short-term emergency lines that allow for quicker liquidity support.
But ample liquidity at the market exchange rate won’t be enough for poor nations. They also need that rate to be made stable.

In a developed country like the U.K., the post-Brexit slide in the pound didn’t trigger an economic downturn, because the loss of purchasing power for Britons was small and there are always investors willing to buy U.K. assets after a fall in sterling.

If Argentina’s exchange rate falls too much, however, this in itself creates a self-fulfilling prophecy that wrecks the economy. Importers may no longer be able to afford vital goods. The only options left are capital controls or borrowing from the IMF, which often makes matters worse.

There is an alternative: The world’s central banks could agree to repurpose swap lines to finance distressed balances of payments. They could set floors—and ceilings—on each pair of exchange rates, making central banks the “value investors of last resort” for currencies.
This would limit panics, but also cap how low developing nations can set their currencies to rob exports from others—a charge often leveled against China. The IMF could regularly set wide bands around what it calculates each country’s currency to be actually worth in real, purchasing-power terms. Unlike in the days of the gold standard, this is what now ultimately anchors currency values.

A stabler world economy would benefit everyone, and investors would still be able to trade currencies within these bands. Of course, it would require central banks to swap as much money as necessary at those preset rates. But the history of monetary policy shows that lending freely at punitive rates provides a much better cushion than generous but limited bailouts.

The IMF was created in 1944 to provide aid in exchange for discipline, but a modern globalized economy requires a more elastic approach. The good news is that, for the most part, it is already in place.

Zoom in on your lockdown meeting techniques

It is hard to project authority online — but pretending you are on TV will help

Viv Groskop

© John Parra/Getty

The early weeks of lockdown have seen an unprecedented take-up of on-screen technologies for both our professional and personal lives. The “Zoom revolution” has swept every country affected by the global pandemic.

People who would not usually even use FaceTime or take a selfie have found themselves comparing the relative merits of BlueJeans, Houseparty, Google Hangouts, Microsoft Teams or Skype.

With this surge in onscreen traffic comes a corresponding desire to look and sound good. This is not necessarily a new challenge, but it is suddenly an urgent and widespread one. I have been teaching workshops and giving keynotes on “owning the room” for the past five years. In corporate environments, it is very common for a question about “nailing” videoconferencing to come up.

No one likes this technology or feels that it shows them at their best. Even before everyone started working from home I was often asked: “How do you own the room when you are not in the room?”

This came up again at a leadership event with a major US corporation earlier this year, pre-lockdown. I turned to the audience for the answer: “Raise your hand if you have ever seen anyone ‘owning the room’ on a video conference and thought, ‘I wish I could come across like that person.’”

In a room of 500 people, only three hands went up. When quizzed further, the “digital role models” they were thinking of were all high-status individuals who were charismatic and well-liked. The people who find being on-screen easiest have easy-going personalities and are often secure in their place in the hierarchy. Surprise, surprise. This offers nothing helpful to the rest of us.

I’ve asked this question in multiple environments, including in some of the companies who originated these technologies. My conclusion is that few people excel in a Zoom-type situation. If anything, screen communications can even reduce the impact of high-status individuals, as there is an equalising effect. This may be a good thing in some environments but can be problematic for leadership.

How to run the meeting

In terms of how the meeting is conducted, follow the usual rules of good practice in real life.

Appoint a chair. Don’t allow long tirades or multiple interruptions. Call on those who are silent for long periods. Behave as you would on a panel at a conference where the audience can always see you: you can be seen at all times (unless you turn off your camera), so look interested.

Of course there is something that feels odd about treating a Zoom appearance as if you are going on television. But the truth is: the brains of others will process your image as if you are on TV. So you would do well to imagine that you are.

Will it destroy your career if you appear in pyjamas, eating cereal and looking bored? Maybe not definitively. Everyone realises that these are strange times and affecting lots of us in unpredictable ways.

So people are likely to have more understanding and compassion than usual. However, we are base and basic.

Our unconscious minds are attracted to what looks good on screen. Show up for others how you would want them to show up for you.

Why are you having the meeting?

It is likely that at the moment these onscreen technologies are being overused as a default, out of desperation and out of novelty. A bit like real-life meetings, which are often used to punctuate working life and/or as an affectation of “busyness” and so often achieve nothing, Zoom can be a way of pretending that we are still coping, that it is business as usual, that important things are still happening.

But are they really being achieved? Or are you holding a Zoom meeting to foster the appearance of industry and efficiency? Is the goal connection and continuation? (Completely reasonable.) Or do you have practical, specific problems to solve? If you have leadership responsibilities, these are important questions to ask.Like real-life meetings, screen gatherings require concentration to be effective.

A 20 minute meeting with 15 minutes of chat and connection followed by five minutes of decision-making can be ideal.

If a real-life meeting is unbearable at an hour and a half, then a Zoom meeting is completely intolerable. (I did a four-hour Zoom meeting this week with eight participants. It took me three days and an hour on the phone to my therapist to recover.)

There is no research into the optimal length of these meetings. But there is a tonne of research that our concentration span needs variation at around 18-20 minutes of screen time, otherwise we reach “cognitive load” and tune out.

If a meeting is going to last longer than 20 minutes, introduce something to vary tone or pace.

Make everyone summarise their takeaway in one sentence.

Or give everyone 60 seconds to sum up their biggest challenge of the week.

What the experts say

Most of the research about the efficacy and psychological effects of on-screen communication has been conducted not in corporate life but in academia and in psychotherapy.

A 2018 survey of 1,800 students by the International Journal of Doctoral Studies found that video conferencing reduced feelings of isolation in students and increased motivation, providing “an avenue for real-time interaction and rich dialogue”.

Academics report that screen meetings are beneficial for introverted students who feel more comfortable asking questions. I am not sure, though, these benefits will be replicated across industries. I am hearing from a lot of people whose stress levels are soaring because of multiple Zoom commitments, which feel exhausting and pointless.

I was struck recently by an interview with a clinical psychologist who resigned — pre-lockdown — from an online therapy business because of ethical concerns: “It all seemed financially driven, rather than care-driven.” Online therapy was becoming popular, she judged, not because it was an effective treatment but because it could be easily rolled out.

I wonder if the current Zoom craze is similar. We are doing it because we can and because it is cheap and easy. But is it obtaining the desired results? Is it goal-focused? Or is it camouflaging an awkward truth that is hard to articulate?

At the moment, it might be impossible to separate out these things. It matters less how well you come across on screen than what you hope to achieve by being there. Never has the idea of “finding your why” been more important.

The writer is an author and coach. Her latest book is Lift As You Climb: Women and the Art of Ambition.

Vital tips for virtual meetings

Don’t eat onscreen. Drink in moderation just as you would in a real meeting. (Would you really take a latte into a meeting? Or a job interview?)

Mute yourself: when you are not contributing.

Rest your laptop on a pile of books. Put the camera at eye level. Make sure a light source is casting light on your face and is not behind you.

Behave like you are in a job interview. You are being scrutinised all the time when you are on screen. Look alert, look positive, put a smile in your eyes.

Look at the camera not the screen itself. If you struggle with this and you have a presentation to give, cover the screen with a newspaper or a piece of cardboard to force yourself to look at the camera and not at the faces of your fellow contributors.

The Coming Stagflation And The Case For Silver

by: Stuart Allsopp


- The policy response to the current financial crisis creates a real risk of stagflation once the current liquidity crunch abates.

- The recent deflationary shock has triggered an all-out government and central bank inflationary response which looks set to dwarf the response seen during the height of the GFC. 

- Policy measures aimed at bailing out Main Street are likely to prove much more inflationary given the higher propensity to consume among the middle class.

- As bond yields remain pinned down by QE and inflation expectations recover in response to further fiscal stimulus measures, this should see both short-and long-term precious metal drivers turn bullish.

- Silver in particular looks like a low-risk, high-potential trade which could easily double over the next 12 months.

Contracting economic output and rising fiscal deficits and debt monetization are an ideal scenario for stagflation to occur. 

The recent deflationary liquidity shock has triggered an all-out government and central bank inflationary response which could see precious metals prices soar. 

Silver in particular looks like a low-risk, high-potential trade which could easily double over the next 12 months.

Economic Contractions And Fiscal Deficits Are The Ultimate Causes Of Inflation

Contrary to the mainstream economic consensus, economic contractions tend to be inflationary while strong growth tends to be disinflationary

As the chart below shows there has tended to be a negative correlation between real GDP growth and inflation in the U.S. over the long term, with high inflation rates occurring amid economic contractions. 

This makes intuitive sense; the fewer goods there are to go around, the more expensive they will become.

U.S. Real GDP Growth Vs Consumer Price Inflation
Source: Bloomberg

In addition to contractions in real GDP, inflation is caused by large fiscal deficits which create government liabilities out of thin air to pay for scarce real goods and services. 

When the government spends money in excess of what it receives in taxes, it does not matter whether it creates a bond or currency out of thin air; the inflationary impact is the same. 

For central banks that have the ability to create their own currency out of thin air thus eliminating default risk, government bonds are essentially just a form of money. 

As John Hussman puts it:

Currency and Treasury securities compete in the portfolios of individuals as stores of value and means of payment.

QE Allows Governments To Run Huge Deficits At No Immediate Cost

If central banks were prohibited from monetizing debt then a large increase in bond issuance due to fiscal deficits would reduce demand for bonds due to fears that the government would not be able to pay back the money through future tax revenues. This would in turn prevent the government from running persistent fiscal deficits. 

However, this is not the world we live in. For countries that can create their own currency at will, there is no constraint to continued deficits.

Ben Bernanke’s comments about Quantitative Easing being just an asset swap are technically correct as it simply replaces one form of government liability with another. 

What is inflationary about QE is that it enables the government to continue running large fiscal deficits at no immediate cost.

Recent Surge In Money Demand Likely To Prove Temporary

Large fiscal deficits and QE are necessary but not sufficient conditions to create high inflation. 

What also needs to be taken into account is money demand. 

The combination of the coronavirus and oil-price shocks has led to a surge in the demand for safe assets which has led to a temporary collapse in inflation expectations as seen by the fall in 10-year breakeven inflation expectations.

U.S. 10-Year Breakeven Inflation Expectations
Source: Bloomberg

As explained here, money supply (and government bond supply) can be completely overwhelmed by a rise in money demand during times of financial crises. 

However, such conditions are likely to prove temporary and the spike in demand for money should ease once financial conditions stabilize as they appear to be doing.

New Stimulus Efforts To Be Much More Inflationary Than Post-GCF Measures

Fiscal deficits and debt monetization in the wake of the Global Financial Crisis failed to create the high levels of inflation many originally expected as the money found its way into the hands of wealthier members of society who have a higher tendency to hoard money as a store of wealth rather than spend it. 

Additionally, foreign central banks absorbed a lot of the increase in money and bond supply via reserve accumulation.

The recent deflationary shock has triggered an all-out government and central bank inflationary response which looks set to dwarf the response seen during the height of the GFC. 

Just as low volatility in asset prices lulled investors into a false sense of security with regards to financial risks, a decade of low inflation despite high fiscal deficits and debt monetization have lulled policymakers into believing that inflation is a thing of the past causing them to throw caution to the wind.

Foreign central banks have ramped up their sales of U.S. Treasures to try stem currency weakness against the dollar over the past month and there is no guarantee that once the dollar begins to weaken again they will resume their long-term trend of purchases. 

The Beijing mouthpiece Global Times noted on March 22 that ‘China needs to be vigilant about the impact of the US money-printing, with proper precautions made to its foreign exchange reserve structure.’

New Stimulus Measures Will Increasingly Be Targeted Towards Mainstreet 

If there is one thing that politicians have learned from the GFC it is not that bailing out the banks is unpopular, but that only bailing out the banks is unpopular. 

The financial sector is perceived to have been the sole beneficiary of the GFC stimulus to the detriment of the ordinary worker. 

This time around, both the financial sector and the real economy are likely to be recipients of monetary bailouts in the form of tax breaks, stimulus checks, subsidies, welfare spending increases, and infrastructure spending.

The fragile state of the social fabric in most western societies is ill prepared to experience an economic crisis and governments and central banks will do everything in their power to try to prevent one. 

An additional thousand dollars in the hands of the average salaryman is likely to prove much more inflationary to million dollars in the hands of a billionaire as the former will have a much higher propensity to consume.

Increased Socialism And Protectionism To Add Fuel To The Fire

Even before the coronavirus shock we estimated the U.S. long-term growth outlook to be slightly less than 1% per year (see 'Brace For Sub-1% Long-Term Growth'). 

This now seems ambitious as the recovery from this current crisis looks set to be hindered by the response undertaken by the government and the Fed. 

The Fed’s decision to buy corporate bonds looks like being only the first step on the path to increased public sector control over asset markets, while government spending levels look set to soar as a share of GDP from already-elevated levels. 

Meanwhile, the trend of politicians blaming wealth inequality on the wealthy looks set to intensify and suggests that efforts to ‘soak the rich’ will gather steam.

Furthermore, globalization could be set to take a decisive blow as governments look to reduce their dependence of essential goods imports in the wake of the coronavirus epidemic. This is particularly problematic given that the U.S. economy is heavily dependent on imports.

As Real Interest Rates Continue To Fall, Precious Metals Will Be The Ultimate Winners

Gold prices follow trends in real bond yields in the short term while over the long term they follow the general price level. 

Gold’s rally since mid-2018 has occurred alongside a fall in real bond yields but despite a fall in inflation expectations. 

As bond yields remain pinned down by QE and inflation expectations recover in response to further fiscal stimulus measures, this should see both short-and long-term gold drivers turn bullish.

Gold Price Vs 10-Year Inflation-Linked Bond Yield (Inverted)
Source: Bloomberg

The biggest winner however could be silver. 

Silver is deeply undervalued relative to gold on a historical basis with the current ratio of 114x more than double its long-term average. 

This may actually understate the level of silver’s undervaluation. 

Silver tends to be roughly 3x more volatile than gold and so usually underperforms in precious metal bear markets and outperforms in bull markets. 

This time around, silver has languished even as gold prices have risen. 

If we adjust silver both metals for their historical volatility as the chart below shows, silver works out to be over four standard deviations from its long-term average.

Silver Vs Gold Price Adjusted For Relative Volatility
Source: Bloomberg

Silver has a tendency to undergo major rallies once momentum picks up. Our theory is that gold is the more convenient store of value while silver is too bulky at low price to be used as a convenient store of wealth. Once silver starts to rise though, it becomes more appealing as a store of value which is why we’ve previously seen major surges in the metal. 

As James Grant noted back in 2016:
Silver is the crazy uncle in the attic of monetary metals.

Federal Reserve taps BlackRock to manage bond purchases

US central bank uses world’s largest asset manager in effort to limit coronavirus damage

Jennifer Ablan in New York, Brendan Greeley in Washington and Richard Henderson in Melbourne

FILE PHOTO: A sign for BlackRock Inc hangs above their building in New York U.S., July 16, 2018/File Photo
BlackRock's Financial Markets Advisory unit, the company’s consulting arm, will act as the investment manager for three new Fed facilities © Reuters

The US Federal Reserve on Tuesday tapped a division of BlackRock, the world’s largest asset manager, to manage billions of dollars in bond and mortgage-backed security purchases as the US central bank works to cushion the economic and financial fallout from the coronavirus pandemic.

BlackRock’s Financial Markets Advisory unit, the company’s consulting arm, will act as the investment manager for three new facilities: two Fed-backed vehicles that will buy corporate bonds, and a programme that will buy mortgage-backed securities issued by US government agencies.

The Fed’s New York branch pointed to the company’s expertise and “robust operational and technological capabilities” on its website. A spokesperson underlined the short-term nature of the engagement as the Fed sets up the new facilities.

The arrangement mirrors BlackRock’s role in supporting the Fed during the 2008-09 financial crisis, when the central bank hired the firm to manage assets from Bear Stearns and American International Group. Then and now, the Fed did not conduct a formal tender process, which drew criticism in the wake of the crisis.

On Monday the Fed expanded its programme of housing agency purchases to include securities backed by mortgages on commercial properties, such as flats. BlackRock will carry out these trades with the Fed’s primary dealers. Larry Fink, chief executive of BlackRock, helped to pioneer mortgage-backed securities as a Wall Street banker in the 1980s.

BlackRock will also serve as investment manager for two new special-purpose vehicles that will buy primary and secondary market corporate bonds. The New York Fed will lend to both vehicles and the US Treasury Department will take an equity stake.

As part of the secondary-market corporate bond programme, the Fed-backed vehicle will buy investment-grade exchange traded funds, marking the first time the Fed has included ETFs in this type of purchasing programme. The vehicle “will not purchase more than 20 per cent of the assets of any particular ETF”, according to details of the programme.*

Fixed-income ETFs, which have boomed in recent years, have been put under strain as markets have sold off in recent weeks. BlackRock is the largest ETF fund manager and offers investment-grade bond ETFs. It could benefit from fees, should the Fed buy its ETFs. The degree to which these will feature in the Fed's purchasing programme has not been finalised, BlackRock said in a statement.

“This is the Fed tapping Goliath for help,” said Tyler Gellasch, executive director of Healthy Markets Association, a trade group. “BlackRock is so large that its investment decisions impact the markets like a federal agency. We hope this will help stabilise the market, but it will almost certainly benefit BlackRock.”

BlackRock said in a statement it would offer details on the primary corporate bond purchases and begin the secondary-market purchases as soon as possible, but “will not engage in discussions with market participants” about the programmes before then.