Regular readers know that we have long argued that – under the current debt-based growth regime – one of the clearest indicators of future economic growth is the current credit momentum. That’s why in 2017, shortly before the Fed raised rates so high, the market survived its first mini-bear market – we warned that “Global credit momentum suddenly hit a negative“Soon after, global GDP growth peaked when China’s production reached a new record low — long before the coronavirus stopped the world — urgently demanding an“ exogenous event ”that would lead to an unprecedented infusion of loans. Fortunately for the world’s central banks and the Economic Establishment, the insidious pandemic turned out to be just such an event.
So, where are we now, now that only in the last 3 months have we seen giant $ 18 + trillion in fiscal and monetary incentives, equivalent to just over 20% of global GDP?
It is unlikely that this should be surprising that, as a result of this unprecedented fire, liquidity that provides credit the recent surge in credit momentum was the largest in historyHowever, for the first time, GDP is not keeping up.
As Francis Yared of Deutsche Bank writes in his latest weekly fixed-income report, “lending and lending growth studies have historically been good indicators of GDP growth.” However, “The sharp discrepancy between credit and activity observed in the US, the eurozone and China is especially unusual and underlines how this crisis differs from the GFC. ”
Jared means the following diagrams: First, the US credit momentum.
Then China …
… and finally Europe
What to do with the above observations when they are associated with a continuing decline in global GDP?
There are two alternatives: i) either the credit impulse will have a huge impact on global growth, although it will be postponed until the loan is in the wider economy, unless, of course, it gets stuck in the stock market, which has already destroyed most of it Loss, or ii) we are good and really innewer abnormal“The one in which even the world’s cheapest debt cannot raise GDP.
The economic establishment has relied on confidence in the first alternative: in the end, if neither the fiscal nor monetary stimulus (as we explained recently) are inflationary or stimulating, this means that the entire Keynesian economic paradigm can be discarded. Needless to say, this will have unprecedented consequences for the world.
Impossible, some may say, but is it really so? Recall that just a month ago, we indicated that marginal utility of debt fell to a record low, because it takes even more debt to achieve economic growth, which is another way of saying that the positive economic effect of any excessive loan impulse is almost zero.
For those who missed this, here is our recent analysis of why “QE no longer stimulates the economy and only leads to higher stock prices. ”
Even some of the Keynesian economics’ most ardent supporters of fraud now admit that the entire modern economic system is on the verge of collapse for one main reason: the marginal utility of debt is collapsing, and more and more debt is required to increase basic GDP.
And there is one more reason why the current system may be the last one any day: the marginal utility of each new QE is now declining to such an extent that soon almost none of the money created by the Fed from the air comes. instead, the economy will become stuck in capital markets, which will lead to hyperinflation of asset prices, even when the economy as a whole collapses. Or, as BMO writes Daniel Critter, “QE penetrated the real economy more slowly than previous QE campaigns,” and for every dollar growing on the Fed’s balance sheet, the money supply M1 increased by about $ 0.32 compared to 0.96 and 0 , 74 dollars. in QE1 and QE2. “The expansionary policy to date has mainly led to an increase in asset prices.” BMO writes about what has been obvious to us and our readers since 2009. Only now we are ten years closer to what is the inevitable ending when the Fed does not influence M1, which will also be known as the “game over” phase.
But let’s go back.
Traditionally, as BMO explains, we analyze the business cycle from the classical economic point of view, where monetary authorities are more passive and the “invisible hand” guides the economy (this happened before the Fed announced the Politburo everything in the USSA and decided to nationalize). capital markets that suppress any “signal” that the bond market may have; the last step will be to start controlling the yield curve, which will be a game for the market). In this context, we look at interest rates, which can theoretically be defined as the rate that makes the consumer indifferent between consumption today and consumption tomorrow. R * is the (unknowable) natural interest rate that supports full employment and stable interest rates. In theory, if r
In the expansion phase, prices and consumption are rising. Since prices and investment opportunities are high, the demand for money among consumers / enterprises is high, and interest rates (r) rise along with borrowingsWhen r rises to r *, consumption slows down, profits drop and a recession sets in. R * decreases as uncertainty and risk aversion increase. This is a recession in the business cycle. (and as long as the Federal Reserve System exists, we will never have such an opportunity, since the Federal Reserve System has also killed the business cycle … as the USSR tried to do).
However, the recession may also be caused by some external shock to the economy, which caused a further decrease in r *. This is because r * responds to uncertainty with a strong negative correlation. The greater the uncertainty, the lower r * falls.
In a recession, r drops because consumption remains low as long as it is greater than r *. The default values accelerate the fall of r. Over time, r * grows slowly as the uncertainty / risk associated with the shock and / or end of the business cycle disappears. However, the longer firms are left without profit due to low consumption, the more defaults are realized and the more r falls. At some point, the combination of a drop in r and an increase in r * leads to r
In addition to accelerating the decline in r, defaults that occurred during the recession also reduce the cost of labor and capital goods, as the resources of insolvent companies return to the economy. In addition, barriers to entry in certain industries disappear when firms of the “old guard” go out of business. Thus, as the economy enters a recovery period, this combination of cheaper labor / capital goods and lower barriers to entry leads to significant business investment and increases growth potential during subsequent expansion.
This is how the world works in theory. Unfortunately, since 1913, the theory has not worked due to the intervention of the Fed. So, now let’s see how it all actually works and imagine a functioning central bank with a wider range of monetary policy instruments.
As the economy cools, the central bank lowers r in an attempt to stimulate consumption, forcing r
Now, in 2008, the shock in the form of subprime mortgages hits the economy and is growing rapidly. R * moves to negative territory, as shown in a recent San Francisco Fed study. The Fed lowers rates, but is limited to a zero border. To further “reduce r”, the Fed begins buying assets during QE and successfully stimulates consumption, as evidenced by the strong correlation between the increase in excess reserves and the increase in M1. M1 is the most basic measure of money supply, which includes, basically, only cash and bank accounts for verification / requirements.
The theory is that for the consumed product or service, it should be paid from M1. Therefore, an increase in M1
The next QE is a measure of the extent to which the QE leads to actual consumption.
Pay attention to the “lower r value” in quotation marks in the previous marking, because r is at the zero border and cannot be reduced (at least in the United States). Therefore, QE increases the supply of money, which should stimulate consumption, which is the same desired effect of lower interest rates. In a sense, an increase in money supply is a synthetic decrease in interest rates. (and the synthetic capital market is increasing),
The combination of consumption due to QE (decrease in r) and the disappearance of uncertainty after a package of fiscal stimulus by a trillion dollars (increase in r) ultimately leads the economy out of recession. However, the reaction rate at 08/09 was slower. QE was not announced until the end of November 2008, after large defaults had already been reached. The fiscal stimulus in the form of the ARRA package did not arrive until February 2009 with an additional lag in implementation, which was characterized by additional default values. As a result, a default of nearly a trillion dollars affected the default in 2008/09, but QE definitely prevented an exponential increase in actual defaults. The BMO, however, notes that defaults again avoided were economic resources that were not returned to the economy, and barriers to entry that were not reduced. This suggests that there were not many attractive investment opportunities after the financial crisis, as can be assumed from the depths of the recession.
As a result, recovery was slow, which ultimately forced the Fed to take additional rounds of quantitative easing in an attempt to stimulate consumption growth.
Which brings us to the seeds of the Fed’s own demise: the problem is that QE seems to experience diminishing returns, as evidenced by the falling correlation between excess reserves and M1 in successive QE episodes after the financial crisis. Since QE leads to a direct increase in bank reserves, only a small portion translates into money supply growth, and therefore, potentially into consumption and investment. QE1 was a very effective and important factor in helping to get the economy out of recession. QE2 had a slightly lower but still high degree of fulfillment equal to 0.735, which indicates that, on average, $ 0.74 for each dollar of QE was translated into an increase in the money supply. We observe an increase in inflation and personal consumption during the QE2 period as evidence of its effectiveness. However, during the third quarter, the correlation fell to $ 0.28 and led to very slight inflation of GDP growth. Thanks to this lens, the impact of QE on the real economy has decreased over time.
How does BMO explain the diminishing effect of QE?
- Reducing marginal utility of consumption: QE (and monetary policy) is often referred to as “borrowing from the future”. However, there is only a limited amount of future consumption that can be carried forward in the current period through monetary policy. This may relate to the consumption of durable goods: since rates have been relatively low for a long period of time, the demand for loans no longer increases at the same rate with gradually decreasing interest rates. At some point, consumption does not bring enough for utility no matter how long prices or interest rates.
- Inequality of wealth: Inequality in welfare exacerbates the effects of reducing marginal utility of consumption. For reasons discussed in more detail below, QE tends to raise the price of financial assets, making those who own assets richer. A large percentage of QE money falls into the hands of the rich, whose consumption patterns are unlikely to change in response to an increase in wealth in the near future.
- Inflation expectations: Finally, the essence of monetary policy plays on expectations. Inflation is self-reinforcing, as evidenced by the very high correlation between inflation and inflation expectations. Around the introduction of QE, it was expected that this could lead to rampant inflation. After going through several stages of quantitative easing without a significant increase in inflation, people usually understand that quantitative easing is unlikely to lead to inflation, so now the incentive to consume is slightly less.
After five years of absence of QE in the United States, it seems that the utility of the current QE has slightly increased compared to QE3. However, consumption tracking remains well below the levels observed between Q1 and Q2. It is likely that the current quantitative easing is unlikely to lead to a significant increase in consumption, since it is not affected (through an increase in the money supply), as in the past, and probably remains much higher than r *.
Worse than us discussed last weekit can be argued that r * is now probably lower than potentially any moment in history, and according to Deutsche Bank, this is always a low of -1%.
Not only is the uncertainty extremely high, but the impact of COVID-19 may directly reduce r *. Recall that r can be defined as the interest rate that makes consumption today indifferent to future consumption. In all economic models, r is assumed to be positive. But when people are afraid to leave home for fear of infection, future consumption is actually more attractive than current consumption. Thus, r * is possibly negative for fundamental reasons for the first time. Strongly increased uncertainty only pushes it to even greater negativity.
When the money supply grows, but consumption is not generated (since r remains well above r *), then the savings rate mathematically increases. Therefore, prices for financial assets are generally rising.
In times of risk aversion, bond prices initially rise, but the supply of safe assets is limited, especially since the Fed buys a significant portion of the treasury market. Thus, investors are being forced into riskier assets. But while r remains below r *, the more savings increase, the greater the mechanical movement of prices of financial assets relative to real economic activity.
This, according to BMO, is the reason for the paradoxical relationship between bond and stock prices in recent weeks, and explains why stocks work so well despite the prospects for a larger economy. Money supply that cannot be converted into consumption should lead to higher prices for financial assets, until defaults lead to the destruction of wealth. What does this mean for recovery? The central bank has shown a decrease in the ability to further generate real economic activity as a result of accommodation policies over the past twenty years. This means that recovery is unlikely until r * increases significantly.that occurs only against the background of the disappearance of the virus uncertainty. It will take a lot of time.
During this time, one of two things will happen. Or the government will continue to help companies avoid
bankruptcy or not. If this happens, trust (and r *) will most likely return comparatively faster at huge cost to the government. However, at the end of this recession there will not be a large return of economic resources, and the subsequent recovery will be disappointing, given the degree of economic pain that is currently felt.
If this is not so, Defaults can potentially reach historical proportions, and the recession will be long and painful. However, using the “break the bandaid” analogy, this scenario may lead to the largest return on economic resources in the country’s history and lead to very strong economic growth after the current recession.
Ultimately, the truth most likely lies in the middle. The government will continue to provide assistance, albeit unlikely to be large enough to save all businesses. Дефолты и понижения будут ошеломляющими, но это увеличит возможности роста в последующем восстановлении экономики.
Что это значит для рисковых активов? Это означает, что до сих пор рисковые активы технически поддерживаются мерами стимулирования, особенно QE, которое уже не так эффективно, как раньше. Однако большая волна дефолтов неизбежна без маловероятного краткосрочного (и полного) решения для COVID-19. Тяжелые значения по умолчанию, виды, описанные вБиблейская “волна банкротств вот-вот затопит США”, вероятно, вызовет еще одну волну слабости цен на рисковые активы, поскольку богатство будет уничтожено, а техническое давление на цены финансовых активов и более высокий процент потребности в сбережениях будут удовлетворены за счет активов-убежищ (Рисунок 3).
Это также объясняет, почему ФРС была вынуждена выйти на рынок облигаций, так как при отсутствии прямого вмешательства на вторичном рынке цены на облигации могли бы создать кратковременный цикл самоубийства, где более низкие цены на облигации приводят к более высоким дефолтам, приводят даже к более низкие цены и так далее. На данный момент ФРС удалось отсрочить этот процесс, но Пауэлл может сделать так много, чтобы компенсировать коллапс фундаментальных показателей, что приведет к продолжающемуся снижению рейтингов, а также возможным дефолтам бесчисленных компаний, многие из которых будут напрямую связаны с ФРС. В этот момент действия ФРС на «рынке» станут темой непрерывных слушаний в Конгрессе и завершатся сомнениями по поводу жизнеспособности доллара как резервной валюты.