Spend! Spend! Spend!

The weekend just passed was one which saw one of the economic dams of our time creak and then look like it had broken. This was due to the announcements coming out of Germany which as regular readers will be aware has a debt brake and had been planning for a fiscal surplus.

Under Germany’s so-called debt brake rule, Berlin is allowed to take on new debt of no more than 0.35% of economic output, unless the country is hit by a natural disaster or other emergencies. ( Reuters)

Actually the economic slow down in 2019 caused by the trade war was pulling it back towards fiscal balance and what it taking place right now would have caused a deficit anyway. But now it seems that the emergency clause above is being activated.

Germany is readying an emergency budget worth more than 150 billion euros ($160 billion) to shore up jobs and businesses at risk from the economic impact of the coronavirus outbreak, the finance minister said on Saturday.

Government sources told Reuters hundreds of billions in additional backing for the private sector would be raised, as Finance Minister Olaf Scholz said a ceiling on new government debt enshrined in the country’s constitution would be suspended due to the exceptional circumstances.

Putting that into context it is around 5% of Germany’s GDP in 2019 and I am stating the numbers like that because we have little idea of current GDP other than the fact there will be a sizeable drop. It then emerged that there was more to the package.

According to senior officials and a draft law seen by Reuters, the package will include a supplementary government budget of 156 billion euros, 100 billion euros for an economic stability fund that can take direct equity stakes in companies, and 100 billion euros in credit to public-sector development bank KfW for loans to struggling businesses.

On top of that, the stability fund will offer 400 billion euros in loan guarantees to secure corporate debt at risk of defaulting, taking the volume of the overall package to more than 750 billion euros.

As you can see we end up with intervention on a grand scale with the total being over 22% of last year’s economic output or GDP. This will lead to quite a change in the national debt dynamics which looked on their way to qualifying under the Stability and Growth Pact or Maastricht rules. This is because it was 61.2% of GDP at the end of the third quarter of last year which now looks a case of so near and so far.

Bond Market

There were times when such an audacious fiscal move would have the bond market creaking and yields rising. In fact the ten-year yield has dropped slightly this morning to -0.37%. Indeed even the thirty-year yield is at -0.01% so Germany is either being paid to borrow or is paying effectively nothing.

This is being driven by the purchases of the ECB or European Central Bank and as the Bundesbank seems not to have updated its pages then by my maths we will be seeing around 30 billion Euros per month of German purchases. Also let me remind you that the risk is not quite what you might think.

This implies that 20% of the asset purchases under the PSPP will continue to be subject to a regime of risk sharing, while 80% of the purchases will be excluded from risk sharing. ( Bundesbank)

The situation gets more complex as we note Isabel Schnabel of the ECB Governing Council put this out on social media over the weekend.

The capital key remains the benchmark for sovereign bond purchases, but flexibility is needed in order to tackle the situation appropriately.

That will be particularly welcomed by Italy as other ECB policy makers try to undo the damage created by the “bond spreads” comment of President Lagarde. Although you may note that most of the risk will be with the Bank of Italy.

Also as a German she did a bit of cheer leading for her home country.

The success of our measures hinges on what happens in fiscal policy. This is a European issue which needs a European solution. No country can be indifferent to what happens in another European country – not only because of solidarity, but also for economic reasons.

Some might think she has quite a cheek on the indifference point as that is exactly how countries like Greece described Germany. Still I also think the ECB has plenty of tools but maybe not from the same perspective.

The ECB is in the comfortable position of having a large set of tools, none of which has been used to its full extent

QE

It was only last Thursday that I was pointing out that I expected QE to go even more viral and last night it arrived at what is in geographical terms one of the more isolated countries.

The Monetary Policy Committee (MPC) has decided to implement a Large Scale Asset Purchase programme (LSAP) of New Zealand government bonds……..The Committee has decided to implement a LSAP programme of New Zealand government bonds. The programme will purchase up to $30 billion of New Zealand government bonds, across a range of maturities, in the secondary market over the next 12 months. The programme aims to provide further support to the economy, build confidence, and keep interest rates on government bonds low.

You can almost hear the cries of “The Precious! The Precious!”

Heightened risk aversion has caused a rise in interest rates on long-term New Zealand government bonds and the cost of bank funding.

Which follows on from this last week.

“To support credit availability, the Bank has decided to delay the start date of increased capital requirements for banks by 12 months – to 1 July 2021. Should conditions warrant it next year, the Reserve Bank will consider whether further delays are necessary.”

This reminds me of one of my themes from back in the day that bank capital requirement changes were delayed almost hoping for something to turn up. Albeit of course they had no idea a pandemic would occur.

Let us move on noting for reference purposes that the ten-year All Black yield is 1.46%.

The US

There are some extraordinary numbers on the way here according to CNBC.

Administration statements over the past few days point to something of the order of $2 trillion in economic juice. By contrast, then-President Barack Obama ushered an $831 billion package through during the financial crisis.

Indeed they just keep coming.

That type of fiscal burden comes as the government already has chalked up $624.5 billion in red ink through just the first five months of the fiscal year, which started in October. That spending pace extrapolated through the full fiscal year would lead to a $1.5 trillion deficit, and that’s aside from any of the spending to combat the corona virus.

At the moment we know something is coming but not the exact size as debate is ongoing in Congress but we can set some benchmarks.

A $2 trillion deficit, which seems conservative given the current scenario, would push deficit to GDP to 9.4%. A $3 trillion shortfall, which seems like not much of a stretch, would take the level to 14%.

Comment

The headline today for those unaware was from Viv Nicholson back in the day after her husband had won the pools. But we see something of a torrent of fiscal action on its way oiled by an extraordinary amount of sovereign bond buying by central banks. For example the Bank of England will buy an extra £5.1 billion today in addition to its ongoing replacement of its holdings of a matured bond.

On the other side of the coin is the scale of the economic contraction ahead. Below are the numbers for the German IFO which we can compare with the fiscal response above albeit that I suggest we treat them as a broad brush.

“If the economy comes to a standstill for two months, costs can range from 255 to 495 billion euros, depending on the scenario. Economic output then shrinks by 7.2 to 11.2 percentage points a year, ”says Fuest. In the best scenario, it is assumed that economic output will drop to 59.6 percent for two months, recover to 79.8 percent in the third month and finally reach 100 percent again in the fourth month. “With three months of partial closure, the costs already reach 354 to 729 billion euros, which is a 10.0 to 20.6 percentage point loss in growth,” says Fuest.

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30 thoughts on “Spend! Spend! Spend!

  1. Just a quickie for the moment Bloomberg says a “Recession Guarnateed”

    https://www.bloomberg.com/news/articles/2020-03-23/recession-guaranteed-recovery-a-maybe-says-bloomberg-economics

    And former governor of the BOE says the current global situation is much worse than the financial crisis in 2008 which I indicated were my thoughts two week or so ago:

    https://uk.investing.com/news/economy/much-more-serious-than-the-2008-crisis-former-boe-governor-king-says-2079380

    The UK government can indeed spend, spend and put their printing presses in overdrive, however at some stage the borrowings will have to be paid back or someone take the hit and there is bound to be much suffering for many.

    I just hope the rich lose much of their fortune for stealing the money off the poor over the last few years, as they are partly the blame for a ballooning of assets worldwide.

    The greedy rich been building large properties and leaving them empty while the working man having to pay higher rents on inflated property prices.

    My motto is help the needy not the greedy.

    • Hi Peter

      That is a good motto and let us hope we live up to it. As for a recession being guaranteed I am not sure where Bloomberg are going? The real issue is as you correctly forecast that the economy is going to take a big step downwards for a while and as we stand we do not know for how long that will be,

    • Interesting that just last Thursday, I was going to a talk by Prof John Kay about his book with Penfold on “radical uncertainty” or uncertainty as it is known elsewhere. Ironically, they talk about black swan events like pandemics and the talk was cancelled! I was going to ask about Penfold’s mishandling of the BoE remit (now largely forgotten after the Carney shambles), but I found the preview on Google Books.
      Having the advantage of being a Published Napoleonic author, I could see it was nonsense in the first two paragraphs, where they claim Napoleon had no idea what was happening at Borodino, fought just in front of Moscow, that we have no idea why Napoleon was even there and indeed that the French burned a Moscow. It is utter tripe.
      The main point of the book is that it is an attack on those, who sought to create risk models in the run-up to 2008, but failed to predict the crash. Thus uncertainty is actually more widespread and so we should learn to live with it.. That of course totally exonerates the CBs, who were busy pumping cheap money into the markets, which led to all the greed and fraud. While it is only 50 pages, I could find no ref to LTCM, which was proof of modelling issues or the late 80s bubble, which really only lacked a derivatives magnifier.

      • Dave

        John Kay has just released a book with Mervyn King on uncertainty:

        I’ll get it after my current read – a biography of Thomas Cromwell.

  2. Hello Shaun,

    re : “If the economy comes to a standstill for two months, costs can range from 255 to 495 billion euros, depending on the scenario. Economic output then shrinks by 7.2 to 11.2 percentage points a year,”

    well we do have the poor unfortunate Greeks as an example…

    be safe everyone

    Forbin

    • Hi Forbin

      Yes we do and of course they ended up at the upper end of the range you quote as opposed to the 2.1% economic growth promised by the Troika for 2012. As to the present situation I fear for Greece as I remember the stories of how the health service was struggling to afford drugs and keep services going. How can they cope with the Corona Virus pandemic?

  3. Fed has announced it will buy corporate bonds, treasuries and agency mortgage backed securities, stockmarket and gold gone vertical.Dollar dropping.

    • Hi KEVIN

      Yes the QE lever was pulled hard.

      “The Federal Open Market Committee (FOMC) will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”

      That meant some US $75 billion of Treasuries and US $50 billion of agency mortgage backed securities each day this week. No wonder the US ten-year yield fell to 0.76%. Also that “Not QE” sure turned into something didn’t it?

  4. “Unless.” renders the rest worthless, as politicians will always find a way to find the criteria relevant, thus the use of such catch-alls as “natural disaster” or “other emergencies”.
    Coronavirus fits both categories, if you want it to.

      • We have been taking these measures for two weeks, as any sensible person has.
        My own view is that the more young fit healthy people who come out the other side of this virus unscathed, and so are (presumably) neither susceptible to infection nor infectious the better.
        Unfortunately, life isn’t as simple as that, and some young people have had a really bad time with this, & I don’t want anyone to be unnecessarily hurt.
        As such, 12 weeks isolation is just the start.

  5. And the current deaths ( still average age 81 yrs) across the globe are 15,000, which represents 3/8ths of the deaths in the UK from flu-related illnesses in 2003/4.
    I contend these measures have nothing to do with the virus, that is just the convenient ‘excuse’.
    The whole western world’s economy is being injected with ‘the vapours’. Plus some really draconian legislation in this ‘war’. For instance the UK’s CV bill ( not requiring a vote) includes new measures for mental health; only one doctor required to sign Sectioning, with unlimited period of detention.Together with increased Police measures to ensure compliance with isolation , civil liberties taken for granted are being removed. They will never come back.

    • Two reports starting to filter out today. The Italian Institute for Health interim report finds that average age of death is 80yrs, and 99% had other life-threatening illness. Indeed they state that they cannot say with any certainty that the patients would not have died anyway without the action of the virus. The Chinese report into the Polymerase Chain Reaction test used to test for CV could have as many as 75% false positives. They have found that of the ‘confirmed’ cases only 10% were actual cases.
      And on the basis of this ‘data’ our experts have run computer models that forecast half a million deaths in the UK alone, and gave justification for cratering the economy and changing civil life for the foreseable future. Which of course our politicians, egged on by their mates in CBs etc , only too gleefully used to pass through legislation that they could only dream about 2 months ago.
      Although I am using a laptop to write this and collect the evidence, I would willingly throw it along with every other computer on their funeral pyre. Humans use of them for evil outweighs their benefits.

    • I live in a quiet area and know personally of two people who have this virus. One in his 50’s doing ok ( only day 3 ) and one in his 40’s seriously ill in hospital. I suspect this is the tip of the iceberg. Sorry but I don’t agree with your downplaying of this crisis.

      • It is interesting to compare some figures. In my area, Borders, which runs from just south of Edinburgh to the English border and the east coast to the middle of the lower part of Scotland, we number 115,000 of which 25% are over 65. We have 11 cases, a rate of 1 in 10,000. Lothians, which is the area around Edinburgh has 900,000 and 44 cases, or 1 in 20,000. Peterborough, where 200,000 are packed into quite a small area has two out of 200,000. I realise there are statistical issues here, but the idea that interaction is causing cases seems rather misguided. I put this on another site and was told I was stupid and should start touching my face. I invited that poster not to get involved in hysterical fights over bog roll again.
        To add insult to injury, we have a new airhead in the team, who sits next to me. During a fag break with some of the other girls, she decided to tell them I was regularly coughing (ironic as I don’t smoke,). The Team Manager said I should go home – I politely told him that his information was wrong (although the office is very dry and promotes tickly dry coughs) and he could go away. He said he would “look at the guidelines”. Somehow I suspect I shall be quoting Mark Twain and inviting him to read Cohen: Folk Devils &Moral Panics. Or I might just suggest he doesn’t take notice of silly little girls believing what they read on the Net during a fag break.

    • You trying to tell me you don’t believe Boris and his chinless wonder sidekick Hancock?

      They got where they have on raw talent, its without doubt these glorious leaders care for us the people and know what they’re doing.

      As for the boy Chancellor who got the job for his ability to repeat what others tell him, he’s just great.

      • Yes, at least the Nazis managed to create many problems themselves to enable them to take draconian powers. Two years, but over the worst in 12 weeks – must be expecting demos about something else then …..

  6. I think it is a times like these that we need to be reminded of a few simple facts, we know them as “there is no such thing as free lunch” or “you never get something for nothing”, but Keynsian central banks aren’t merely trying to prevent their economies from imploding as a result of Corona virus, they are trying to prevent the bubbles their policies have created from deflating and starting an economic collapse caused by mass defaults, a liquidity crisis and insolvencies, this would have happened at some time in the future anyway – the virus isn’t the cause, it is merely the catalyst or a spark for a bonfire of the asset bubbles and malinvestments created by their policies over the last few decades.

    Ludwig Von Mises put it perfectly:
    “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

    Looks like central banks are choosing option B because it has worked so well in the past hasn’t it?,

    Quel surpris.

    • Hi KEVIN

      The central banks are pouring out QE. I posted the US Fed numbers above and if we include the maturity investment the Bank of England has done £10.2 billion today and Friday although the pace now slows. Next comes the ECB which has set out a pace averaging a bit less than 6 billion Euros each working day.

  7. Shaun, it’s amazing isn’t it: Banks in Euroland are suffering because of negative interest rates and banks in New Zealand are struggling because of high interest rates. Bank CEOs really earing their bonuses in such a difficult market, n’est=pas?

    • Hi DD

      The truth is that much of the banking model is broken. There is money in mortgages and in providing a service. But the latter is something banks have pulled away from. There is no gain from sitting on money now in a ZIRP world and actual losses from the NIRP areas.

  8. Hi Shaun, interesting times…and extremely worrying ones too. My view is that the current expansion could lead to inflation just as easily as to deflation. And maybe both at the same time, how crazy would that be? It seems to me that anything is possible, such is the monster created by a ten year diet of QE and can-kicking. An extraordinary position and extremely worrying too.

    I suspect, if debt dynamics go haywire, this is going to herald the end of the Euro as we know it. The currency may split, north and south. Or it may fail entirely. But if it survives as currently constructed I’ll eat my hat. Just my ha’peth worth. Thanks for the great commentary as ever.

    AZ

    • Hi Andy Z

      I agree we will see examples of both. I cycled up to the Tesco at The Oval yesterday and opposite it is a garage which is usually pretty cheap and at 117.8p for diesel that was a 10p drop or so on what I last recall. But some goods will be shooting up in price and also inflation from buying something more expensive because you can’t get what you usually do.

      The test case remains Italy I think….

  9. As to reference the title of today’s blog, “Spend Spend Spend”, just exactly what are the three big central banks trying to achieve? You might all think they all have the same objective, but this crisis isn’t producing the same motives, the Fed is primarily fixated on the survival and profitability of their member banks, its brief of full employment and price stability mean nothing since they assume if the banks are OK, those two criteria will look after themselves,price stability is taken care of similarly to here by employing complex statistical methods to hide the real rate of inflation and the depreciation of the purchasing power of the currency, unemployment is similarly fiddled to exclude millions of workers as they are considered “not looking for work” so not unemployed , so ostensibly,either or both can are ignored in order to protect “their precious”.

    The ECB doesn’t really care about the banks(negative interest rates are kryptonite to banks), they are primarily concerned with keeping the EU together and making sure no country ever leaves(Greece anyone).

    And lastly to our old lady, protecting the precious to the last, but indirectly it is then in the business of protecting the entire UK housing market , which has taken over the rest of the real economy in both scale and importance as far as the Bank of England is concerned.

    So they are all using the same tools, zero or negative rates(real and nominal) and money printing/QE/monetisation, but to achieve different ends.

    • They tried and failed to save capitalism in 2008 and have been seeking a scapegoat ever since.
      Coronavirus is very, very handy for some.
      It has really, really gone pear-shaped, but the coronavirus is not the culprit.
      The hope is, obviously, for a bout of 70’s/80’s type inflation at the very minimum.

  10. The difference is that Germany can afford it, having run near-balanced budgets for some years and run an economy on the basis producing something useful. The great GBP continues its slide against the euro and parity is looking imminent.

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