The COVID-19 crisis is different from Lehman for a laundry list of obvious reasons, but in some key respects it’s similar.
JPMorgan sums up the situation in just seven words: “More debt, more liquidity, more asset reflation”.
That, ultimately, is our future, the bank’s Nikolaos Panigirtzoglou says, in a somewhat fatalistic edition of his popular “Flows & Liquidity” series.
One thing we should be clear about (and insistent upon) is that the extent to which liquidity serves primarily to inflate asset prices (as opposed to manifesting in real economic outcomes) is a function of our willingness to admit that QE is simply debt monetization if central bank balance sheets are never unwound.
Once we admit that to ourselves, we will be free to eliminate the superfluous primary dealer middlemen on the way to direct government financing, which in turn opens the door to the funding of initiatives with the potential to bring about real economic change that matters for everyday people (e.g., infrastructure spending, health care overhauls, etc.)
In other words, rather than simply pumping vast sums of liquidity into bank coffers and assuming (hoping, praying) it will get where it needs to go, we would inject it directly into the economy.
The near dollar-for-dollar coordination between central bank asset purchases and government debt issuance in response to the COVID crisis is taking us closer than ever to the kind of overt monetary-fiscal partnerships that can break the perpetual motion machine of financial asset price inflation/inequality creation which kicked into high gear after the financial crisis. But we’re not there yet.
“Why go through the charade of buying bonds in the market, providing an incentive for companies to issue debt and buy back more equity and sending share prices to unstable levels?”, SocGen’s Kit Juckes asked last month, hitting on the key point. “Partnering with government to provide short-term cash to stressed households and companies makes more sense”.
Indeed it does, and that’s what governments across the world have been busy doing for the past several months.
But, concerns about inflation (not asset price inflation, but real world inflation), fairy tales about deficits, and a generalized aversion to anything that sounds like a “free lunch”, means these kinds of monetary-fiscal partnerships aren’t likely to be realized in full or for very long. That, in turn, means we’re destined to go even further down the road traveled after Lehman, which, in essence, is the scenario JPMorgan’s Panigirtzoglou lays out.
“The need to replace lost income is inducing more debt creation by both the private sector, i.e. households and non-financial corporations, but also by the government sector, which, via stimulus programs, aims at smoothing private sector’s income disruption”, he writes, adding that so far, fiscal support in the wake of the coronavirus crisis totals around $9 trillion, or 12% of global GDP.
When you take account of the assumed ~5% drop in output due to the effects of the crisis on economic activity, you’re left to ponder a global government debt-to-GDP ratio of around 105% by December, up sharply from under 90% late last year.
At the same time, private sector borrowing (which includes bank loans and net corporate debt issuance) summed to around $5 trillion in H1 and will likely total $7 trillion by year-end.
All told, that’s $16 trillion in new debt.
That would “raise the total debt in the world, private and government debt, to a new record high”, JPMorgan observes. When you factor in the expected 5% GDP slump mentioned above, total debt-to-GDP for the world as a whole will likely rise by around 35 percentage points, to 278%.
That 35 percentage point rise is nearly double that witnessed in the aftermath of Lehman.
Note from the chart that the relationship between surging debt levels and interest rates is inverse, which is hardly surprising. As Panigirtzoglou writes, “very accommodative central bank policies and low interest rates are likely to continue for a very long time to make it possible for both the government sector and the private sector to sustain their much higher debt levels”.
Of course, this is counterproductive on all manner of fronts and, at least on one read, is destined to perpetuate the dynamic illustrated in the figure below (the wealth concentration figures are for the US only).
“The private sector would likely be inclined to save more in the future [and] persistently high private sector savings rates would keep economic growth and inflation low”, JPMorgan says.
Without inflation, the debt burden remains, and sluggish economic activity means the return on capital will surely outstrip growth, leading to ever more inequality and ever higher levels of wealth concentration.
Assuming we lapse back into old habits, eschewing fiscal initiatives in favor of austerity and putting the burden solely on central banks, monetary policy acting in isolation will produce the same results it did in the post-financial crisis world — namely, it will inflate the value of asset prices with very little in the way of “trickle down” to the real economy.
This is not a recipe for success when it comes to Main Street, but for the owners of financial assets (and especially risk assets), it’s conducive to gains.
“Given that debt creation and QE will continue to be stronger than normal, we believe that the total money or liquidity creation could exceed $15 trillion or more globally by the middle of 2021”, JPMorgan goes on to say, adding that “these elevated cash holdings create strong background support for non-cash assets such as bonds and equities, but given how low bond yields are at the moment… we believe that most of this liquidity will eventually be deployed into stocks as the need for precautionary savings subsides over time”.
Read more about how to break the loop