by Alasdair Macleod, GoldMoney:
Few mainstream commentators understand the seriousness of the economic and monetary situation. from a V-shaped rapid return to normality towards a more prolonged recovery phase.
The fact that a liquidity crisis developed in US money markets five months before the virus hit America has been forgotten. Only a rising gold price stands testament to a deeper crisis, comprised of contracting bank credit while central banks are trying to rescue the economy, fund government deficits and keep the market bubble inflated.
The next problem is a crisis in the banks, wholly unexpected by investors and depositors. At a time when lending risk is soaring off the charts, their financial condition is more fragile than before the Lehman crisis. Failures in European G-SIBs in the next month or two are almost impossible to avoid, leading to a full-blown monetary and credit crisis which promises to undermine asset values, government financing and fiat currencies themselves.
We can now discern the path leading to the destruction of fiat currencies and take reasonably guesses as to timing.
How central banks view the current situation.
The financial world is bemused: what is it to make of the economic effects of the coronavirus? The official answer, it seems, is on the lines of don’t panic. The earliest fears of millions of deaths have subsided and in the light of experience, a more rational approach of easing lockdown rules is now being implemented in a number of badly hit jurisdictions. Whether this evolving policy is right will be proved in due course. But the motivation is moving from saving lives to restricting the economic damage.
While I am a critic of the inflationist policies of central banks, it is always valuable to look at monetary policy from a central banker’s point of view. Last Friday, Andrew Bailey, the new Governor of the Bank of England, gave an interview to Chris Giles of the Financial Times, where he spoke frankly and reasonably freely about the challenges the Bank faced in common with other major central banks.[i]
Regarding inflation, from his comments it is clear Bailey defines it as changes in the general level of prices, which is hardly surprising, since central banks are mandated to target it. He believes that the rate of price inflation will fall towards zero, citing recent moves in the oil price as a major factor, though the oil price has since recovered. This gives him room to use monetary policy to its greatest extent.
His view was that monetary policy would minimise what he called “scarring”. This is the new buzzword for economists who generally dismiss the economic effects of the current crisis as being temporary, as in when it heals the only evidence left will be a scar. In other words, some overindebted businesses will fail and others would be victims to changes in consumer patterns once normality returns. Therefore, the working assumption is that once the coronavirus crisis is behind us the economy would broadly return to normal, and while he didn’t specifically say it, he expectats is a V-shaped recovery, possibly with a moderate time element to it.
The bank is undertaking a £200bn programme of quantitative easing, which amounts to two-thirds of Britain’s expected funding requirement relating to the coronavirus, in order to satisfy the following policy objectives:
- To stabilise financial markets, buying £50-60bn of gilts every month, in common with actions of other central banks in their markets. This suggests the economy is expected to be on the way to recovery by late-July.
- To reassure the market that extra government debt would be absorbed and to smooth the profile of overall government borrowing. This will enable the bank to keep gilt yields low, and those of corporate bonds as well.
- To meet economic objectives. In other words, pursue a Keynesian policy to return to full employment.
- To address counterfactual issues that can be expected to arise if the Bank did not do QE. Presumably, other than disrupted markets Bailey was referring to fears of deflation in the absence of monetary stimulus.
If Bailey is right and QE of £200bn will see the British economy through the crisis, then that £200bn will be an addition of a little more than 10% to the national debt. The addition to February’s M3 money supply is 6.8%, which is hardly a problem. But there will be trouble if he is wrong, glitches that could arise from one or more of three sources. If other central banks, principally the Fed, dilute their currencies by a larger amount proportionately, the effect on commodity prices, particularly agricultural products, could be to drive them up in sterling terms, helping to undermine sterling’s purchasing power for life’s essentials. Secondly, 28% of gilts in issue are owned by foreigners, who, needing the money in their own currencies, are likely to turn sellers. The third threat is of systemic failure, requiring extra expenditure to rescue one or more major banks and to manage the fall-out.