The coronavirus will redefine what currency-issuing governments can do – finally
Life as we knew it is changing fast, almost by the hour. Most of my speaking engagements, which were heavily booked for the foreseeable future, have been cancelled or deferred. All the gigs that my band was booked for have been cancelled until people start returning to the now, empty venues. And, more significantly, the ideologues are giving way to the pragmatists in the policy space. Almost (see below). The sudden realisation that even Germany will now spend large amounts to protect their economy exposes all the lies that have been used in the past (up until about yesterday) to stop governments doing what they should always do – maintain spending levels in the economy to sustain full employment and ensure no-one falls through the cracks and misses out on the material benefits of growth. In the early days of the GFC, I thought that the neoliberal era, supported by the mainstream macroeconomists, might be coming to an end. Maybe I was a decade out in my prediction. Perhaps this crisis, induced by a human sickness, will end the madness that has redistributed massive volumes of income to the top-end-of-town, sustained elevated levels of labour underutilisation and seen the traditional progressive political voices become mouthpieces and even agents for the neoliberal economic lies. I was wrong in 2008 on this score. I hope something good like this comes out of the current disaster. The coronavirus comes on top of already growing dissent over the failure of mainstream economic policy. It will redefine what governments can do with their obvious fiscal capacity and will demonstrate once-and-for-all the lies that the mainstream economists tell about deficits, inflation, interest rates, etc. It will categorically demonstrate the capacity of the currency-issuer. All that will lay the foundation for a better future, if we get beyond this current malaise.
Last week, there was a coordinated policy response in Australia as the RBA cut rates and the Australian government stopped raving about its surplus ambitions and introduced a stimulus (aimed at business) of about 1 per cent of GDP.
I did some interviews on the national broadcaster (ABC) in the aftermath and indicated that 1 per cent of GDP would hardly be enough – I think more like 4-6 per cent will be required (at least) – and that targetting business was the wrong way to ensure those affected by the virus crisis are best protected in income terms.
What is now being realised is that the global economy is sinking into depression (or a very severe recession) which will be unlike the typical V-shaped recession where output falls quickly (and sometimes significantly) but growth resumes relatively quickly and robustly once confidence returns after some sort of fiscal stimulus.
That is what happens in a standard demand-side event where firms get skittish and reduce investment spending, lay off workers who then stop spending much and sales plummet. The government steps in, sales rise again and away it all goes again.
The GFC was not such an event – it was a balance-sheet recession – where the initial problem came from financial markets (over-indebted borrowers and over-valued assets) and fed into the real economy as bankruptcies multiplied.
The solution then, which wasn’t properly implemented by deficit-shy governments, was to support growth with large and sustained fiscal deficits which allowed sales and national income to rise and saving and balance-sheet restructuring to occur in the non-government sector.
That process is a sort of dragged out U-shaped event – a rapid descent followed by a very drawn out recovery that required fiscal support for years while the balance sheet repair was going on.
The coronavirus event is different again. It has supply and demand elements which are impacting on growth.
The supply dimensions (factory closures, etc) mean that the stimulus injections designed to help the demand collapse need to be carefully targetted. It is also why monetary policy is less likely to be effective.
And the fiscal support will be required for an extended period and should not be withdrawn until business investment is growing back on trend and household debt is significantly reduced.
The point is that the vestiges of neoliberalism have to be expunged in this crisis. We cannot return to where we started both in terms of aggregates (like household debt) and policy mentality (surpluses are the only desirable goal).
I talked about where I would spend government currency in the two-part blog series:
1. The coronavirus crisis – a particular type of shock – Part 1 (March 10, 2020).
2. The coronavirus crisis – a particular type of shock – Part 2 (March 11, 2020).
So I won’t repeat what I said.
Other than to say that this would be an ideal time to announce some directional changes in government policy – for example:
1. Introduce a Job Guarantee – to give an income security option to all those (particularly low-income, precarious workers) who will face massive income losses as a result of being made redundant. There are no end of productive activities that can be done which will not be constrained by supply-chain disruption arising from the factory closures brought about by the coronavirus.
And specifically, this would be a salvation to the arts/music scene which is now being devastated by the cancellations as a result of the virus.
Instead of performing live (while the restrictions continue), these workers could write and record new material, paint or sculp things etc.
But they would be able to maintain (mostly) their rents, mortgages, and other nominal commitments that are not ‘cancelled’ as a result of the virus spread.
2. Restructure the gig economy – introduce far-reaching reforms to force employers to pay sick and holiday pay and to treat all workers as employees rather than independent contractors.
Initially, a publicly-funded phase-in period could be offered (the stimulus part) so that workers sick or in quarantine would continue to stay solvent and which would not penalise the employers who are already likely to be enduring a massive collapse in revenue.
But once the crisis passes then the phase-in support vanishes and the employers have a choice – restructure their operations or exit.
3. Create a public bank – the private banks are going to need substantial public support. As in the GFC, many will become insolvent unless they are guaranteed by the government.
The government should guarantee all deposits for a time and offer to integrate them into a new public bank. Depositors would then have a choice. After some period, the guarantee would lapse and only apply to the public bank and consumers would understand the risks of their choices.
4. Restore national ownership of the airlines. The tourist industry is facing ruin. The airlines are going to need massive public injections to stay solvent anyway. Many were privatised in the early days of the neoliberal hey-day. The government should offer full support but take over ownership.
And more.
It is no surprise that Europe is dragging its feet on fiscal support.
We had the ridiculous situation last week, where Madame Lagarde, no central banker that is for sure, addressed the press conference after the ECB Governing Council had met on March 12, 2020, and immediately created financial chaos.
The – Transcript – records that she was asked about the implications of the obvious increase in “debt issuance” that will be required to deal with the crisis and the fact that “certain countries are hit especially hard, like Italy”.
She was asked: “What can the ECB do if the spread for government bonds increase?”
Her reply was extraordinary:
My point number two has to do with more debt issuance coming down the road depending on the fiscal expansion that will be determined by policymakers. Well, we will be there, as I said earlier on, using full flexibility, but we are not here to close spreads[1]. This is not the function or the mission of the ECB. There are other tools for that, and there are other actors to actually deal with those issues.
Now if you read these statement regularly you will note there are really never footnotes appended after the fact.
That [1] note linked to a subsequent press comment Lagarde made to CNBC after all hell broke loose in the secondary bond markets (Italian yields rising sharply) and Lagarde had obviously been hauled over the coals by other members of the Governing Council.
After that, she claimed that she was “fully committed to avoid any fragmentation in a difficult moment for the euro area.”
Some have speculated that her initial statement was not a gaffe but a well-designed ploy to put pressure on Germany to announce a major spending injection.
Others have interpreted it as the statement of a lawyer (given Lagarde’s training) about the Treaty obligations of the ECB. That may be true but ignores the reality that the only reason the Eurozone survived intact in 2010 and 2012 and subsequently was because the ECB became a quasi-fiscal agent in the absence of a federal capacity and defied the strict rules of the Treaty by funding government deficits to the tune of billions of euros.
The Eurozone only survived because the currency-issuer acted outside the ‘law’ which should tell you everything about the flawed architecture of the EMU.
This morning (March 16, 2020) we read – Christine Lagarde apologises for botched communication of ECB strategy – and learn that the Madame spoke to the Governing Council members on Friday and said she was:
… sorry for comments that led to the biggest single-day fall in Italian government bonds in a decade.
But despite being known as “Madame la Gaffe” (from her days as French Finance Minister), she keeps her job.
Interestingly, the German press gave Lagarde support for her ridiculous comments.
The Frankfurter Allgemeine ran an Op Ed from several economists (mostly retired) including Edmund Stoiber, Peer Steinbrück, Wolfgang Clement, Günther Oettinger, Hans-Werner Sinn, Franz-Christoph Zeitler, Kurt Faltlhauser und Marcus Vitt (March 15, 2020) – Für eine neue Geldpolitik der EZB – which accorded with Madame Lagarde’s claim about the ECB role.
They claimed that as the coronavirus crisis was “primär um eine Angebotskrise” (“primarily a supply crisis”), there was no demand-side role required by the ECB.
They also said that the crisis “ist ein Signal für eine Zinswende nötig” – that is, that interest rates should be pushed up as the infection rate subsides.
They also said that:
Wie Präsidentin Lagarde zu Recht ausgeführt hat, ist es auch nicht Aufgabe des Eurosystems, Zinsunterschiede zu verringern.
In other words, La Madame was right in saying the ECB is not about controlling bond yields.
And, we read that the German (Source):
Federal Ministry for Economic Affairs and Energy published an order on 4 March 2020 in the Federal Gazette prohibiting the export of protective medical equipment (medical face masks, gloves, protective suits, etc.)
European solidarity anyone?
How much of the shortage in Germany of “protective medical equipment and in capacity in intensive care units” the result of their obsession with primary fiscal surpluses?
Of course, division within Europe is the norm.
It is clear that the European elites in Brussels are not united in a way forward to deal with the crisis.
All their previous forecasts for this year and associated ‘budgeting’ are now null and void.
They are staring at a massive collapse in growth on top of an already slowing economy.
They are staring at thousands of shops, service outlets (cafes etc), tourist operators, airlines, and major sporting codes becoming insolvent.
They are staring at millions entering the ranks of the unemployed, many without any defined income support available and starting from an already precarious state.
And, as a consequence, they are staring at the need for fiscal deficits to go many multiples over the Stability and Growth Pact upper thresholds.
Today’s Eurogroup meeting will have to state categorically that the fiscal rules are no longer applicable and sustained increases in deficits will have to become the norm.
The ECB will have to confirm that they will fully support the governments by large-scale purchases of their bonds in the secondary markets to prevent the bond markets from demanding punishingly high yields.
The problem for the Eurozone, that Madame Lagarde seemed to forget, was that the ECB is the only European institution that can control ‘spreads’ of Member State bond yields against the bund.
That is the system they created. They have to live with the consequences of that.
And the more vulnerable nations, such as Spain and Italy at present, will have to be more or less permanently supported through ECB funding, if they are to remain solvent and overcome the huge costs incurred by their coronavirus strategies.
Madame Lagarde was right in saying that:
An ambitious and coordinated fiscal stance is now needed in view of the weakened outlook and to safeguard against the further materialisation of downside risks …
But, the EMU doesn’t have that capacity in its current configuration.
The individual Member States surrendered that capacity when they decided to use a foreign currency and collapse their own central banks into the Eurosystem.
If they try to expand their deficits they must satisfy the private bond markets who realise they are investing in states that carry credit risk (because they use a foreign currency).
This is especially the case when the Member States are bound by fiscal rules that turn on alarm bells for the bond markets as breaches are approached.
Which means that all the rules that constrain the fiscal capacity of the Member States have to be set aside.
And to contain the credit risk – which means to effectively deal the private bond markets out of the game – the ECB has to be decisive and eliminate the influence of the bond markets.
They, alone, can do that in this poorly designed currency union.
Whether the Eurogroup can agree to any of that is another matter.
The track record is certainly not good and the portents are not there at present.
They might agree to some billions of stimulus (at present only €7.5 billion) with rules and sunset clauses about no permanent transfers and all the rest of their gibberish.
But they will need multiples of that and the transfers will have to be permanent. Get over it!
Euroleaks
Essential listening and reading, the full audio and transcripts available of the 2015 Eurogroup meetings at which Syriza participated in the lead up to the June surrender to the neoliberal austerity – Euroleaks
Conclusion
In my recent lecture tour of Europe I argued that we were already amidst a paradigm shift in economic policy thinking as the dissonance of the neoliberal era brings together disparate groups – an anti-establishment citizens’ revolt, central bankers calling for fiscal action, and financial market players realising their business model has been almost terminally compromised – realise that mainstream macroeconomics is a failed discipline.
The coronavirus comes on top of that already growing dissent.
It will redefine what governments can do with their obvious fiscal capacity and will demonstrate once-and-for-all the lies that the mainstream economists tell about deficits, inflation, interest rates, etc.
It will categorically demonstrate the capacity of the currency-issuer.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.
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