Some solutions for economic crisis.
With the outbreak of the pandemics at March 2020, the annual public deficit grew from 1 trillion dollars at 2019, number by itself unprecedented, to 4-5 trillion for year 2020 or 20-25% of the GDP. As explained in paper…..
https://rodeneugen.com/2020/06/13/one-swallow-does-not-make-a-spring/
The public deficit, indirectly results quantitative easing policy of the Federal reserve bank, that causes increase of US treasury security holdings by the Fed.
Subject to understanding that there is no negative interest rate option, this policy reached its bottom with zero interest rate, caused by the policy of quantitative easing itself. The other monetary policy the Federal reserve bank can do is purchasing mortgage backed securities or corporate bonds instead of treasury securities. This means subsidising the mortgages by decreasing the interest rate on them. The next step could be corporate bonds, their price and consequently the interest rate on them will be disconnected from their real economic performances. How much of this money will be invested in increased production capacity and how much into buyback of their own shares, is to be seen. Purchase of non financial corporate bonds by Federal reserve, will make out of these non financial corporations money creating institutions. Just as the banks, when giving loans to non-financials, they create additional money in the monetary system, so will purchase of corporate bonds by the Federal reserve bank add additional money into the economy.
The result can be, that new emissions of bonds will be translated to new cash money in the system
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
Since the beginning of 2020 to June the Federal reserve banks treasury holdings increased by 2 trillion dollars from 2.3 to 4.3 trillion dollars. This means, even if not formally, but in practice, the US government owns itself its debt at this level. The mortgage backed securities holdings of the Fed. grew at the same time from 1.4 to 1.9 trillion dollars between February and June 2020.
The composition of the Federal reserve holdings,
Consequently the increase in federal reserve balance sheet was translated to excess reserves of the commercial banks deposits in the Federal reserve bank and increase in M2 by 2 trillion US dollars. All this means more liquidity in the financial system, that reduces the capacity of the Federal reserve to control the money flow through the regular open market operation. If the crisis will continue, and the unemployment will be alongside with inflation, (stagflation), the Federal reserve will be forced to take regulatory acts, that will intervene in the financial markets.
Inflation is a result of limited supply capacity, caused by shortage and consequent price increase in some major commodity or skilled professional workforce, crucial to achieve full employment of the production capacity in the economy. In the contemporary economy, due to globalization of the production capacity, there is hardly seen any such production capacity shortage that could disturb production and supply of the consumer markets and cause inflation. But political intervention into international trade, could cause blockage in international supply chains, as it happened to lower degree already before the outbreak of the pandemic. In this case the US government will have very little room to correct the economy with monetary means or additional tax release, that could be implemented immediately.
According to the following chart, representing the annual trend of US imports from China, it seems, since 2018 there was downward trend of US imports from China since 2018, the year the US started its policy of disruption in the trade between these two countries.
——
Since the outbreak of the pandemic the commercial banks credit increased by 1 trillion dollars from 13.9 trillion to 14.9 trillion between 14.2-1.5.2020, and then it suddenly changed its trend. The banks seem changed their credit policy due to increased risks, the new realities impose on the businesses.
https://fred.stlouisfed.org/series/TOTBKCR
Other changes in the monetary parameters is near to zero basic interest rate. That slightly went through correction, between 2016-2020 and dropped to zero again with the outbreak of the pandemic.
https://fred.stlouisfed.org/series/FEDFUNDS
Since the economy after 10 years of near zero interest rates is adjusted to the low level of interest, meaning investments with potentially low yield and/or high risk were done due to low interest rate. Additional reduction or continuous zero interest rate will make little change in the economy. Introduction of negative interest rates has its limitations, since it would make the transformation to cash economy profitable.
To translate the excess liquidity into economic growth and then to employment, demands transfer of liquidity to non-financial businesses in form of loans, that are invested into new additional production capacity. But new loans need more than liquidity. It needs new business opportunities, new markets, new technologies, new ventures, and banks that feel secure about future developments.
The excess liquidity created after 2008 financial crisis were deposited into federal reserve bank that increased until end of 2014, when it reached 2.7 trillion dollars. Since 2015 the excess reserves of commercial banks started its decreasing trend until 2.2020, when it started its dramatic climb and more than doubled within three month.
https://fred.stlouisfed.org/series/EXCSRESNS#0
If to learn from the 2008 financial crisis, the credit to non non-financial sector decreased immediately after the crisis, and started its increased trend only from 2012, four years after the introduction of the quantitative easing policy. Most probably similar development is expected to happen with the covid-19 crisis.
https://fred.stlouisfed.org/series/CRDQUSAPABIS#0
Quite obviously the economy is in liquidity trap?
Liquidity trap means, Very low-interest rates and still preference for saving rather than spending and investment, slow/negative economic growth and low inflation.
Low inflation sounds a positive phenomenon, but in economy of high debt, only high inflation can reduce the debt level, necessary for economic revival.
Assuming that boosting the aggregate demand and returning to the pre-pandemic narrative is the right solution to achieve long term sustainable prosperous economy, monetary policies seems to have limitats to achieve this goal. Even if almost unlimited money is poured into the economy, it still have to be correctly distributed, so that very little supply capacity will be damaged by bankruptcies, and the aggregate demand will stay at least in its previous level. The policy of Quantitative easing, is pouring liquidity into the banks and to non financial corporations, (if corporate bonds are purchased by the federal reserve bank). Reimbursement directly to private households could be a promising policy, but it can be done only as government budget decision, that demands approval of the Congress, as contrary to Quantitative easing policy, that can be decided by professionals of the Federal reserve board.
How will look the post pandemic economy, without centrally managed decisions?
- Unemployment level of 10-20% out of the workforce.
- The income gap between rich and poor will farther deepen.
- Many mid and small sized businesses, mainly in tourism, retail, performing arts, etc. will be out of the business.
- The banks will be overwhelmed by financial liquidity, while there will be a credit squeeze for most of the businesses.
- In the banks will accumulated bad debts of businesses that didn’t do it through the pandemic.
The only way to change this reality will be by heavy intervention of government. There are two major ways to intervene in this emerging reality on the most fundamental level.
- To introduce universal basic income policy.
Universal basic income (UBI) calls for the government to give every adult a fixed payment, regardless of work status, health, wealth, or other criteria, used today as a condition for social aid. Being basic, it is intended to provide foundational income for people’s most fundamental needs. There were several experiments with UBI in places as Finland, Kenya or other places.
The universal basic income policy would mean: “every U.S. citizen over the age of 18 would receive guaranteed payments to cover their daily needs.
The main problem with this program is, it may cause decrease in work force participation rate. Shrinkage of workforce in the economy, where jobs aren’t disappearing but rather the nature of work is changing, means damage in economy, but also can negatively influence the economic dynamics, caused by shortage of new innovative workforce and decrease of entrepreneurial ventures.
UBI is a very expensive program, and in most countries, with weak currency and limited capacity to borrow, will require substantial tax increases or spending cuts, that would farther deteriorate their economy. This problem could be solved by introducing global virtual currency, something like libra, currency presented as an option for future currency by Facebook, plan that in meantime seems to be freezed.
Many of the most disadvantaged citizens would likely be left disconnected from the realities of economically productive activities. This would leave them in their state of relative poverty, and stigmatized by the society.
- Initiate investments in public infrastructure, and communal services and needs.
Investments in public infrastructure and services is a very complicated and politically controversial policy. To be successful, it needs long process of planning, preparation of needed resources and recruitment of public support. In today’s political environment, it is hard to see, such a policy will be adopted.
Still i would like to check, what fields of public services and investments could be those included in such a program? US is far behind Europe in investment in publicly financed investments as transportation in fast trains,
ecologically friendly smart cities, and other investments in ecologically friendly urban and whole regional systems.
As to public services, the demand for public services is by its definition unlimited, while the supply has to be limited. Still investments in education, health care, social services, arts, basic sciences are the fields with potential to increase demand for new additional employees, that can have positive impact on the economy.
- Monetary solution
The global monetary system will be flooded with cash money accumulated in bank accounts, waiting for investment opportunities. The interest rates will be close to zero for years, giving advantages to the wealthy, with collaterals to leverage against new, cheap bank loans. On the other hand, the earnings of those with regular, relatively low income, as wages, or pensions, will be diluted.
Close to zero interest rate will encourage investments in risky, sometimes white elephant projects. This means waste of resources, and damage in economic efficiency, and productivity.
The concept of virtual currency, similar to libra represented by Facebook, which was smashed from the table in the pre-pandemic world by regulators and political pressure, will probably become a necessity after the post-pandemic world.
Such a currency if based on basket of existing reserve currencies, as the US dollar, Euro, Japanese Yen, British pound and Swiss franc, can be one of the solution, how to bring stability back to the financial system, overflowed by reserve currencies, due to enormous public debts in the countries with sovereign reserve currency. Such a currency should be rather a result of cooperation of major world economies, than initiative of leading global corporations.
EugenR Lowy עוגן רודן 