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A New Era of Alphabet Soup?

19 May 2020   |  

Unprecedented times beget unprecedented measures—and with the global financial crisis still visible in our rear-view mirrors, global central banks have in some ways responded to fresh crisis with substantially similar tools. Meaning they’ve lowered rates (to the extent they can, given relatively low rates to start with) and they’ve offered various lending facilities to ensure markets maintain sufficient liquidity levels.

Some of the lending facilities aren’t new—some were born amid the euro zone crises of the earlier 2010s and the global financial crisis itself. But others are new—and the list of acronyms is accordingly getting increasingly hard to memorize. Consider just those extant in the US: PDCF, CPFF, MMLF, PMCCF, SMCCF, TALF, FIMA, PPPLF, MSLP and MLF. The BOE has three main lending facilities (TFSME, CCFF and CTRF), the ECB has maintained one—albeit in its third iteration—(TLTRO III) and the BOJ has two (one defying even an acronym and SLF).

The reason for the explosion of lending facilities is partly tied to already-low interest rates—which make it hard for central banks to incentivize lending with rate cuts. Even if central banks could cut rates, though, given the massive uncertainty that accompanies the current, epidemiologically driven crisis, tough to say whether banks would be willing to lend to small businesses and individuals whose futures (and accordingly, their abilities to repay) are arguably historically murky. Boeing provides an interesting case study—the company recently approached the government for a bailout. But at least for now, it didn’t actually take more than a Fed lending facility to save the company. Investors saw the Fed’s willingness to buy corporate bonds as a sufficient signal that they’d ultimately be made whole.

The long-term impact will likely take years to fully unpack. An immediate, clear effect has been the explosion of global central bank balance sheets.  As a percentage of GDP, the US is well beyond the levels it reached during the Great Depression and World War II. In terms of the types of assets it’s now willing to buy, it is also in uncharted territory (at least domestically—Japan’s central bank has been pursuing such extraordinary monetary policy for some time now).

Another clear concern is the growing moral hazard inherent in central banks’ offering to bailout individual countries or—in the US’s case—states and municipalities (let alone companies).  In a sense, this is at the heart of the euro zone’s ongoing battle over how to support struggling economies like Greece’s and Italy’s (among others)—specifically, it’s at the heart of the demands from economically stronger countries that economic conditions be attached to any individual country bailouts. It’s not hard to envision a day in which debate on the US Senate floor revolves around the concessions states like Illinois or California will need to make in order to receive federal support for their massive debt levels. Maybe that day doesn’t come, but if it does, C-SPAN would probably see some of its better ratings in recent years.

The other moral hazard, of course, resides at the federal level (in any country): Given a massive blank check—which the country’s treasury (facilitated by its central bank) can effectively fund indefinitely by blowing out its balance sheet and buying anything and everything in its sight—why would governments stop running up their already meaningful budget deficits and/or national debt levels? The answer historically has been, “Because at some point, they will have upped the ante one too many times, and investors will call their bluff”—and then, in a puff of smoke, the involved countries’ creditworthiness will evaporate overnight and they’ll be headed for Zimbabwe-style hyperinflation. To date, the major developed world economies haven’t crossed that threshold. Maybe they won’t ever. After all, one big edge the US specifically has is it still possesses the deepest and most liquid credit markets in the world. The dollar is the world’s reserve currency. Provided investors maintain their faith that global governments will eventually find their ways out of the woods, a disastrous outcome is far from a forgone conclusion.

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