Central banks opt for nuclear option
By: Robert Pritchard – 24 March 2020
The end of the bazooka?
Over the past few days, the financial press has often reported that the resources available to central banks to support the economy have been exhausted. The bazooka, once introduced by ECB Mario Draghi, would have lost its effect. The role of the central banks would have been played out. The first is true, the second is not. Indeed, the bazooka has worn off. It can be driven back into the hangar eight years after that. However, the role of the central banks is not over yet. Last week, the ECB decided to move to even heavier guns. The European Central Bank had a shiny arsenal of intercontinental ballistic missiles (ICBM) pulled in. With these long-range nuclear weapons the central bankers choose the nuclear option in fighting the coronavirus. Of course, this week the Federal Reserve bank of the United States couldn’t stay behind: away with that dilapidated bazooka, long live the Titan II.
After all, the ECB’s decision last week to step up its buy-back programme was nothing less than a declaration of war on the virus. The Pandemic Emergency Purchase Programme differs from previous support measures in several respects. This time the central bank provides itself with maximum flexibility. The bank is no longer tied to a certain period of time, can purchase various assets of its choice and no longer has to adhere to any distribution key. If one wants to support a specific country (Italy, Greece), one can do so. The ECB states that if self-imposed limits hinder the effectiveness of the policy, the rules about the limits will change. The ECB had already decided earlier to buy 120 billion euro extra. This will be surpassed by the current programme of 750 billion. Together with the current programme, this amounts to a stimulus of some 1,000 billion euros in the course of this year. More importantly, the ECB reserves the right to buy even more if it wishes. Between the lines, even the purchase of securities other than bonds (ETFs) is no longer excluded.
The Fed cannot stay behind
Normally, the U.S. Federal Reserve is always in charge of such actions. They couldn’t stay behind. Certainly not now that the Trump government’s support program is still a while away. The package that the Federal Reserve presented on Monday goes much further than what the central bank did during the credit crisis. The Fed will buy government and mortgage bonds indefinitely until the markets have stabilised. For the first time, it will also buy corporate bonds. Since this is not permitted by law, a shortcut will be followed. Furthermore, various support measures for businesses and households have been announced. But here, too, the term applies as new without limitation.
Modern Monetary Theory
So now the central banks are throwing even heavier guns into battle. There is now unlimited quantitative easing. Where until recently the Modern Monetary Theory (MMT) was still being laughed at under the pressure of the coronavirus, everything now seems liquid. MMT actually states that governments can borrow indefinitely as long as inflation does not rise. And the latter is currently not the case. Thanks also to the historically low oil price.
Of course the central banks can’t fight the virus. That’s up to the medics. But with these unprecedented stimuli, they’re buying time. They enable the economy and business to survive the coming difficult period. As soon as the virus is defeated, economic recovery can begin all the faster. This recovery is not entirely unjustifiably doubted by many economists. After all, the economic damage caused by all the lockdowns will be immense. But the interventions of the central banks, in addition to government support programmes, are also unprecedented.
Unprecedented nuclear option
Already now, reported macro figures show that the economic damage is exceptional, even greater than during the credit crisis. But investors shouldn’t be surprised that the subsequent recovery may also be astonishing. The nuclear option used by central banks is unprecedented. It should be noted, however, that the resources that are currently being deployed are so heavy that the world will soon look different anyway. Just like the deployment of real nuclear weapons. For example, the state’s grip on economic life throughout the world will have increased considerably. And when the dust clouds have risen, the markets are likely to experience enormous withdrawal symptoms as soon as the stimulus has to be withdrawn. But that’s a concern for the time being.