No chimneys!

On 16 April, the Governing Council of the ECB sang the following tune from the rooftops in Brussels:

“The Governing Council is committed to doing everything necessary within its mandate to help the euro area through this crisis. It is fully prepared to increase the size of its asset purchase programmes and adjust their composition, by as much as necessary and for as long as needed. It will explore all options and all contingencies to support the economy through this shock.”

ECB president Christine Lagarde recently clarified this by saying the ECB will continue to stimulate credit in the secondary market by buying bonds (predominantly sovereign bonds) but that chimney money (i.e., direct financing helicopter money) would not fly.

In other words, no bypassing of the bond market and direct ECB lending to Brussels.

On the other hand, Lagarde’s predecessor Mario Draghi would be going to the chimneys.

In the past, he argued strongly for a fiscal instrument to take the weight off monetary policy. That fell on death ears. So he is now suggesting loans should be made to companies and then ripped up. This would constitute a liability to the central bank without a corresponding asset – effectively the same as chimney money.

The ECB’s asset purchase program applies to public and private debt, so it’s not as though a debt forgiveness could not happen in the future.

Meanwhile in Japan, the Bank of Japan recently promised to buy an unlimited quantity of bonds. Effectively, a put option from Governor Kuroda.

Kuroda has joined the ECB and the U.S. Fed in a coordinated global monetisation of COVID-19 - lenders and investors of last resort.

And, equities continue their dance.

It is still possible that like the Bank of England, these centrals may be asked to stock the chimneys before this is all over.

$10 trillion plus.

So far, politicians and key central bankers over the past 5 weeks have set up or have put guarantees in place to support ~$10 trillion to keep the lights on until COVID-19 has been blown away.

But many questions arise.

1. Once the virus lock-downs are over perhaps in the second half of the year, what flationary effect will the $10 trillion tsunami have on the real economy?

2. Once the machine starts to fire up again, how will governments and centrals wind back stimulus to avoid a slingshot of inflation?

3. Of the new loans that require servicing and repayment, will there be sufficient sovereign GDP and corporate earnings earnings to repay it? Or will governments end up tearing up debt and owning a portfolio of struggling businesses on care and maintenance? Mega deficits?

4. How bad will it get for banks – some profit downgrades and dividend rollbacks, or a race for tier 1 capital?

These questions will remain unanswered for some time, but in the meantime we are seeing emergency equity raising and a clear trend into gold and digital assets, albeit with S&P500 option volatility down and strong equities sessions across the northern hemisphere last night (despite oil still playing out).

Tuppence a bag, new debt is unproductive.

The productivity of QE Infinity in creating new GDP has diminished by around 25%.

As I’ve previously written, the circa $70 trillion in new debt created between the GFC and April last year produced $14 trillion in incremental annual GDP over that period. In other words, only around 20c in the incremental debt dollar was productive. The rest is somehow caught in a blocked chimney, probably parked with central banks, stuck in the external banking system or lost in unproductive government spending, corporate defaults, forgiveness, buybacks and other items.

However, if we add the recent $10 trillion of estimated debt to be pumped into the global debt lakes, this makes $80 trillion of leverage since the time of Lehman. And, if as predicted by the IMF, GDP falls by 3% this year, incremental growth in GDP since the GFC would decrease to somewhere around the $12 trillion level.

In turn this means only 15c in every incremental debt dollar since the GFC would go to productivity. So whilst necessary to keep people and the world ticking over, we may see a 25% decrease in debt productivity.

That’s why QE Infinity is not a sustainable solution.

Stay tuned.

Mike.

NextLevelCorporate is a leading financial & strategic corporate advisory firm with a multi-decade track record that speaks for itself. Helping clients in all industries to prepare for, respond to and deliver transformative corporate finance strategies and transactions in and out of Australia, is our passion.

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