The Implications of 2020’s Bailouts in China and… Pretty Much Everywhere Else?

11
Jul

Right from the very beginning of the COVID-19 situation (before it was even called COVID-19), China made it clear that it will do whatever it takes to bail out companies and, indeed, it has injected vast quantities of capital into the proverbial system to ensure companies stay afloat (especially in light of the fact that while China doesn’t seem to be on an unsustainable path when it comes to public debt and consumer debt, its corporate debt levels are alarming, with China’s corporate debt to GDP value even exceeding that of Japan).

As the crisis spread to other nations, the exact same principle was valid.

In the United States, the Federal Reserve very quickly lowered rates back to zero, ensured that the financial system has more than adequate liquidity (unprecedented repo operations, for example), eliminated reserve requirements and essentially embarked on a journey of Quantitative Easing. Furthermore, in light of the fact that the market was not satisfied with monetary stimulus alone, a lot was done on the fiscal side as well, including yet another record-breaker: $2 trillion in fiscal stimulus, anything from bailing out airline companies to sending the average citizen a $1,200 check.

In the European Union, it is worth noting that as disaster struck, interest rates were already in negative territory but still, the European Central Bank did its best to assure markets that it also plans to be aggressive, with measures including an additional 750 billion EUR in bond purchases. Unfortunately, when it comes to the EU, the fiscal stimulus dimension (and to a lesser extent the monetary one) tend to be trickier in light of the fact that political consensus which is extremely difficult to achieve is required. More often than not, creditor nations such as Germany and the Netherlands are less than eager to contribute to the bailouts that need to take place in debtor nations and as such, just like in the context of the sovereign default fears that took center stage a few years ago, a frustratingly bureaucratic back and forth dance ends up taking place.

But still, even in more complex (in terms of consensus) jurisdictions such as the European Union, nobody dares question the idea that bailouts and unprecedented action are a necessity in light of the fact that, in an effort to combat the COVID-19 spread, drastic containment measures have been implemented, with the end result being that when it comes to a wide range of industries, economic activity essentially ground to a halt.

An important question arises, however: what happens next?

Time and time again, the ChinaFund.com team has made it clear that there is no such thing as an expert who can predict the future and those who claim otherwise are either ignorant or downright charlatans. The best our team or any other team of experts can do is take several steps back and with a cool head, try to assess a wide range of possibilities in a probabilistic manner: instead of trying to determine what WILL happen, the name of the game is trying to figure out what is more LIKELY to happen or, in other words, what the most probable outcome is (with there being no guarantees whatsoever that even highly probable events will unfold).

Right off the bat, we want to make it clear that we are dealing with a deflationary force that can be considered nothing short of crippling. Compared to the economic activity shutdown situation of 2020, the Great Recession seems like a walk in the park and precisely therein lies the problem: the worldwide economy can most definitely not “afford” an extremely severe recession. The Great Recession alone risked crippling the financial system and as such, the authorities in pretty much all jurisdictions do not want to take any chances with the 2020 situation, which risk being quite a bit worse.

Therefore, from bailouts to ultra-dovish monetary policy, all countries are throwing the proverbial kitchen sink at this problem, especially in light of the fact that most economic thinkers with decision-making power tend to lean strongly Keynesian at this point in time. And in terms of prescriptions, Keynesianism makes it rather clear that when economic activity takes a hit, the authorities need to step in so as to create demand.

In our case, this is done by essentially flooding the system with liquidity, to the point of… yes, essentially “printing” the money that is used to bail out companies, help households and generally speaking try to re-ignite the economy. It has been done to combat the Great Recession and inflation has been anything but problematic (on the contrary, it was consistently lower than the authorities had hoped), so what could possibly go wrong?

In our opinion… a lot.

The main difference, this time around, lies in what happens with the money that is “printed” or in other words, whether or not it finds its way to the “real” economy to enough of a degree to generate inflation problems. After the Great Recession, while it is true that trillions were indeed created, a lot of that currency ended up “stuck” as banking system reserves or, at best, found its way to various assets and generated asset price rather than consumer price inflation.

At this point in time, however, “Main Street” demands a much larger piece of the stimulus pie and more likely than not, it’s going to get it. From China to the United States and even European Union, we are and will continue to be dealing with unprecedented injections of liquidity pretty much everywhere: from the banking system to the rest of the financial sector, from ultra-large corporations which will bailed out to households that now demand the same treatment.

As such, much to the surprise of many colleagues who are stuck in a “deflation-only” mindset, the ChinaFund.com team would like to end this article by asking a rhetorical question: does it not make sense, this time around, to dust off our inflation books as well?

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