Here at ChinaFund.com, we like to keep our thoughts and website organized so as to deliver the best possible results and in the spirit of just that, it makes sense to start with a bit of an inventory of (quasi-axioms) before proceeding with today’s article, one through which we will try to identify the limits of monetary stimulus (not just in China but elsewhere as well) in a post-pandemic context:
- From China to the West, economic systems are not able to withstand a “real” recession, we are simply in a far too over-leveraged environment for the idea that “the market will reach an equilibrium state” to be consistent with the goal of the system in its current form surviving. To put it differently, the market may very well be able to sort itself out but should that be allowed to happen, it would be overly-optimistic at best and naïve at worst to assume the economic system status quo can be preserved
- The entire world seems to be determined to avoid systemic disruption scenarios and as such, countries left and right are embarking on ultra-aggressive stimulus journeys. In a previous article, one meant to tackle the question of whether or not China is hopping on this trend, we have made it clear that not only is China more than willing to hop on, a compelling case could be made that as far as the post-pandemic stimulus trend is concerned, China may have very well been the initiator
- Compared to the Great Recession where central banks were in the spotlight and central bankers ended up being considered heroes by those who believe the day was saved (much less so by those who state that the can was simply kicked down the road in an unsustainable manner), the market has made it clear that this time around, it expects a symmetrical reaction from governments as well… monetary stimulus correlated with equally aggressive fiscal stimulus, in other words
The third quasi-axiomatic statement warrants further attention, in our view.
First and foremost, why do we consider it quasi-axiomatic?
In our view, it would be pointless to waste additional time explaining our reasoning in light of the fact that the statement in question has already been validated empirically. To put it differently, central banks have once again stepped to and have tried to grab the market’s attention through swift and aggressive monetary policy. In the Federal Reserve’s case (even if this came after a very persistent push from Donald Trump), this action consisted of suddenly cutting interest rates by 50 basis points, followed by an equally swift additional cut which took rates back to zero. Furthermore, record-breaking liquidity was provided by the Fed, anything from unprecedented repo market action to unlimited quantitative easing and the elimination of reserve requirements.
Needless to say, few experts would have been able to predict this level of aggressiveness. On the contrary, let us not forget that in 2019, the Federal Reserve had embarked on a monetary tightening course and those who “dared” assume that zero-bound rates and additional QE would be on the table so soon have oftentimes been ridiculed. Furthermore, it was expected that eventually, other central banks would be forced to follow suit.
The exact opposite happened.
And the elephant in the room is represented by precisely the so-called tightening that took place and especially the magnitude of it. The idea that central banks lower rates in certain scenarios is hardly new. After the Dot-Com bubble for example, Alan Greenspan lowered them from 6.5% all the way down to 1% but by the time the Great Recession hit, at least they climbed back up… not to 6.5% again zone but to the 5% one, a reasonable enough development. In the aftermath of the Great Recession, the market demanded more action and as such, interest rates were lowered all the way to zero in the US and even went negative in other jurisdictions. Furthermore, while they did eventually climb back up, this happened only very timidly so, with the 2020 situation finding them nowhere near the 5% level they were at prior to the Great Recession.
When analyzing the European Union and Japan, with their negative interest rates, the situation seems even more dire and it does not take a monetary policy expert to understand that under current circumstances, a compelling case can be made that central banks aren’t in a splendid situation in terms of ammunition.
Can interest rates go slightly negative in the United States?
Can they go even further into negative territory in the European Union and Japan?
But, realistically speaking… just how low can they go?
In theory, there is nothing in terms of bureaucratic framework stopping the let’s say Federal Reserve from lowering interest rates all the way down to 99% but that would be pointless in light of the fact that literally nobody would remain willing to keep money in the banking system and as such, it would immediately implode.
In other words, the average individual would most definitely not tolerate that aggressive of a rate reduction, we believe it is fair enough to consider this statement once again quasi-axiomatic.
Would they tolerate -70%?
The list could go on and on but upon realistic reflection, it becomes rather obvious that the “bare minimum” in terms of what the average citizen would tolerate in terms of negative interest rates is a lot closer to today’s realities than to double-digit ones. For this reason if nothing else, we have no choice but to acknowledge that in 2020 and beyond, the limits in terms of how low central banks can go will become apparent. As a conclusion, it should therefore be expected that this time around, the burden of taking decisive (to the point of unprecedented) action is very likely to be placed on governments, with the fiscal stimulus dimension being in the spotlight to a much greater degree than in the Great Recession days.