Money on the Sidelines: The Implications of Indecisiveness in China and the West


2020’s realities, from an economic perspective, seem peculiar to say the least in light of the many powerful contradictory forces that are influencing human activity at the same time. In the spotlight, we have the COVID-19 (of course) implications which are heavily deflationary. Contrary to what happened with the Great Recession, where a financial crisis (toxic derivatives, especially Mortgage-Backed Securities) led to an economic crisis, it has been the other way around: the COVID-19 pandemic led to unprecedented (in terms of scale) containment measures, which led to the economy essentially grinding to a halt and the various implications thereof, anything from bankruptcies to (technical) unemployment.

A textbook deflationary scenario, correct?

In theory or if you will on the surface, yes.

Practically speaking, however, we need to take a major step back and look at the broader picture. More specifically, at the fact that the economic crisis came in a context where interest rates had been very low for an extended period of time (even negative in the European Union and Japan) and credit very easy to come by. This, among other things, also led to asset price inflation with respect to anything from stocks to real estate.

It also lead to other let us call them unintended consequences: a lot of capital on the sidelines.

Think of this as observation number one.

As far as observation number two is concerned, we fast-forward to 2020 and take a look at the various measures which have been implemented all over the world by governments as well as central banks, from China to the United states and from the European Union to Japan: stimulus, stimulus and more stimulus. From lowering already-low interest rates to flooding the financial system with liquidity and even sending checks to the average citizen (the Universal Basic Income concept in its infancy, if you will).

Those who had been preparing for another financial calamity “suspected” that when another financial crisis would manifest itself, central banks would resort to… well, more of the same, lowering interest rates on the one hand and providing liquidity on the other. The same way, fiscal stimulus measures were included in the equation but for the most part, the average observer expected central banks to remain in the spotlight. In the opinion of the team, however, it is fairly safe to state that not even the most pessimistic “bears” would have expected a response of 2020’s magnitude to come so quickly.

Instead, many would have expected debates upon debates among decision makers, with right-leaning ones stating that perhaps the government and central bank shouldn’t intervene very aggressively, whereas left-leaning ones would demand status quo Keynesian action. Strangely enough, that didn’t happen, with the United States representing a textbook example to that effect. A United States run by none other than the Donald Trump REPUBLICAN administration, most definitely a right-leaning one. However, instead of manifesting skepticism and giving let’s say credit to the free market, Donald Trump did the exact opposite by encouraging significant stimulus on the government as well as central bank side, to the point of even criticizing Federal Reserve Chairman Jerome Powell for not being aggressive enough at the very beginning, with Trump clearly stating that he expected the United States to “lead” (to use his exact expression) rather than follow by “out-stimulating” its competitors.

The same principle was valid in other jurisdictions and as such, fear compelled pretty much everyone to agree that an aggressive combination between monetary and fiscal stimulus (because early on, by crashing after “central banking only” responses, the market made it clear that this time around, it demands extremely strong fiscal stimulus as well aside from more aggressive monetary stimulus) is the way to go.

Libertarians agreed with Keynesians. Fiscally conservative Germans agreed with their more lenient French counterparts, the list could go on and on but this much is certain: among mainstream economists and politicians at least, it seemed that nobody dares question the fact that being aggressive is the only option.

We will now take a step back and look at our two observations: the fact that there was already quite a bit of money on the sidelines to begin with (observation one) on the one hand and the fact that unprecedentedly aggressive monetary as well as fiscal stimulus is being prescribed (observation two) on the other.

Needless to say, what was first described as a textbook deflationary scenario now seems… well, anything but. For this reason if nothing else, the “money on the sidelines” argument, it would perhaps be wise not to rush into comparisons to the Great Depression, simply because market and political conditions differ dramatically: from President Hoover who listened to his advisors and let the free market sort itself out in the aftermath of 1929 (a decision that proved to be less than ideal in hindsight) to today’s politicians, who are doing the exact opposite.

In light of the fact that Hoover’s decision has proven to be less than ideal and that today’s political decision-makers are doing the exact opposite, can or should we conclude that everything will be “fixed” properly this time around? Of course not because as we have mentioned repeatedly to the point of obsessively on, nobody can predict the future and time will ultimately tell. Therefore, no, it would be hazardous to jump to quick conclusions with respect to the glorious new paradigm of central banking and fiscal stimulus we will find ourselves in, it remains to be seen if the results will be positive or negative in the mid to long-term. What we can be close to certain of, however, is that developments will most likely be DIFFERENT this time around and as such, resorting to simplistic comparisons with the Great Depression might not be the best idea in the world. Instead, it would be wise to keep your ear even closer to the ground than usual so as to be quick to adapt to events, as they unfold. As always, the team will gladly be of assistance with just that and is only a quick message or email away.

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