Decisive Fiscal Action?

Fiscal policymakers have been taking decisive action since the day began in Asia. The moves so far are trend-consistent in that they shore up the economy and financial markets. Such moves are logical amid short-lived crises. But the pivot underway towards normalising co-existence with COVID-19 will require difficult economic choices amid a recovery that most central banks at this stage do not anticipate before 2021. 

The price of stability will be high, as a deep dive into the U.S. budget and the looming conflict between federal and state governments illustrates.

A different kind of normalisation is in view globally across a range of policy issues. Regulators and legislators in Europe are attempting to maintain momentum regarding strategically significant sectors like artificial intelligence and information technology. 

ECB economists continue for the second day in a row to release research that quantifies the extent to which European economic growth is exposed to exogenous shocks. BIS economists coincidentally released a pair of research studies that hammer home the same point by demonstrating the extent to which the global economy depends on the U.S. dollar for stability. 

It's business as usual in the trade arena as well today, with minor skirmishes (mostly involving China) providing insight regarding shifting geopolitical priorities.

I. Decisive Fiscal Action

Governments were handing out cash again today, some for the first time. The moves remain conceptually consistent across borders, with policymakers seeking economic stabilisation often in sectors unique to their cultures.

Canada: The federal government has officially become the lender of last resort for Canada's largest companies. It launched the Large Employer Emergency Financing Facility for companies with annual revenues in excess of C$300MM and "significant operations or workforce in Canada" that seek at least C$60MM in financing. Two state-owned banks (Business Development Bank of Canada and Export Development Canada) will disburse loans and guarantees.

India: Finalised a national economic support package valued at $260bn, which is nearly 10% of GDP.

France: The government authorised EUR140mm in subsidies to distil surplus wine into alcohol. The amount is not large (unions wanted more) but the symbolism is massive. Even more stunning: the federal government granted small and medium sized companies exemptions from paying social security contributions.  

United Kingdom: While the UK has famously begun relaxing its mobility restrictions, the government is making no pretence that the economic situation will ease. Discussions have begun on how the Coronavirus Job Retention Scheme (which covers 25% of the workforce currently) can be extended past the end-June expiration date. Initial discussions are exploring the possibility that the current coverage rate (80% of wages) can decrease (possibly to 60% of wages). 

The clear implication, however, is that significant state funding for salaries will remain necessary through the summer. The sheer scale and multi-month (if not multi-year) duration of the pandemic-related economic crisis will require more than just emergency measures. The United State is just starting to grapple with these issues.

The most significant member of the fiscal fire brigade today, was the United States.

First the Federal Reserve Bank of New York today commenced open market purchases of Exchange-Traded Funds (ETFs) under the Primary and Secondary Corporate Credit Facility created by the CARES Act last month. The move simultaneously generates financial stability while providing support to publicly listed companies in the United States.

Second, Congressional Democrats finally unveiled their pandemic relief package. Votes are promised on Friday. Few in Washington expect the package to become law in its current form. 

The issue is not so much the eye-popping $3 trillion size. Some components will not likely generate much controversy except to haggle over the allocation size. In particular, the proposed $1.5bn for broadband infrastructure spending will be seen by many on both sides of the aisle as too small to support large-scale distance learning. Few will complain about adding funds for the Paycheck Protection Program, but some may seek more than $10bn. Few will dispute the wisdom of spending $3.6bn to create secure remote voting options for the November election.

Partisan and ideological wrangling will likely focus on the proposed $75bn in housing assistance. The proposed bill would provide direct subsidies to cover not only rent and mortgages but also: property taxes, property insurance, utilities, and 'other housing-related costs.' Moreover, those federal subsidies would be dispensed through state and local governments. 

Real, substantive debate can be expected on the classic federal/state division of labor. Battle lines are already being drawn. 

--New York Governor Cuomo already has indicated that he needs $61bn in order to avoid having to make budget cuts.

--Treasury Secretary Mnuchin has already indicated that states should use the facilities created by the CARES Act last month to borrow from the Federal Reserve. 

Left unsaid for the moment is whether (or not) even the United States can afford to implement seemingly unlimited fiscal support structures for an indefinite period of time. 

The amounts being discussed are staggering. Last week's Treasury announcement of $3 trillion in bonds being offered to the market have been countered with today's $3 trillion spending bill.

It is worthwhile to take a close look at the economic data before assessing the spending priorities articulated in what many are already referring to as "CARES 2."

Tax receipts were down -55% y/y in April. This reflects the extension until July for personal income tax payments. Even if tax receipts surge in July and August (after the extension has expired), the projected budget deficit for fiscal year 2020 is expected to be $1.48 trillion. The debt-to-GDP ratio will exceed 100%.

The challenge is that the vast majority of the U.S. budget consists of non-discretionary spending. The chart on the left illustrates not only the sharp increase in federal spending in response to the pandemic; it also illustrates the composition of that spending...and by implication how much of it is not discretionary.

Budget cuts may become inevitable at the federal as well as state levels.

This is not a discussion that policymakers or voters want to have right now. 

Democratic leadership in Congress compromised with Republicans and the Administration during the first phases of the pandemic. They promised their left flank that the spring spending bill would provide an opportunity to drive home their vision of a government-centred framework for redistributing income. With working class labourers from farms, grocery stores, meat packing plants, couriers, and gas stations increasingly being viewed on the "front lines" of the pandemic, the politics could quickly become more toxic.

II. Trade Skirmishes

Tariffs and trade agreements as levers of statecraft were on display today among the Pacific powers. 

In order to punish Australia for insisting publicly and loudly on an international investigation regarding the origins of the Wuhan virus, China is preparing to impose an 80% tariff on imports of Australian barley. The move will generate pain; Australia exports 50% of its barley ($1.3bn) to China. China is also likely to ban beef imports from 4 Australian companies. While the amount is not economically significant (only 20% of Australian beef exports), the point is to send a message.

The United States has been the loudest and least diplomatic voice regarding the COVID19 virus. Yet China is not seeking retribution (yet). Instead, officials leaked to Reuters that China's commitment to the Phase I trade deal is solid. Possibly to signal good faith, China made it possible for 79 US-made products to be eligible for waivers from the 2019 round of retaliatory tariffs.

The move must frustrate EU Commission vice President Sefcovic who today was publicly pressing China to increase market access for EU firms.

III. Tech Policy

Legislators in Brussels and London are trying hard to address next-generation policy issues amid the pandemic. Relatively quiet moves now, while the focus is on other issues, will make it possible to take quick action later. Consider:

UK: The House of Commons will hold a hearing on how increased reliance on social media and other electronic media increase vulnerability to disinformation and provide opportunities for online criminality.

European Parliament: MEPs today debated multiple reports exploring how best to regulate artificial intelligence, how to apportion legal liability for mistakes made by AI systems, and how to allocate intellectual property ownership in situations where creativity has been automated.

IV. More European Vulnerabilities

Yesterday's ECB economic research provided plenty of painful details regarding vulnerabilities in the European economy. In particular, the research noted that high reliance on dollar-based invoicing together with a high import consumption rate decreases the effectiveness of the ECB's monetary policy.

Today's economic studies deepen the analysis by investigating how vulnerable EuroArea growth rates might be to external shocks. The answer turns out to be both good news and bad news. In this context, a good news outcome would be one in which internal European growth rates were a function of internal activities rather than international spillovers.

The ECB research indicates that up to the first half of 2018 and then again between January 2019 - February 2020, growth rates measured through purchasing manager index (PMI) data were "due to foreign developments."

The six month period in between generated growth dynamics from internal sources (the good news) but the dynamics were negative (the bad news). Specifically, "53% of the decline in manufacturing activity in 2018 is attributable to domestic factors." Those factors were associated with the shift towards more stringent environmental standards across Europe.

BIS research today added to the challenges by analysing dollar funding pressures in March and April of this year. 'While they conclude that central banks succeeded in safeguarding financial stability, they also note that the extreme pressure "was a reminder of global banks' reliance on short-term unsecured funding in U.S. money markets." This will not be a surprise to European banks servicing corporate customers that invoice in USD.' The sobering implication, however, is that financial stability was purchased by providing nearly limitless Federal Reserve liquidity.